The audit committee: What is it and what is its role?
Boards rely on the audit committee to offer effective oversight of the annual auditing process, making it one of the cornerstones for effective corporate governance. Members of the audit committee do their best quality work when members are independent and objective. Regardless of their experience, nearly all audit committees have room to improve the financial reporting process. Effective audit committee oversight is vital for protecting investors and the health of the capital markets.
Audit committees also oversee the system of internal controls and ensure that the company complies with laws and regulations. Audit committee oversight extends to IT security and operational matters, including audit management software. Certified public accountants report directly to the committee, as opposed to reporting to management. The role of the audit committee includes such responsibilities as appointing and overseeing the work of the auditor and managing the auditor’s compensation.
Here, you'll discover the following topics:
- What is an audit committee?
- Who makes up the audit committee
- Audit committee responsibilities
- How chief audit executives can support the audit committee
What Is the Audit Committee?
The audit committee is responsible for helping independent auditors oversee the corporation’s financial reporting system in a process independent of management. They achieve this in the following ways:
- Providing vital oversight of the corporation’s financial reporting processes, internal controls and independent auditors
- Serving as a check and balance over the company’s financial reporting practices
- Granting a forum for discussing financial concerns candidly and objectively
An audit committee is appointed by the board and is composed of between three and seven board directors who aren’t part of the corporation’s management.
Who Should Be a Member of the Audit Committee?
Audit committees should have at least one individual on the committee who is considered a financial expert. The audit committee chair should be a certified public accountant (CPA) or otherwise considered a financial expert; however, it’s not necessary for all members of the committee to be financial professionals.
For companies operating under the Sarbanes-Oxley Act, the Act requires corporations to appoint only independent members to the audit committee. The Act also requires companies to disclose whether they have appointed at least one financial expert to the audit committee. Best practices also provide guidance for the composition of audit committees. Boards should appoint at least one member who has recent and relevant financial experience.
Benefits of Independent Members
Regulations often require organizations to have an audit committee that can act independently. But having a committee independent from management also allows the committee to more freely express opinions and act in the best interest of shareholders.
Responsibilities of the Audit Committee
While the audit committee is responsible for performing the audit, they are also responsible for other essential tasks relative to the audit and the corporation’s internal control system. Audit committee responsibilities encompass many oversight responsibilities, including fraud prevention, ethics and compliance, oversight of the independent auditor and involvement with external communications. Additional functions of an audit committee include:
- Risk Oversight: The audit committee ensures that the company’s risk management plan is well-defined and effective. Management should discuss the company’s policies and guidelines that govern risk management. Both parties should be knowledgeable about major financial risk exposures and the steps managers should take to monitor and control risks.
- Ethics and Compliance: This is an important function of the audit committee because it requires members to address allegations or violations of the code of ethics promptly and consistently. Audit committees must protect individuals who come forth with reports of questionable behavior by employees. The company must have a fair process for addressing violations of ethics or compliance, which should include regular compliance audits.
- Oversight of the Independent Auditor: An essential part of the audit committee's duties is to be responsible for appointing, compensating and overseeing the duties of the independent auditor. This responsibility extends to resolving any disagreements with management. Audit committee members should meet with the independent auditor at least quarterly.
- Oversight of Internal Audit: Audit committee members’ roles require them to oversee and make suggestions for improving the company’s internal operations and processes. Proper oversight of the internal audit requires companies to enlist the help of independent internal auditors to ensure the integrity and transparency of the processes.
- Facilitate External Audit: During the annual audit, the audit committee meets separately with external auditors to examine matters that need to be discussed privately. It’s important for audit committees to work toward preventing fraud. Auditors with forensic audit expertise are adept at detecting willful accounting errors and anomalies. Because of their unique relationship with external auditors and the importance of their duties, audit committees must have authority over their budgets and for managing external auditors.
- Manage Financial Reporting and Controls: The role of the audit committee requires them to be familiar with the processes and controls for financial reporting and internal controls. This requires working with members of management, independent auditors and internal auditors to acquire adequate knowledge about the company’s financial reporting and internal controls. The committee uses this information to determine whether the company’s financial reporting processes are designed and operating effectively.
- Understand NASDAQ and NYSEU Requirements: Audit committee responsibilities require committee members to know and understand NYSE and NASDAQ auditing requirements. Regulations require audit committees to review any significant changes in accounting principles and the adequacy of internal controls. Audit committee functions include reviewing the company’s response to material control deficiencies and reviewing the effects of alternative GAAP methods with management. NASDAQ requires audit committees to disclose the audit committee’s purpose as stated in its charter.
- Review of Filings and Earnings Releases: Financial analysts, ratings agencies and other financial experts rely on audit committees to oversee earnings releases, SEC filings containing financial information and other financial reports to ensure they’re transparent and fair. Audit committee teams are also responsible for working with legal teams to ensure that disclosures are accurate and complete and include reporting on financial trends
- Provide Recommendations to Management: The audit committee should allow management adequate time to review and comment on the audit committee’s annual audit findings. An important function of an audit committee is to provide management with an audit committee report and final management letter that offers recommendations on how to comply with best practices for financial reporting and internal controls.
Audit committee members are responsible for performing a wide variety of duties, working closely with a wide variety of stakeholders. Financial regulations are also evolving, especially during these volatile economic times. Audit committees should stay current with financial trends, global risk reports, and new or evolving legal or regulatory requirements. This is all to ensure that the company has sound financial reporting practices and robust internal controls.
The Audit Committee's Role in Corporate Governance
The audit committee plays a vital role in corporate governance because they hold the board and the organization accountable in almost every area, from internal and external audits to financial and risk management. The audit committee and management must maintain the internal controls and governance that ensure that the financial reporting process is accurate and effective.
Before the audit committee begins its work, committee members must understand how management develops and reports internal financial information. Having a good understanding of audit reports ensures that audit committee members will know the potential impact of financial statements and how they interact with compliance and risk management. All audit committee members must also be up to speed on recent professional and regulatory changes and announcements to maintain the appropriate controls throughout the audit process.
How Chief Audit Executives Can Support Today’s Audit Committees
Audit committees are responsible for so much more than annual reports. The varied role of the audit committee requires them to address a wide range of challenges, from diversity, equity and inclusion to access to talent and supporting the overall good governance of organization. Their ongoing activities can strengthen compliance and bolster good governance, but only with the support from effective chief audit executives (CAE).
CAEs champion internal audits for management and the board, creating a culture that encourages internal audits to lead with strategic insights. Proactively identifying risks is a good start, but modern internal audit teams also need to have a true partner to the Chief Audit Executive to embrace challenges and strengthen the organization’s competitive edge.
Read more about the five ways CAEs can keep pace with their internal audit teams.