Empowering Corporate Governance: The Vital Role of Audit Committees

By Bharti Verma

Published on: October 20, 2023 at 15:36 IST

Corporate governance refers to the system of rules, practices, and processes by which a company is directed and controlled. It involves a set of mechanisms, both internal and external, that aim to ensure that a company operates in an ethical, transparent, and accountable manner, while also creating value for its shareholders and stakeholders.

An audit committee is a vital component of an organization’s corporate governance structure. It is typically a subgroup of the board of directors and is primarily responsible for overseeing the financial reporting and auditing processes. The audit committee’s role is critical in promoting transparency, accountability, and the integrity of financial information.

In this Article we will be comprehensively evaluating the role of audit Committee in empowering corporate governance

What is corporate Governance?

Corporate governance is a system of principles, policies, and practices that guide how a company is directed and controlled. It aims to balance the interests of various stakeholders while promoting ethical behavior, transparency, and long-term sustainability. Effective corporate governance is essential for building and maintaining trust in businesses and financial markets.

What is Audit Committee?

Audit committees has a vital role in promoting high quality auditing through their oversight of the audit process and the auditor. It is typically comprised of members from a company’s board of directors who are independent of the company’s management. The primary purpose of an audit committee is to provide oversight and ensure the integrity of a company’s financial reporting and internal control processes.

Which Companies Need to constitute Audit Committee?

In accordance with Section 177 of the Companies Act, 2013, and Rule 6 of the Companies (Meetings of Board and its Powers) Rules, 2014, certain criteria determine the requirement for companies to establish an Audit Committee.

These criteria include:

1. Listed Companies: All companies that are listed on stock exchanges.
2. Public Companies with Paid-Up Share Capital: Public companies with a paid-up share capital of 10 crore rupees or more.
3. Public Companies with Turnover: Public companies with a turnover of 100 crore rupees or more.
4. Public Companies with Outstanding Loans, Debentures, and Deposits: Public companies with an aggregate value of outstanding loans, debentures, and deposits exceeding 50 crore rupees. This is determined based on the figures in the latest audited financial statements.

Composition of Audit Committee

The composition of an Audit Committee is governed by specific requirements as per regulations.

Here are the key points related to the composition of the Audit Committee:

1. Directors: The committee must have a minimum of three directors as its members.

2. Independence: At least two-thirds of the committee members should be independent directors. Independence ensures impartial oversight.

3. Independent Chairperson: The chairperson of the committee should also be an independent director, ensuring objectivity in the committee’s functioning.

4. Company Secretary: The Company Secretary serves as the secretary to the audit committee, assisting in administrative matters and facilitating its operations.

Essential Requirement to be a part of audit Commitee:

1. Financial Literacy: All members, including the chairman, are required to be financially literate. This means they should have the ability to comprehend basic financial statements such as the Balance Sheet, Profit and Loss Statement, and Cash Flow Statement.

2. Accounting or Financial Expertise: At least one member of the committee must possess expertise in accounting or related financial management. This can be demonstrated through experience in finance or accounting, holding professional certifications in accounting, or having a relevant financial background.

Meetings of Audit Committee

The Audit Committee, as mandated by regulatory authorities, is an integral part of corporate governance, responsible for overseeing financial reporting, internal controls, and related party transactions.

To fulfill its role effectively, the committee conducts periodic meetings, where crucial financial matters are discussed and decisions are made.

Let’s delve into the essential aspects of these meetings:

1. Meeting Frequency and Timing:

• The committee should convene at least four times a year. This ensures regular and thorough oversight of financial matters.
• The maximum interval between meetings should not exceed 120 days. This ensures that financial matters are promptly addressed, preventing any undue delays.

2. Quorum Requirements:

• To conduct a valid meeting, a quorum is essential. The quorum is the minimum number of members required for the meeting to proceed.
• The quorum for an Audit Committee meeting should comprise either two members or one-third of the committee members, whichever is greater. This ensures that the meeting is attended by a substantial portion of the committee members.
• Crucially, the quorum must include at least two independent directors. The presence of independent directors adds impartiality to the decision-making process.

