CORPORATE GOVERNANCE Take Home Assignment [CAT 3]

TOPIC: The Role of Audit Committee in Corporate Governance: An Overview

Submitted by: Ankita Sinha, Sem: IX, Sec- A, Roll No- 156
The present note seeks to give an outline of the starring importance of an Audit Committee in
maintenance of the spirit of corporate governance in the company. The Audit committee is solely
constituted for the purpose of maintaining financial transparency in the company, and thus
improving accountability in all financial dealings of the company. This ensures that an investor
who has an interest in the company has the means to access information with respect to the
utilization of the funds of the company. The note gives a brief account of the historical
development of the audit committee and its relevance in todays time.
In order for a nation to survive and prosper, it is a fundamental requirement that it be governed
by some authority which embodies the place of a leader or path builder for the rest of the
subjects to follow. Further, in order for any institution to strive for a role in this nation, it is
important that it operates under this authority and thus, the interests of the subject are protected
in the nation. Thus, drawing an analogy here, in a corporate body, working for a profit motive,
the primary structure within which it works are the laws and regulatory requirements in the
certain country, where it is established. The guiding force in the functioning of the body therefore
is the legal structure and spirit of shareholder protection that flows from it. An audit committee
in a corporate entity is an external monitor of the financial holdings and transactions of the
company, and the present note on the Role of auditors shall further elaborate the same.
Corporate governance is the edifice on the basis of which a corporate entity is supposed to
operate, it is the ethos and principles of accountability under the corporate governance scheme
which ensures that the rights of shareholders are safe & secure. The audit committee assumes a
vital place in this structure, so much so, that it is an essential requirement that companies should
have an independent structure to verify and safeguard the integrity of financial reporting. This
integrity can only be achieved and maintained, thus, by the establishment of an Audit committee.
The existence of an audit committee is recognized internationally as an important feature of
corporate governance.
Auditors being key persons in corporate world play a major role in not only addressing the issues
but also coming up with plans to find the solutions for closing the issues. Most of the scams,
frauds etc come to light only due to good Audit mechanism in place. Auditors work neither for
Board nor for Stakeholders, they work for identifying the compliance part and try to remove any
deviations by placing proper controls. So, the primary role of Auditors is to check whether the
financial information provided to stakeholders are reliable or not. Audit Committee is a body
which comprises of independent directors whose main objective is to assure the integrity of

financial statements, adhering to regulatory compliances, placing internal controls and mitigating
any risk there on. A qualified person, who inspects the accounting records and the practices of an
organization, is the basic definition of a Company Auditor.
In financial accounting, an audit is categorized by the self-governing evaluation of the justice by
which a company's financial statements are presented and prepared by and to its supervisor.
This task is largely performed by the trained, experienced, self-governed and intent persons,
known as accountants or auditors. Auditors are on the whole very informed with every
characteristic of auditing and they in turn matter a report known as auditors report. Since, the
auditor acquire immense knowledge in their company and the marketplace in which the company
operates, auditors are highly practiced to grant information outside their part of auditing to the
company. Other services that they can offer are successions planning, management consulting,
planning taxes and deregulation preparation. There are generally two types of auditors:
External Auditors: These auditors visit from outside the company to access and weigh up
the financial statements of their clients or to carry out essential evaluation than necessary. They
are usually appointed for a time span of 1 year.
Internal Auditors: They are hired by the companies as employees to access and assess
the internal direction necessary in the company. They testify directly to BODs or the highest
management. They are answerable to have a through view on related issues of the frauds and
conflicts that are visible in a companys record. As a common statement, audits are always
supposed to be an independent evaluation which includes few degrees of both quantitative and
qualitative analysis; whereas a judgment requires more dependent and more counseling
approach.
The reason being, the purpose of a judgment is to assume something or calculate the worth for it.
Although the process producing a judgment may involve an audit as an independent professional,
its aim is to give a measurement instead of expressing an opinion for the accuracy of statements
or the level of excellence in their performance.
The concept of audit committee came in the wake of the American case of McKesson v. Robbins
Inc1 involving auditors liability. In the year 1972, the Securities Exchange Commission of USA
first recommended that publicly held companies must establish audit committees, in its initiative
to strengthen the corporate governance regime. The Sarbanes-Oxley Act, 2002, with its objective
of the protection of investors by improving the accuracy and reliability of corporate financial
statements incorporated provisions on the role of audit committees. It also made provisions for
stiffer penalties for auditors, corporate officers, company directors and others who would violate
the Act.
1 351 US 305 (1956)

