“The battle for financial statement integrity and reliability depends on balancing the pressures of multiple stakeholders, including management, regulators, investors and the public interest” American Institute of CPAs.
The Audit Committee is widely recognized as an important mechanism required to ensure good corporate governance.Section 359 (3) & (4) of the Companies and Allied Matters Act 2004 provides that every public company shall have an Audit Committee and the Committee shall consist of an equal number of Directors and representatives of the shareholders of the company (subject to a maximum number of six members). The Committee “shall examine the External Auditor’s report on the Financial Statements and make recommendations thereon to the annual general meeting as it may think fit”.
In addition to its statutory functions, the SEC Code of Corporate Governance provides that the Audit Committee shall assist in the oversight of the integrity of the company’s financial statements, compliance with legal and other regulatory requirements, assess the qualifications and independence of the external auditor and assess the performance of the company’s internal audit function. The Committee is also expected to discuss the annual audited financial statements and half yearly unaudited statements with management and external auditors.
The definition of financial literacy is vague as Article 30.2 of the Securities & Exchange Commission Code simply states that members of the Committee should have basic financial literacy and should be able to read financial statements. It is unclear whether the ability to read and understand financial statements suffices as financial literacy or whether some additional expertise in this area is required. The Canadian Securities Administrators’ National Instrument 52-110 states that it is not necessary for a member of the Audit Committee to have a comprehensive knowledge of accounting and auditing standards to be considered financially literate.
Given the responsibilities imposed on the Committee by CAMA and the SEC Code, it is clear that Audit Committee Members need to be able to read and understand financial statements, including the company’s balance sheet, income statement and cash flow statement.
Each member is not expected to be an expert in accounting or finance because the Audit Committee is at liberty to seek independent expert advice as required. It is however important that committee members are able to ask the right questions, evaluate and interpret responses. To ensure the effectiveness of the Committee, it is expedient that at least one member of the Committee should possess appropriate knowledge and experience to review the financial reporting process. This has become more important given the adoption of the International Financial Reporting Standards (IFRS) which require more disclosures and more detailed reporting.
To be effective, Audit Committee members are expected to possess the following:
- The ability to understand accounting policies, estimates and judgments as enunciated by Management and the External Auditor.
- An understanding of the company’s business and any unique features related to its operations that may impact on the accounting policies.
- A knowledge and understanding of the strategies that have been adopted by the company and the risks inherent in any transformation strategies.
- An ability to understand the entity’s risk environment and appetite.
- Sufficient independent judgment and the ability to ask the right questions. In this regard, the Board representatives on the Committee should be independent non-executive directors.
Committee members must also be prepared to devote enough time and attention to the performance of their duties.
According to Article 30.1 of the SEC Code, it is the responsibility of the Board to ensure that the Committee is constituted in the manner stipulated and is able to discharge its statutory duties and responsibilities effectively. Consequently, the Board should ensure that members of the Audit Committee continue to receive relevant financial and other training. They should also receive regular updates on the company’s operations typically from the Internal Audit Function and from Management.
Audit Committees play a critical role in the financial reporting process by overseeing and monitoring the integrity of financial reporting. The Audit Committee is a key organ within the Corporate Governance Framework and is expected to assist the Board of Directors in the discharge of the latter’s oversight responsibility, particularly in relation to financial reporting, integrity, internal control, risk management and corporate standards of behaviour. It is imperative that Committee members possess the relevant skills and have access to the appropriate tools to remain effective.