What qualities are expected of audit committee members?

The primary purpose of a company’s audit committee is to provide oversight of the financial reporting process, the audit process, the company’s system of internal controls and compliance with laws and regulations.

Table of Contents Show

Audit Committee Role and Duties
How an Audit Committee Operates
What Makes Audit Committees Effective
Explore How a Master of Accountancy Could Enhance Interaction with an Audit Committee

The audit committee can expect to review significant accounting and reporting issues and recent professional and regulatory pronouncements to understand the potential impact on financial statements. An understanding of how management develops internal interim financial information is necessary to assess whether reports are complete and accurate.

The committee reviews the results of an audit with management and external auditors, including matters required to be communicated to the committee under generally accepted auditing standards. Controls over financial reporting, information technology security and operational matters fall under the purview of the committee.

The audit committee is responsible for the appointment, compensation and oversight of the work of the auditor. As such, CPAs report directly to the audit committee, not management.

Audit committees meet separately with external auditors to discuss matters that the committee or auditors believe should be discussed privately. The committee also reviews proposed audit approaches and handle coordination of the audit effort with internal audit staff. When an internal audit function exists, the committee will review and approve the audit plan, review staffing and organization of the function, and meet with internal auditors and management on a periodic basis to discuss matters of concern that may arise.

Audit committees must have authority over their own budgets and over external auditors. It is through these protections that investors will come to trust the financial reports released by companies.

While boards should seek members who can provide a diverse range of competent perspectives based on their experience and expertise, it is nevertheless imperative that board members are knowledgeable and conversant in the language of finance and accounting. This need is particularly acute for the audit committee.

Effective April 2003 the Securities and Exchange Commission (SEC) adopted a rule directing the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that is not in compliance with the audit committee requirements mandated by the Sarbanes-Oxley Act of 2002. The requirements relate to:

The independence of audit committee members;
the audit committee's responsibility to select and oversee the issuer's independent accountant;
Procedures for handling complaints regarding the issuer's accounting practices;
The authority of the audit committee to engage advisors;
Funding for the independent auditor and any outside advisors engaged by the audit committee.

The rule implements the requirements of Section 10A(m)(1) of the Securities Exchange Act of 1934, as added by Section 301 of the Sarbanes-Oxley Act of 2002. Under the rule, listed issuers must be in compliance with the new listing rules by the earlier of their first annual shareholders meeting after January 15, 2004, or October 31, 2004. Foreign private issuers and small business issuers will have additional time to comply.

In July 2015, the SEC voted to publish a concept release seeking public comment on audit committee disclosure requirements, focusing on the committee’s oversight of independent auditors. The SEC is interested in receiving information about the audit committee and auditor relationship and whether improvements can be made to enhance the information provided to investors about the audit committee’s responsibilities and activities.

“Effective audit committee oversight is essential to investor protection and the functioning of our capital markets,” said then SEC Chair Mary Jo White. “The way audit committees exercise their oversight of independent auditors has evolved and it is important to evaluate whether investors have the information they need to make informed decisions.”

In addition to seeking views about audit committee disclosures, the concept release invited comment on whether SEC disclosure requirements should be refined to provide more insight into the information the audit committee used and the factors it considered in overseeing the independent auditor. This includes considerations related to the process for appointing or retaining the auditor and the qualifications of the auditor and certain members of the engagement team, among others.

All audit committee members should be independent. Independence is needed to prevent insiders from influencing the work and oversight of the committee and the work of the external auditors. Companies operating in specialist niches should have to meet the same audit committee disclosure and structure requirements as companies operating in more traditional markets. This is because companies in specialist niches are affected by the same conflicts and potential for accounting fraud as more traditional companies and therefore should meet the same independence and financial experts’ requirements as traditional companies. In cases where this is not feasible they should disclose such deficiencies to investors to alert them to the possibility of management influence on the audit committee.

Audit firms should use auditors with forensic audit backgrounds to assist in the audits and for training audit staff in identifying cases of intentional accounting errors and irregularities. Auditors should be able to identify earnings management or accounting irregularities, and thus, deter such activity.

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 (SEC) in areas such as audit committee composition, independence and member qualifications. The audit committees of governmental entities must comply with requirements established in state statutes, city or county charters, municipal codes or local laws.

The expertise of members and the ongoing training they receive have a significant effect on an audit committee’s ability to carry out its responsibilities. Audit committees must continuously update their knowledge in areas such as new accounting methods, technology and financial disclosures.

What Makes Audit Committees Effective

How effective the committee is in executing its audit committee responsibilities can be influenced by several factors:

Having a strong audit committee chairperson who can facilitate productive meetings and communicate effectively is essential to the success of an audit committee.
Providing training to audit committee members through adjunct meetings, retreats or courses offered by governance organizations helps committee members carry out their responsibilities.
Performing a self-assessment helps an audit committee identify and address opportunities for improving its oversight activities.
Ensuring transparency in its activities allows an audit committee to share important information with stakeholders.
Establishing effective communication — both internally among audit committee members and externally with management, auditors and non-audit board members — helps an audit committee demonstrate how it is carrying out its responsibilities.
Ensuring diversity among committee members in terms of experience and knowledge enhances its capabilities and proficiency.

Among the most important characteristics of an effective audit committee is strong communication with and oversight of auditors. Audit committees need to have a good working relationship and direct line of communication with the public accounting firm that serves as the organization’s external auditor. They also must establish a strong rapport with internal auditors to promote effective internal controls.

Explore How a Master of Accountancy Could Enhance Interaction with an Audit Committee

Understanding audit committee responsibilities is essential for individuals who wish to pursue careers in auditing or public accounting. Through the University of North Dakota’s online Master of Accountancy program, students can acquire valuable knowledge to draw upon when interacting with and reporting to audit committees. Learn how to enhance your expertise today.

Sources:

Association of Local Government Auditors, Audit Committee Guidance

CFA Institute, Audit Committee Role & Responsibilities

Deloitte Center for Board Effectiveness, Audit Committee Requirements and Governance Topics

Harvard Law School Forum on Corporate Governance, “The Strategic Audit Committee: a 2020 Preview”

The Institute of Internal Auditors, The Audit Committee: Purpose, Process, Professionalism

International Federation of Accountants, “5 Key Factors to Enhance Audit Committee Effectiveness”

KPMG, Keeping pace with disruptive risk and digital transformation, 2019 Audit Committee Pulse Survey

NACD BoardTalk, “How to Get First-Time Audit Committee Members Up to Speed”

U.S. Securities and Exchange Commission, Statement on Role of Audit Committees in Financial Reporting and Key Reminders Regarding Oversight Responsibilities