Audit Committees: Fad or effective tool of management?

It appears that most annual reports published in Sri Lanka show the existence of an Audit Committee, a report of the Committee and even a Governance Report issued by them. Despite these many company accounts show glaring inadequacies with compliance, good governance and even violation of the rights of minority shareholders, glaring conflicts of interests and violation of accounting standards and of course misrepresentation of vital shareholder information. Who is to judge the effectiveness of the functioning of the committee – Shareholders, Media, Analysts or Creditors? The expected best practice is for the Audit Committee itself and the Board to be the judge.

Audit Committees should:

*Challenge management plans, processes and capabilities to ensure that management’s stewardship of the business incorporates an appropriate balance of control and risk;

*Assist in the identification of key business risks;

*monitor management's commitment to the maintenance of a system of internal control to effectively address business risk;

*Support the role of both internal and external auditors by encouraging them to discuss their findings and views freely, and;

*Act independently and objectively in helping to resolve differences of view between auditors and management.

*Monitor and ensure that business dealings comply with set Standards of Business Conduct and are aligned to accepted business principles.

Audit Committees can only be as effective as the Board, and more particularly the Chairman and Chief Executive, allow them to be. Active support and encouragement by the Board is an essential pre-requisite of an effective Audit Committee.

At the same time, Audit Committees are only as good as their members. One of the most important attributes is a willingness to question accepted and standard practice, and not to necessarily accept the first response given. Audit Committees will help to enhance standards of corporate governance only if the committees include truly independent members with the experience, skill, commitment and understanding of the business.

The essential attributes for an effective Audit Committee include:

*Composition
Audit Committees should have at least two truly independent members, plus one individual with in-depth knowledge of the business. One of the three members should have a strong financial background.

*Authority and status
The Audit Committee should have sufficient authority to act with independence and integrity..

*Terms of Reference
The Terms of Reference should detail clearly the authority and responsibilities of the Committee, and should also emphasise the Committee's right of access to all information and to request any person to attend and answer questions. The Committee should also be able to initiate special investigations.

*Size
The size of the Committee should be sufficient to provide the appropriate mix of skills, independence and experience to provide an appropriate variety of opinions which engender participative debate.

* Members
The members should also have a sceptical approach to their role and be able to ask searching questions, without necessarily accepting the first answer. A varied and successful business background is often a precursor to an effective member.

*Chairman
The Chairman should be independent of, and have the confidence to challenge, the Chief Executive of the company. A recent independent survey of the FTSE 100 Companies put "a good Chairman" as being the single most significant factor in ensuring the effectiveness of an Audit Committee. He should periodically meet the relevant internal audit manager to discuss internal control issues affecting the company.

*Time
The members should have sufficient time to properly carry out their duties. This means more than merely attending the meetings, but the time to understand a company's business.

*Remuneration
The remuneration of members can prove useful in emphasising their accountability, whilst also recognising the considerable time required to be an effective member.

*Terms of office
Membership of the Committee should change on a periodic basis so as to encourage new and fresh insight into the role.

*Agenda
One of the keys to a successful audit committee is a thought through agenda which seeks to challenge the control environment. It should reflect the concerns of the membership and not be driven by the auditors. The agenda for the meeting should be prepared well in advance and be owned by the Chairman of the Committee. Furthermore, the relevant papers for the meeting should be distributed a sufficient time before the meeting to allow full understanding of the issues involved.

*Attendance
Attendance by the CEO, finance director, internal and external audit is expected to be the norm at all audit committee meetings. A positive and encouraging trend is the invitation to attend to those who have a specific responsibility for an area under review.

*Private discussions
Private audiences between the audit committee (without executive management) and the external auditors and, separately, the internal auditors at least annually, but ideally at each meeting, are now expected as a routine. This privacy can help ensure complete frankness of expression and communication.

*Frequency
There should be at least 2 meetings a year to allow for timely coverage of key events such as the review of the annual accounts and the review of internal and external audit plans.

*Reporting
The reporting responsibilities of the Committee should be clearly laid out, again to emphasise the accountability of the members.

*Minutes
The minutes of the meeting should be circulated to the Board and should include a report highlighting those significant issues which were raised at the previous meeting. They should also include details of action points arising with assigned responsibility for their resolution.

*Escalation procedures
In the unlikely event whereby the Committee is faced with circumstances which it feels it cannot resolve without assistance it must be to keep the Board.

The Committee's key focus:
"to assist the Board in the management of business risks and internal controls" with evidence of a high quality debate on the business risks facing the company, and the adequacy of the measures in place to address them. Time to look in the mirror and for the physician to heal thyself first! (Comments on this article could be sent to -- wo_owl@yahoo.co.uk).