An audit committee is one of the major operating committees of a company's board of directors that is in charge of overseeing financial reporting and disclosure.
All U.S. publicly-traded companies must maintain a qualified audit committee in order to be listed on a stock exchange. Committee members must be made up of independent outside directors, including a minimum of one person who qualifies as a financial expert.
Key Takeaways
- An audit committee is made of members of a company's board of directors and oversees its financial statements and reporting.
- Per regulation, the audit committee must include outside board members as well as those well-versed in finance or accounting in order to produce honest and accurate reports.
- Committee members must sign off on the company's books and take responsibility for any misreporting.
How an Audit Committee Works
The audit committee works closely with auditors to ensure that company's books are correct and that no conflicts of interest exist between auditors or any outside consulting firms employed by the company. Ideally, the chair of the audit committee will be a Certified Public Accountant [CPA]. Often, however, a CPA is not available for the audit committee, let alone a member of the board of directors. The New York Stock Exchange [NYSE] requires that the audit committee include a financial expert, but this qualification is typically met by a retired banker, even though that person's ability to catch fraud may be less than expert. The audit committee should meet at least four times a year in order to review the most recent audit, either in-person or via teleconferencing. An additional meeting should be held if other issues need to be addressed.
Audit committees maintain communication with the company's chief financial officer [CFO] and controller. The committee has the authority to initiate special investigations in cases where it is determined that accounting practices are problematic or suspect, or when serious issues arise with employees. An internal auditor would assist the committee in such efforts.
The audit committee's role includes the oversight of financial reporting, the monitoring of accounting policies, the oversight of any external auditors, regulatory compliance and the discussion of risk management policies with management. The duties and composition of a company's audit committee can be found in SEC Form DEF 14A, or proxy statement.
Committee members may change from time to time, depending on the movement of personnel on or off the board or change of committee assignments. Aside from annual compensation for directors, those who serve on an audit committee [the same applies for all committees] are paid additionally for each meeting attended.
Audit Committee Hazards
The audit committee must take its responsibilities very seriously. Financial reporting, compliance and risk management are subject to a number of hazards, especially when the company is a large organization with thousands of personnel and reporting systems stretching across the globe. Exogenous threats such as cyber hacking are under the purview of an audit committee, making its job even more challenging. Cybersecurity should be an increasing focus for audit committees in corporate boardrooms everywhere.
Composed of individuals who serve on an organization’s board, an audit committee is responsible for ensuring an organization operates in an ethical environment and complies with laws and regulations. Charged with oversight of financial reporting, risk management and internal controls, audit committees also are responsible for selecting the public accounting firms that serve as their organizations’ external auditors as well as for maintaining relationships with their organization’s own internal audit team.
The essential nature of audit committee responsibilities was reinforced in 2002 with the passage of the Sarbanes-Oxley Act, which significantly strengthened the role of audit committees in organizational governance. Individuals who pursue an online Master of Accountancy degree can acquire knowledge and skills that could be beneficial when they interact with and report to audit committees.
Audit Committee Role and Duties
The breadth of an audit committee’s role and duties is demonstrated by its responsibilities. Some of the most significant responsibilities under the purview of an audit committee include the following:
- Ensuring the organization’s financial statements are understandable and reliable.
- Ensuring the organization establishes a thorough risk management process and effective internal controls.
- Reviewing the organization’s policies, particularly in areas such as ethics, conflict of interest and fraud.
- Reviewing the organization’s litigation and regulatory proceedings.
- Selecting and implementing a direct reporting relationship with the public accounting firm that serves as the organization’s external auditor.
- Establishing communication with the organization’s internal auditor and reviewing all audit findings.
Audit committees also play a significant role in setting the tone of an organization. They do so by ensuring their organizations develop and implement a code of conduct and establish effective communication channels. Audit committee members also need to be aware of what management is doing to achieve compliance with laws and regulations, and they must be knowledgeable about issues such as ongoing investigations and disciplinary actions.
With such a broad scope of responsibilities, these committees can face significant challenges. In its 2019 survey of 1,300 audit committee members worldwide, KPMG identified two of the greatest challenges to audit committees performing their core oversight responsibilities:
- Maintaining internal control over financial reporting, disclosure controls and procedures.
- Helping ensure their organization has the talent and resources to maintain quality financial reporting.
KPMG also reported that audit committee members viewed technological innovation, digital disruption and the complexity of business as the factors that place the most pressure on risk management and internal controls.
How an Audit Committee Operates
The charter an audit committee establishes sets the foundation for its operations. The elements of the charter lay the groundwork for carrying out all audit committee responsibilities. For example, an audit committee’s charter may be drafted to accomplish the following key tasks.
- Set forth the audit committee’s purpose and list its specific responsibilities in detail.
- Establish the audit committee’s authority to carry out specific responsibilities, such as appointing and compensating an external auditor, obtaining information and meeting with officers of the organization.
- Define the composition of the audit committee, how members will be appointed and any requirements for expertise among the members.
- Describe how the audit committee will conduct meetings, how often it will meet, who must attend meetings and the circumstances under which the audit committee will meet in executive session.
The precise composition of an audit committee depends on the type of organization the committee serves. For example, publicly traded companies in the United States must comply with the rules of the U.S. Securities and Exchange Commission, Statement on Role of Audit Committees in Financial Reporting and Key Reminders Regarding Oversight Responsibilities