Definition:
An audit committee is a group of non-executive directors set up by and work under the supervision of the board of directors of an entity.
This committee is sometimes set up as the requirement of law, and regulation of the country or jurisdiction where the entity operating in, and sometimes is set up as adoption of best practices of good corporate governance.
The member of the audit committee generally comes from a much different variety of experiences, background, and industry, but it must at least has one member who has expertise in finance.
Another approach to explaining about audit committee, I think, would be starting from the structure of the board of directors.
Normally, the board of directors has different sub-committees set by the board for different objectives and specializations. And, one of those committees is the audit committee.
Now, you understand the principle of the audit committee, and after completing this article, you will be able to:
- Fully understand what the audit committee is and why it is important for an entity.
- The main requirement of this committee
- Role and responsibilities of the audit committee
- The main advantages and disadvantages
- Remuneration and nomination of the audit committee
Now let’s start with the main requirement of the audit committee and why this committee is so important for the success of the entity.
Related book: Audit Committee Hand-Book for a member of the audit committee or for an executive officer who works in the audit department or finance department.
Audit committee requirements:
The audit committee is a combination of non-executive and independent directors working independently from all operation and operating activities of the entity. The first major requirement of the member to become a member of the audit committee is independence.
Independence here refers to both independence from operation and independence from any kind of interest involved with the company. This is very important.
As required by UK good corporate governance, member of the audit committee need to be independent, and one of them need to be a financial expert.
Member of the audit committee must have full-time experience as a company employee for the past three years.
This is to ensure that the member has enough experience and abilities to provide the right advice and control the expert team in the right direction.
Members of the committee are not allowed to be major customers and suppliers of the entity. This is to ensure that the conflict of interest level is minimized to the lowest level as small as possible.
Having large transactions for both being the large suppliers and customers for; example, the entity interest might be lost as the result of bias or maybe potential fraud.
Role and Responsibilities of the audit committee
- Report to the board of directors
- Oversight of the quality of the internal audit department
- Question CFO on the audit finding found by the internal audit department
- Advice to the board for any problem related to audit internal control, and risks
- Oversight the quality of external audit quality and independence
- Work as the coordinator between the finance department and external audit if there is a conflict of interest.
Advantages of the Audit Committee
Well, there are many advantages to the entity from the audit committee. I think the first benefit is compliance with law and regulation.
As we said above, in some countries, laws or regulations are required the entity that operates in the country to set up an audit committee to oversee certain areas like internal audit, external audit, compliance, and internal control of the entity.
Having the committee, the board will have very good and expert people to advise and support improved financial reporting. From the good governance perspective, having an audit committee to oversee the audit and internal control of the entity is highly recommended.
Disadvantages of Audit Committee
The first disadvantage of having the audit committee is incurring high costs to the entity.
Most of the audit committee members are senior people and no matter what kind of method we use to provide the benefit to them, it is still expensive.
Most of the best-recommended practices are to provide the remuneration by hours they contribute to the entity, like the number of hours or the time they join the meeting.
Another disadvantage related to the audit committee is an independence problem. The audit committee is required to work independently. Still, some are the key people who could be the entity’s suppliers or customers, and somehow it can affect their decision-making.
Can the CFO be a member of the audit committee?
No, a member of the audit committee should not be the company’s CFO. However, it is recommended from the best practice, and sometimes it is required by the local law to have at least a member of the audit committee, who has practical financial expertise.
Is the audit committee mandatory?
Having an audit committee set up and reporting to the board is not mandatory for every company. It is depending on the law of the country in which the company operates.
In general, the company that is required to have an audit committee includes a listed company or company that is intended to list on the stock exchange as well as a public interest entity is required to have an audit committee.
