How best to choose and get the most out of an audit committee.

 

What criteria should be used in selecting an audit committee?

The fundamental criterion for the selection of audit committee members is that they are independent non-executive directors. It is important that at least one of the members of an audit committee has a financial background and it is essential that all audit committee members have a basic understanding of financial matters.

The audit committee must operate independently of any executive management processes and be seen to be operating with a high degree of objectivity. It is considered good practice for the audit committee to consist of at least three non-executive directors, with a quorum of two. The Chairman of the organisation should not be a member of the audit committee.

The audit committee Chairman should be a senior non-executive director – not the Chairman of the organisation’s board and not a newly appointed non-executive director.

The Chairman of the organisation, the Chief Executive, other executive directors and senior managers will often attend audit committee meetings at the invitation of the audit committee Chairman. It is quite common for the Finance Director to regularly attend audit committee meetings.

The audit committee Chairman will plan the agenda on an annual rolling basis and will invite specific executives or senior managers to attend on particular occasions to provide assurances and explanations regarding their areas of functional responsibility.

Normally, representatives from the internal and external audit providers, together with the Company Secretary will regularly attend committee meetings and there should be a designated note-taker, who will not be one of the non-executive directors,

How can independent non-executive directors (INEDs) best serve an audit committee?

The purpose of an audit committee is to give confidence to the Board in the reliance it places on its sources of assurance. The role of the independent non-executive director members of the audit committee is to critically review the organisation’s governance and assurance processes at a sufficient level of detail to enable the Board to operate strategically with confidence in the day to day management of the organisation.

Audit committee members need to be mindful that if ever there was a crisis in the organisation then one of the first questions people will ask is “what were the audit committee doing?” They should be asking themselves “what could go wrong?” and do we have the right controls in place to either prevent things from going wrong or to address them rapidly and effectively if they do. The independent non-executive directors on the audit committee need to make sure that the risk and performance management systems are fit for purpose and that they are underpinned by an Assurance Framework.

The Assurance Framework is the ‘lens’ through which the Board examines the assurance it requires to discharge its duties. The key question Board members need to ask is ‘How do we know what we know?’ The Assurance Framework should provide the answer.

Audit committee members, rightly, focus on internal financial control matters and the annual audit takes up a significant amount of their time. However, they also need to look at risk, quality and performance to ensure the Board has sufficient assurance in non-financial metrics as well as the financial ones.

Other duties of an audit committee member include ensuring that there is a culture which encourages the reporting of serious incidents and near-misses with a clear whistle-blowing policy; critically evaluating the performance of internal and external auditors and taking part in the selection and recommendation for appointment or re-appointment of the auditors to the Board

How could professional organisations help to improve the quality of audit committees?

Organisations can improve the quality of audit committees by:

  • Issuing guidance on the role, responsibilities and duties of an audit committee member
  • Issuing guidance on the selection criteria for audit committee members and working with recruiters and search and selection providers to ensure that they are clearly articulated to potential recruits
  • Lobbying for the adoption of a recognised qualification such as the Institute of Directors’ Chartered Director as the pre-requisite for audit committee members
  • Providing training and on-going support for audit committee members to ensure that they have sufficient CPD (the Chartered Director requirement is 30 hours per annum)

How can an audit committee work best with internal and external auditors?

The audit committee agrees the annual programme of work for the internal and external auditors together with the associated costs. Performance against these programmes is then monitored by the audit committee on a regular basis.

It is essential that the audit committee has a good working relationship with the internal and external audit providers as they can provide both assurance and insight into the management arrangements within the organisation.

The Head of Internal Audit is required to provide the audit committee with an annual opinion on the overall adequacy and effectiveness of the organisation’s risk management, control and governance processes.

The audit committee is also responsible for making recommendations to the Board about the appointment or re-appointment of the internal and external auditors.

Representatives of both the internal and external auditors will normally attend most audit committee meetings though there may well be a private session of the committee before the main meeting from which the internal and external auditors are excluded. The audit committee Chairman is also likely to have contact with the internal and external audit team leads outside of committee meetings if there are urgent matters to be discussed or concerns that need to be raised.

Directors often serve on multiple companies. What effect can this have on their oversight?

It is quite common for non-executive directors to serve on more than one Board and they may well serve on multiple audit committees. In these circumstances the normal ‘conflict of interests’ procedures should apply and there should be a standing item at the beginning of the audit committee agenda calling on members to declare any areas of possible conflict of interest in the matters to be discussed on the agenda. There should also be a register of interests for all directors which should be reviewed annually.

Non-Executive Directors should also avoid, where possible, being members of the audit committees of two organisations in the same sector who are possible in competition with each other.

Providing that any potential conflicts of interest are dealt with in an open and transparent manner then it can be an advantage for non-executive directors to be members of multiple audit committees as they can bring experience of best practice and different ways of working.

What sort of training programmes exist for INEDs that could help companies move towards international best practices?

The ideal training program for independent non-executive directors is the Chartered Director qualification from the Institute of Directors. This should be a pre-requisite for all company directors.

Additionally there are the Certificate and Diploma in Company Direction from the Institute of Directors, the Financial Times Non-Executive Director Certificate and Non-Executive Director courses from Excellencia.

Audit committees should review their performance annually and consider their own training needs to ensure that members have the skills to perform their role effectively.

Every audit committee member should have an appropriate understanding of finance, internal control, governance, risk, quality, performance and assurance, which will need to be kept up to date as legislation and best practice changes.

 

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