Audit committees: A healthy environment of challenge
JOHANNESBURG – An effective audit committee is the cornerstone of a well-governed organisation, and independence is a key prerequisite.
It is no surprise that the oversight of an organisation's financial controls, assurance and reporting should be one of a governing body's most important tasks – and that it should delegate this key responsibility to a specialised and independent committee.
While some organisations are required to appoint an audit committee by statute, the King IV Report on Corporate Governance recommends that, as leading practice, any organisation that issues financial statements should consider establishing such a committee.
Given the importance of what audit committees do, it is thus critical that governing bodies pay close attention to how they are constituted and how they function. Members of governing bodies should also remember that, as is true in all cases where authority and responsibility are delegated, the governing body itself is ultimately accountable.
King IV offers a series of recommendations designed to help governing bodies achieve the outcomes of Principle 8: The governing body should ensure that its arrangements for delegation within its own structures promote independent judgement, and assist with balance of power and the effective discharge of its duties.
King IV defines an audit committee's role as providing independent oversight of two key areas, among others: the effectiveness of the organisation’s assurance functions and services, and the integrity of the financial statements.
A key concept here is that of independence, and it's one that needs deep thought.
In 2016, the Independent Regulatory Board for Auditors (Irba) raised the red flag over this question. Based on research and consultation, it indicated that, generally speaking, auditors were not independent of their clients nor of their clients’ audit committees.
The Irba’s release seems to trace this lack of independence to an over-cosy relationship created by long tenures, specifically referencing a rule introduced by the Irba that requires an auditor to disclose the number of years he has undertaken the audit for a particular client.
As a matter of principle, the Irba argues that “a healthy environment of challenge” needs to exist between the auditor and the audit committee including, more broadly, the organisation’s governance structures.
As one might expect, it is critical that audit committee members should have the “necessary financial literacy, skills and experience to execute their duties effectively” (Recommended Practice 55).
It would be prudent for at least one member to be a financial expert commensurate with the complexity of the organisation’s financial affairs and their impact on the broader financial system.
Another important contributor to an audit committee's effectiveness is the extent to which its members are independent of the company.
King IV recommends that its members be independent, non-executive members of the governing body and that it be chaired by one of them, as appointed by the governing body.
As is always the case in King IV, disclosure is critical because it forces those responsible for governance (in this case the audit committee members) to explain why they took the actions they did, and how those actions moved the organisation closer towards achieving the desired end goals.
King IV’s Recommended Practice 59 suggests that certain items be disclosed in relation to the audit committee.
In line with the importance of the audit committee's independence, as noted above, these include a substantial section on independence.
Other items to be disclosed would include significant matters relating to the annual financial statements and how they were addressed, and the audit committee's views on the quality of the external audit, the effectiveness of the chief audit executive and the internal audit, the Chief Financial Officer and the finance function, and the arrangements in place for combined assurance.
Parmi Natesan and Dr Prieur du Plessis are respectively chief executive and facilitator of the Institute of Directors (IoDSA). email:[email protected]