What makes a Good Audit Committee?

Audit Committee (AC) is the oldest, and one of the most important Board level committees. It is considered to be the most important committee because its key roles involve recommending of financial statements for approval, interaction with Statutory and Internal Auditors, ensuring existence of proper internal controls, and approval of related party transactions (RPTs). With changes in law and regulations, most ACs have seen an expanded role, with a number of mandatory and non-mandatory roles being added to their scope of work.

For an AC to add value, it is important to have the following considerations:

1. Composition – For a proper functioning AC, its composition plays a key role. SEBI LODR Regulations, 2015 (LODR) require at least 2/3rd of the members of AC to be Independent Directors (IDs), with the Chair of AC also being an ID. Given the important role played by this Committee, some companies proactively consider having an AC comprising all IDs as a positive. It is believed that such ACs are objective and independent in their discussions and decision-making.
2. Skillsets – LODR requires the Chair of AC to be an expert in finance, and other members to have knowledge of finance. It is important to have Directors with the right skillset and aptitude as members of the AC.
3. AC Chair – AC Chair plays an important role in ensuring an effective AC. He/she sets the tone for committee meetings. AC Chair has to be an ID, and has to be an expert in finance. His/her knowledge is often extremely important when it comes to steering the meetings, and communicating with the CFO and the auditors. He/she also has to ensure that management presents proper agenda for meetings. He/she should have the ability and willingness to ask the tough questions. Given the importance of the Committee, he/she is often considered to be the senior most ID, and is also tasked with the additional responsibility of chairing meetings of IDs. Attending Annual General Meetings, to answer shareholder queries, is yet another role assigned to him/her.
4. Induction of AC members – Given the role of the AC, it is a good practice to have a proper induction programme for newly inducted members of the committee. The focus of this programme should be on the role of the Director as an AC member, and the attributes required.
5. Number of meetings – LODR requires the AC to meet at least four times in a year. Increasingly it is seen that the quarterly meetings, as mandated, focus only on financial statements. Given the additional roles to be performed by the Committee, it is a good practice to have at least 2 additional meetings, in which the focus can be on items such as Internal Audit.
6. Pre-AC meetings with CFO – A number of companies have found the practice of the AC Chair having a pre-AC meeting/ call with the CFO beneficial. In such meetings/ calls, the CFO is able to brief the AC Chair about the agenda, the updates since the previous AC meetings, and any issues that the company might be facing.
7. Pre-AC meetings with Statutory Auditors – A number of companies have also find the practice of the AC Chair having a pre-AC meeting/ call with the Statutory Auditors beneficial. In such meetings/ calls, the auditor is able to brief the AC Chair about any item that he/she may want to bring to the attention of the Chair.
8. Interaction with Auditors – Most good ACs have started the practice of interacting with Statutory Auditors and Internal Auditors, without the presence of management persons. This forum gives the auditors the opportunity to mention any issues/ problems that might be faced. This also becomes a good forum to understand how the company can improve its existing practices. AC can also ensure that the Statutory and Internal Auditors interact with one another.
9. Interaction with Chief Risk Officer (CRO) – Risk management and Internal Audit go hand in hand. Some companies therefore have started the practice of inviting the CRO to the AC meeting, for interaction with AC members.
10. Internal Audit – It is the role of AC to approve the annual Internal Audit plan, and to have the Internal Auditor report to it every quarter on findings and the next steps. Good ACs ensure that Internal Audit function has the necessary independence that it requires to function. For this, it is important that Internal Audit reports to AC on functional matters.
11. RPTs – There are a number of stipulations with respect to RPT. The practice that a number of good ACs have found useful is to, on a random basis, ask for the working papers relating to 1-2 RPTs, to ensure that the management follows the correct process/ procedure for ensuring that the transaction is at arms length and in the ordinary course of business. This would also ensure that the management would be careful when it comes to putting through such transactions.
12. Whistleblower mechanism – AC Chair should ensure that a whistleblower can have access to him/her in exceptional cases. AC should also ensure that the mechanism functions independently.
13. Prohibition of Insider Trading – In the case of violation of Insider Trading regulations, AC must ensure that the penalty imposed is in accordance with the violation, and a soft treatment is not given.
14. Legal cases – A number of good ACs ensure that they have exposure to the material legal cases, along with a status update.
15. Oversight of subsidiaries – ACs of holding companies should invest time in interacting with the Statutory Auditors of the subsidiaries, to ensure that nothing of consequence is missed. This is especially important when the auditor of the subsidiary is different from the auditor of the parent.

The AC is the repository of trust of stakeholders. It cannot afford to underperform.