Corporate governance is a set of rules, practices, processes, and regulations which specify how companies should operate. It is the system through which companies are directed and controlled in the interests of shareholders and other stakeholders. Usually, this direction and control come from the company’s management. However, there are some external factors that may influence it as well.
Corporate governance became prevalent due to various controversies that came forward from unethical practices. Therefore, it helps companies by providing them with a framework for best practices. These practices illustrate how companies should operate to achieve their objectives. It also promotes transparency within a company and provides security for a company’s stakeholders.
One of the areas that corporate governance defines is the addition of committees to companies. These committees are a part of a company’s board of directors. Similarly, they may include both executive and non-executive directors. One of these committees includes the audit committee.
What is an Audit Committee?
An audit committee is a type of committee introduced by corporate governance. This committee is responsible for handling a company’s financial reporting and disclosure process. It also entails managing the company’s internal controls that overlook this process. In some cases, the audit committee may also be responsible for managing a company’s risks.
In public companies, an audit committee constitutes the primary body responsible for overlooking financial reporting and disclosures. The requirement for having an audit committee differs according to various jurisdictions. However, most jurisdictions require publicly-listed companies to have an audit committee.
How Does an Audit Committee work?
For most companies, having an audit committee fulfills two requirements. The first requirement comes from every company’s role in establishing a system of corporate governance. The next one stems from the responsibility for companies to have a committee overlook their financial matters. It also includes internal controls systems, risk management systems, etc.
The jurisdiction in which a company operates dictates the composition of its audit committee. In the USA, every publicly-listed company must have an audit committee. This committee must only include independent outside directors. At least one of those directors must have a background in finance or be a financial expert.
For most other jurisdictions, the requirement to have financial experts on the committee remains the same. However, the composition may differ. Some international best practice standards may also provide guidance on its structure. For example, the Institute of Internal Auditors recommends that audit committees have between three to six members.
What Are the Roles of the Audit Committee?
There are several roles that an audit committee must fulfill in any company. Primarily, the audit committee is responsible for overlooking a company’s financial matters. However, there are also various other roles that the committee must satisfy. Some of the primary roles that an audit committee is responsible for include the following.
Overlooking Financial Reporting and Disclosures
Audit committees are responsible for reviewing a company’s financial statements regularly. However, their responsibility does not limit them to reviewing only. They also determine the estimates and judgments used by the management in preparing the financial statements. If there are any accounting principles changes, the audit committee is also responsible for evaluating that.
The audit committee also has the right to conduct investigations if it finds any anomalies in the financial statements. However, they usually employ external parties to do so.
Liaising with External Auditors
One of the other primary tasks that are a part of the roles of an audit committee is acting as a liaison with external auditors. The audit committee is responsible for approving the selection of an external auditor for a company. Similarly, during the external auditor’s work, the audit committee is responsible for ensuring the auditor’s independence. The committee also oversees their work.
Ensuring Compliance
The audit committee is also responsible for ensuring the company complies with all required regulations. The committee is also responsible for managing any risks associated with any lapses in compliance. Similarly, the audit committee also takes part in overseeing any ongoing litigations and managing the risks.
Overseeing Internal Controls
Another area of significant concern for an audit committee is internal controls. The audit committee is responsible for overseeing a company’s internal control systems for effectiveness and efficiency. For companies that have an internal auditing function, the audit committee is also responsible for managing it.
Managing Risk
Some companies establish a risk committee that identifies and mitigates its risks. However, some others may lack such a function. In that case, the audit committee will overtake all the responsibilities. Therefore, the audit committee also plays a role in identifying and managing a company’s risks. It also coincides with the committee’s role in ensuring compliance.
Conclusion
Corporate governance defines a set of rules, practices, processes, and regulations that specify how companies should be directed and controlled. It also describes various committees that companies should have, one of which is the audit committee. The role of the audit committee is to oversee a company’s financial reporting and disclosures process. However, it may also perform other tasks, as mentioned above.
