Audit Committee

What is an Audit Committee?

Definition: An audit committee is the section of an organization’s board of directors that is in charge of monitoring an organization’s financial reporting and authenticating its accuracy.

An audit committee is one of the major operating committees of a company’s board of directors that is in charge of overseeing financial reporting and disclosure. Committee members must be made up of independent outside directors, including a minimum of one person who qualifies as a financial expert.

What Does Audit Committee Mean?

In laymen’s terms, it’s comprised of approximately five individuals who are usually from outside of the organization itself. Their primary responsibility is to provide an objective and unbiased view of the organization’s practices. The purpose of the audit committee being comprised of members from outside of the organization is to ensure that the audit process is neutral by removing the conflict of interest.

Businesses use internal committees when they want to verify that their managers and financial analysts are using the correct internal protocol for financial reporting items like; business regulations, accounting policies, and risk management policies. Typically organizations will rely on this committee to help create financial reporting procedures as well. The advantage of these audit committees is that they have helped companies to run substantially smoother since their initial installment.

In a U.S. publicly traded company, an audit committee is an operating committee of the board of directors charged with oversight of financial reporting and disclosure. Committee members are drawn from members of the company’s board of directors, with a Chairperson selected from among the committee members. A qualifying (cf. paragraph “Composition” below) audit committee is required for a U.S. publicly traded company to be listed on a stock exchange. Audit committees are typically empowered to acquire the consulting resources and expertise deemed necessary to perform their responsibilities. The role of audit committees continues to evolve as a result of the passage of the Sarbanes-Oxley Act of 2002. Many audit committees also have oversight of regulatory compliance and risk management activities.

Not for profit entities may also have an audit committee.

Internationally, an audit committee assists a board of directors to fulfil its corporate governance and overseeing responsibilities in relation to an entity’s financial reporting, internal control system, risk management system and internal and external audit functions. Its role is to provide advice and recommendations to the board within the scope of its terms of reference / charter. Terms of reference and requirements for an audit committee vary by country, but may be influenced by economic and political unions capable of passing legislation. The European Union directives are applied across Europe through legislation at the country level. Although specific legal requirements may vary by country in Europe, the source of legislation on corporate governance issues is often found at the European Union level and within the non-mandatory corporate governance codes that cross national boundaries.

Example

Jamie runs a company called the Brew Beerdogs. Its nearing the end of the 4th quarter in the fiscal year, so Jamie decides that she wants to audit her company in order to ensure that the financial reporting and numbers that she received are accurate. She presents the idea to her board of directors and they approve. From there, she seeks out a panel of about 5-7 individuals outside of the company and assembles these individuals together to form her official committee.

Once the committee has received approval from the board, they then proceed to commence with their audit her organization. Using her guidelines and federal regulatory policies, the committee that Jamie composes analyzes the efficacy and adherence to these standards by different facets of her organization. Their final report confirms that the financial regulators in her company are acting within their bounds and that the financial reporting is accurate. They also return a list of suggestions to Jamie as well.

Responsibilities of the Audit Committee

The primary purpose of a company’s audit committee is to provide oversight of the financial reporting process, the audit process, the company’s system of internal controls and compliance with laws and regulations.

Boards of Directors and their committees rely on management to run the daily operations of the business. The Board’s role is better described as oversight or monitoring, rather than execution. Responsibilities of the audit committee typically include:

  • Overseeing the financial reporting and disclosure process.
  • Monitoring choice of accounting policies and principles.
  • Overseeing hiring, performance and independence of the external auditors.
  • Oversight of regulatory compliance, ethics, and whistleblower hotlines.
  • Monitoring the internal control process.
  • Overseeing the performance of the internal audit function.
  • Discussing risk management policies and practices with management.

Audit Committee Hazards

The audit committee must take its responsibilities very seriously. Financial reporting, compliance and risk management are subject to a number of hazards, especially when the company is a large organization with thousands of personnel and reporting systems stretching across the globe. Exogenous threats such as cyber hacking are under the purview of an audit committee, making its job even more challenging. Cybersecurity should be an increasing focus for audit committees in corporate boardrooms everywhere.