The Role of Audit Committee in Corporate Governance

The concept of an audit committee was first endorsed in 1939 by the New York Stock Exchange (NYSE). During the 1970s, the audit committee's role was very welcome due to the great demands for corporate governance and corporate accountability. Audit committees are identified as effective means for corporate governance that reduce the potential for fraudulent financial reporting. Audit committees oversee the organization's management, internal and external auditors to protect and preserve the shareholders' equity and interests. To ensure effective corporate governance, the audit committee report should be included annually in the organization's proxy statement, stating whether the audit committee has reviewed and discussed the financial statements with the management and the internal auditors.

Audit Committee Composition and Meetings

Although it is compulsory in many countries that all publicly held companies should have audit committees, many non-public companies have audit committees voluntarily established for better oversight and monitoring of these companies’ financial and accounting performance. Usually the audit committee should be composed of three to six members. Audit committee meetings have a major impact on the evaluation of the organization’s overall performance and its internal control functions. The three features of such meetings are frequency, attendance, and content.

Roles of Audit Committee in Corporate Governance

General

As part of the corporate governance mechanism, the audit committee oversees the organization's management, internal and external auditors to protect and preserve the shareholders' equity and interests; however, the audit committee's nature and scope of work should be reviewed to make sure that it is capable of playing its role in this regard appropriately, especially after being recently criticized for its shortcomings in achieving the corporate governance objectives.

Role in Internal Audit

The scope of the internal audit function is determined by the audit committee. One of the main responsibilities of the audit committee is to enhance and maintain the internal auditors' independence in order to enable them to achieve their duties. The internal auditors provide the committee with the necessary information to which they have direct access, same as the organization's management, in order to enable the audit committee to accomplish its oversight and monitoring mission. On the other hand, the audit committee supports the position of the internal audit function and submits management's irregularities and other relevant managerial and financial issues to the board of directors, after discussing such issues with the internal auditors and relevant other parties.

Role in Internal Control

The audit committee receives reports about the internal control's effectiveness and efficiency from the organization's management, internal and external auditors. The committee has full authority to investigate any issue which may affect the organization's internal control and financial reporting. It should have access to all relevant information, and access to resources which may enable it to perform such investigations appropriately. The committee meets with the management, internal and external auditors to discuss issues related to internal control anytime it deems necessary. It also submits reports to the board of directors about the results it reaches to, as well as recommendations regarding the improvement of the internal control process and how to maintain an effective and efficient internal control system. Evaluation of the internal control structure and process is considered one of the most, if not the most, important oversight responsibility faced by the audit committee.

Role in External Audit

The external auditors submit their reports to the audit committee where both parties discuss important issues, such as management’s errors, irregularities, and fraud; problems or obstacles in the internal control process; and problems related to the preparation of financial statements or financial reporting. External auditors’ reports are to be reviewed by the committee so that the committee members discuss such reports with the concerned parties, and make sure that the valid notes are taken into consideration and executed by the management. Additionally for independence purposes, the audit committee may review any non-audit service agreements with the external auditors to understand the nature and magnitude of relevant fees paid. As part of the organization’s corporate governance, the audit committee should examine the non-audit services rendered by the external auditors in order to prevent any conflict of interest or impairment of the external auditors’ independence.

Role in Accounting and Financial Reporting

One of the main responsibilities of the audit committee is to oversee the financial reporting process in order to enhance the quality of this process. The audit committee is responsible for monitoring the organization’s accounting policies, principles, and practice. It reviews the organization’s financial statements monthly, quarterly, and/or annually according to the organization’s size, system, and nature of business. The role of the audit committee in exercising an active monitoring of the organization’s financial reporting process is well established and confirmed by many corporate governance codes and professional announcements recently.

Role in Regulatory Compliance

The audit committee is responsible for overseeing the organization’s disclosure process, ensuring that the organization complies with the relevant local and international laws, implementing regulations and ethical standards and principles, and complying with the organization’s bylaws and internal guidelines. The audit committee discusses with the organization’s management, attorney, and general counsel any litigation or regulatory compliance risks.

Role in Risk Management

The audit committee discusses with the organization’s management the policies and practices used to identify, prioritize, and respond to the risks that threaten the achievement of the organization's objectives or opportunities that enhance the achievement of such objectives. The audit committee is also involved in non-financial risk topics.