3. Participation of Auditors and Key Management Personnel:

• Auditors of the company and key managerial personnel have a significant role in financial oversight. They have the right to be heard during committee meetings, particularly when discussions revolve around the auditor’s report.
• However, it’s important to note that auditors and key management personnel do not possess voting rights in the committee meetings. This maintains the independence and objectivity of the committee’s decisions.

The Role of audit Committee

1. Financial Reporting Oversight:

The primary role of the audit committee is to oversee the company’s financial reporting. This involves reviewing and ensuring the accuracy, completeness, and transparency of financial statements.

2. Selection of External Auditors:

Audit committees play a pivotal role in the selection of external auditors. They evaluate audit firm proposals and recommend the appointment of an independent auditor to the board of directors.

3. Oversight of External Auditors:

Once external auditors are engaged, the audit committee monitors their performance. They review the scope of the audit, audit plans, and the audit firm’s independence.

4. Review of Internal Controls:

   Audit committees assess the adequacy and effectiveness of the company’s internal controls. This is essential for preventing and detecting financial irregularities and fraud.

5.  Risk Management:

Audit committees are involved in risk management, particularly as it pertains to financial and reporting risks. They identify and address potential risks to the organization’s financial integrity.

6.  Compliance and Regulatory Adherence:

Ensuring that the company complies with relevant laws, regulations, and accounting standards is another key responsibility of the audit committee.

7.  Communication with External Auditors:

The audit committee maintains open and direct communication with external auditors. This includes discussing audit findings, potential issues, and any concerns about financial reporting.

8. Reporting to the Board:

Audit committees report their findings and recommendations to the board of directors. These reports are crucial in guiding the board’s decisions and actions related to financial matters.

9.  Whistleblower and Ethics Programs:

Some audit committees oversee whistleblower programs and ethical practices within the organization. They provide a channel for employees and other stakeholders to report concerns related to financial misconduct or unethical behavior.

10.  Cybersecurity and Technology Oversight:

    In the modern business environment, audit committees may also be involved in assessing and monitoring cybersecurity and technology-related risks, particularly those that can impact financial data and reporting.

11. Financial Reporting and Disclosure:

 Reviewing the financial reporting process and disclosure to ensure accuracy and transparency.

12. Related Party Transactions

Approving and scrutinizing transactions involving related parties to prevent conflicts of interest.

13. Auditor’s Report:

Evaluating the annual financial statements and the auditor’s report before submission to the board.

Mandatory Review and Disclosure by Audit Commitee

The Audit Committee is tasked with reviewing and disclosing critical aspects, including:

• Management Discussion and Analysis: This provides insight into the financial condition and results of operations.
• Related Party Transactions: Assessing transactions with related parties to ensure fairness and transparency.
• Management Letters and Internal Control Weaknesses: Addressing issues raised by statutory auditors in their letters concerning internal control weaknesses.
• Internal Audit Reports: Evaluating the findings of internal audits, which assess the adequacy of internal control systems.

Essential Reporting and Disclosure by Audit Commitee

Transparency is a fundamental principle of corporate governance. Therefore, it’s essential to disclose pertinent information. The following are the reporting and disclosure requirements:

• The composition of the Audit Committee must be disclosed in the Board’s report.
• Any recommendations made by the Audit Committee that were not accepted by the Board should also be disclosed.
• The Annual Report should include details about the Audit Committee in the corporate governance report.

Penalty for Violation of Audit Committee Provisions

The company shall be punishable with fine of Rs. 1 Lakh to Rs. 5 Lakhs and every officer of the company who is in default shall be punishable with imprisonment up to 1 year or with fine of Rs. 25,000/- to Rs. 1 Lakh, or with both.

Conclusion

The audit committee is a key part of corporate governance, focused on ensuring the integrity of financial reporting and the prevention of financial irregularities. Its independence, oversight of external auditors, and commitment to transparency are vital for building trust with stakeholders and maintaining a company’s financial integrity.