(c) Institute of Chartered Accountants of Scotland. Contact ICAS for permission to reproduce this article., Internal Auditing

THE ROLE OF A MODERN DAY AUDIT COMMITTEE: Evolution not revolution

By Jim Barbour

Many of the prominent failures of corporate governance in the last couple of decades have involved breakdowns and deficiencies in communication, internal controls processes and financial reporting.

The volatility of capital markets combined with a thirst for transparency and investor information is increasing at a steady rate. The upswing of recent government intervention puts the audit committee under the spotlight and demands a response from boards, management and auditors.

The argued perception is that the external auditor failed to discover and boards and audit committees failed to prevent failures.
While Brussels and the UK have been the epicentres of the audit shake up, tremors have extended worldwide. ICAS and the Financial Reporting Council recently joined forces with the Australian Institute of Chartered Accountants to explore the workings of the audit committee further and the challenges faced.

The resulting report, ‘Walk the Line’, sought to present an international view on the role of audit committees in helping their boards discharge their financial and fiduciary responsibilities to shareholders.

Chairmen of audit committees and boards on different sides of the world were interviewed but a similar message came through. There is a simmering danger of unrealistic expectations around what committees can achieve. Throughout the scrutiny there needs to be continued calls for caution as to how far the role extends.

Many of the regulations and governance structures imposed on audit committees across the different jurisdictions differ in the detail, and the exact remit of the committee also varies; but all share the common objective of ensuring effective, independent oversight of financial reporting.

The report findings suggest that a major overhaul of the remit and the composition of audit committees are not necessary. But challenges still remain, not least how to communicate meaningfully to shareholders what audit committees are doing to protect their interests.

The key to a truly effective audit committee is the behaviour and culture emanating from the board throughout the organisation’s management, committees and assurance activities. This is something that cannot be regulated for.

The modern day audit committee will need to take a more public face. Its long-term effectiveness will in part depend on its ability to renew itself and deliver a next generation of members.

Infusing fresh talent with new ideas will offer different perspectives and lines of questioning. Diverse backgrounds and varied experience enhance the efficacy of committees, especially when advising newly-listed companies. This means that companies need to look beyond financial and auditing professionals to get the mix of skills and experience needed.

Today, the ability of committee members to understand a company’s business and risk profile is just as vital as financial expertise.

In some cases the audit committee is combined with a risk committee; in others a finance committee. Many interviewees, particularly in Australia, preferred the separation of the audit committee from either the risk or finance function. This preference is not universal. Interviewees in America and the UK expressed little enthusiasm for separate risk committees, stressing that without close cooperation between those committees key information could be lost.

Another important consideration is the size of the audit committee. Too small and you risk not having the range of perspectives that are needed. Too large and it becomes unwieldy. The audit chairman needs to work with the board chairman to ensure the size of the audit committee is effective.

Audit committees owe their primary responsibility to the board and work best when they are an integrated part of the board process. Open debate and mature questioning are fundamental to their effectiveness. Fundamentally committees need to ensure high-quality and reliable information is sourced to fulfil their role. The committee Chairman is the lynchpin and critical ingredient behind a successful audit committee. By visibly demonstrating that all this already exists, it is a case of evolution not revolution for audit committees to remain standing as a main pillar of the corporate governance system.

James Barbour is director of accounting and auditing at ICAS, the professional body of Chartered Accountant.

This article was contributed by the Institute of Chartered Accountants in Scotland.