This article is written by Indra Priyadarshini, a student of Alliance University, Bangalore. This article discusses the role and significance of audit committees in India.
The main purpose of establishing good corporate governance is to bring about a more transparent and accountable system. As the number of corporate scandals is increasing in both India and other countries around the world, corporate governance is emerging rapidly in order to improve the financial scenario by acquiring the confidence and trust of investors. In this regard, Audit Committees are significant as they provide a mechanism to ensure reliability on financial statements.
The Audit Committee facilitates the independence of an audit process. The process of auditing the operations of a corporation is quite complex. It requires a proper understanding of the rules and judgments taken by the management while preparing financial statements. Section 177 of the Companies Act, 2013 and Rule 6 and 7 of Companies (Meetings of Board and its Powers) Rules, 2014 deals with the Audit Committee. It acts as a channel for the flow of information from the management to the auditors. It also helps in reducing the pressures of management on an auditor. Thus, it is essential that the audit committees are independent of the management. These committees have the responsibility of deciding the work or scope, fixing the audit fees, and determining the extent of non-audit services.
Functions and Powers of Audit Committee
The following are the functions of an audit committee:
- It has to supervise various activities of the management like the management of credit, liquidity, and market along with legal and other risks of the corporation.
- The committee has to aid the Board in the implementation of its oversight obligation relating to review procedure, arrangement of inside control, and inspecting the consistency with other laws and principles.
- It has to set up an internal audit function and appoint an independent internal auditor along with the terms of the commitment and dismissal.
- It has to evaluate and check whether the annual internal audit plan is in accordance to the corporation’s objectives.
- It has to observe and review the sufficiency and adequacy of the internal control framework of the corporation.
- The committee has to evaluate the reports made by the internal and external auditors as well as the quarterly, half-year, and annual financial statements.
- Review and fix the non-audit work, if any, of the external auditor and evaluate non-audit fees paid to the external auditor in connection to its significance to the total annual income of the external auditor as well as the corporation’s general consultancy costs. The committee should prevent any non-audit work that will conflict with the obligations of the external auditor or may risk his independence. All the permitted non-audit work has to be reported in the yearly report.
- Finally, the committee must also decide the reporting line of the Internal Auditor in order for him to carry on his duties and obligations. He will practically report to the Audit Committee. The Audit Committee has to make sure that in the execution of the work of the Internal Auditor, he shall be free from any obstruction by outside parties.
The following are the powers of the audit committees:
- The audit committee has the authority to call for the comments of the auditors about internal control systems, the scope of the audit, and the evaluation of financial statements before their submission to the Board.
- It can examine any issues regarding the internal and statutory auditors and the management of the corporation.
- The committee can inspect any matter related to the items referred to it by the Board.
- It can receive professional advice from external sources.
- Finally, the audit committee can have access to all the information available in the records of the corporation.
Importance of Audit Committee
The audit committee plays a crucial role in any corporation. It contributes to the regulation and enhancement of financial practices and detailing. The committee often hold discussions with the Chief Executive Officer and financial officers to audit and ensure the viability of hierarchical controls and outer financial reporting. They regularly work along with the finance committee. The committee provides productive anti-fraud programs. The audit committee is more experienced in various fields like management, finance, legal and operational issues. Thus, they can ensure a more proactive job working along with the NFP’s leadership team and auditors in making and reviewing an organization-wide fraud prevention and recognition program and ensure that proper investigations take place in case any fraud is revealed. The committee can also provide support to the organization’s leadership team in establishing extensive morals and consistent programs. The audit committee plays a proactive role in the review process of both programs.
The audit committee helps to improve the internal audit function. The general respectability of the internal audit function increases when the organizational structure allows the internal audit team to reveal specifically to the audit committee. Under such organizational structure, the internal audit team can assist the audit committee in matters relating to the organization’s capability to fulfil its financial and consistence obligations and ensure that the organization changes its practices and internal controls as and when needed. The external audit of an organisation is directed by the audit committee. The audit committee, along with the external auditors, screen their administrations and activities to ensure that autonomy is persisting between the external auditor and the organization’s management team. The committee also discusses their independent perceptions on management’s capacity with the external auditors in order to maintain the strong internal controls, financial reporting and proper business practices.
The audit committee has another important function, which is to re-establish reliability with the stakeholders. An NFP’s reputation is its most significant resource. The committee showcases an image of independence, credibility and trust. Therefore, it builds the confidence among present and potential constituents, contributors, creditors, and other stakeholders. NFPs and their audit committees can maintain and further expand on this positive image by showing the role and composition of the committee, achieving transparency in financial disclosures, and communicating the organization’s compliance and ethics policy.
The Audit Committee has a very significant role to play in a corporation. Thus, it is necessary to improve its working and efficiency through the enactment of a proper and comprehensive code of conduct and other rules and regulations. The minimum financial qualification and functional experience recommended for eligibility to be an audit committee member should be increased from having merely a comprehensive set of knowledge about financial statements, where only the Chairman is required to be an expert in the committee. A minimum of six audit committee meetings should be held in a year, out of which two meetings must be for the purpose of reviewing the control environment and risk management related matters thoroughly. There must be a proper method established to keep a check on the maximum number of audit committees a person can be a member of. The audit committee meetings must be held at least one day prior to the board meeting, so that there is sufficient time to deliberate and discuss the major issues. The appointment of the audit committee should be done through a properly established selection procedure and should not be done by the chairman, board or promoters. The tenure of the audit committee members should be specifically defined, and a transparent succession planning process must be established. The appointment of internal auditors and their reporting should be done by and to the audit committee. These are few ways through which the efficiency of the Audit Committee can be increased for better management of companies.
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