In the Indian scenario2 of Corporate Governance there were lot of committees /bodies set up
under Ministry of Corporate Affairs (MCA) and SEBI which looked in to the framework of
Corporate Governance and came out with many recommendations which were later adopted by
the professional Audit bodies. SEBI commissioned a series of projects to improve Indian
corporate governance by building on CIIs code (and by converting the voluntary code into a
mandatory one). This work would eventually lead to the Clause 49 reforms. The first SEBI
committee, comprised of 17 prominent business leaders and chaired by Kumar Mangalam Birla,
advocated a variety of new governance requirements including a minimum number of
independent directors, the creation of audit committees and shareholders grievance committees,
and additional management disclosures on firm performance.
The Kumar Mangalam Birla Committee on Corporate Governance 3 recommended the
establishment of an Audit Committee in its report, with the view that it was indispensable in the
larger frame of governance principles for a corporate entity. It recommended thus, that the
committee must be constituted under the board of directors, and it will thus be sub-group of the
directors on board, and act as a monitor for the company. The Audit committees job would be of
oversight and carrying out of the job would require senior financial management and outside
auditor. The committee recommended that thus, a qualified and independent audit committee be
set up by the board of the company. The composition as suggested under the report, was based on
the fundamental premise of independence and expertise; wherein, the committee was to have
three members, all of them being non-executive and independent directors, with at least one of
them, having expert financial accounting knowledge. The chairman was recommended to be
present at shareholder meetings, to be able to address any financial queries by the shareholders,
thus, fostering an environment of transparency.
The SEBI Report4 recommended that the Committee recommends should have following
powers:
To investigate any activity within its terms of reference.

To seek information from any employee.

To obtain outside legal or other professional advice.

To secure attendance of outsiders with relevant expertise, if it considers necessary.

Confederation of Indian Industries (CII) set up a Task Force under the chairmanship of Shri
Naresh Chandra, the Task Force visited various key areas which played vital role in Corporate
Governance. Some of the areas on which recommendation were made Board of Directors, Role
2 http://www.ijcem.org/papers012012/ijcem_012012_03.pdf
3 February 2004
4 Kumar Manglam Birla Committee report (February, 2004)

of Auditors, Role of Regulatory and Role of External Institutions. The report recommended that
the Audit Committee and Executive management should collectively identify the sources of risk
and try to minimize or mitigate the risk. Such Risk Management policy should be revisited on
timely basis. Further, it also suggested an Audit Oversight Mechanism Government to
intervene and strengthen the Quality Review.
The Narayan Murthy Committee5 reforms expanded on the Birla Committees work in several
areas, including the frequency of meetings of Audit committee; it was now required to meet more
frequently (four times per year), and members had to satisfy new financial literacy requirements.
International Audit Standards maintain that an auditor's mandate may require him to take
cognizance and report matters that come to his knowledge in performing his audit duties which
relate to: Compliance with legislative or regulatory requirements; Adequacy of accounting and
control systems; Viability of economic activities, programmes, and projects.
Two variant situations emerge when the functions of auditors and the requirements of good
governance are placed face to face. The former is confined to 'economic actions and events,
while the later is the outcome of a wide range of managerial functions. The question then arises
whether the auditors should cross their operational limits in order to bring about the desired level
of improvement in the quality of governance, or, alternatively, while restricting themselves to
their term of reference, they should operate more effectively so as to help improve the quality of
governance.
Lately, a view has emerged that auditors should play a more vital and direct role in establishing
good governance. Should this mean to expect them to cross the established borders of genuine
audit functions, it would be stretching the string too far, without gaining anything positive and
substantial. The only alternative then is to make the auditors feel more conscientious, more
dutiful, and therefore to be more effective, while restricting themselves to their term of reference.
International Auditing Standards (IAS) also recognize that the matters that may be relevant to the
governance of any business entity may be broader than those that form the subject matter of IAS,
which are directly related to the audit of financial statements. IAS 260 categorically requires the
auditors to communicate with the officials charged with the governance of an entity the matters
arising from the audit of financial statements. They will not be required, the IAS continues, "to
design procedure for the specific purpose of identifying matters of governance interest".
Under the Indian Companies Act, 2013, Section 177 of the Act, 2013 lays down the constitution,
composition and the roles and responsibilities of the Audit Committees. It applies to all listed
companies and to public companies with paid up capital of rupees 100 Crore or more or
5 http://www.acga-asia.org/public/files/ACGA_India_White_Paper_Final_Jan19_2010.pdf

aggregate outstanding loans/borrowings/debentures/deposits exceeding rupees 200 Crore, as

specified by the Rules released for public comment in September 2013. Rule 6 and 7 of
Companies (Meetings of Board and its Powers) Rules, 2014 deals with the Audit Committee.
The focus of the Audit Committee has shifted specifically on new committee dynamics, financial
reporting, risk oversight, oversight and evaluation of performance and effectiveness of the audit
process, rotation of the statutory auditor, interaction with the statutory auditor and the internal
auditor, oversight and evaluation of internal financial controls, related party transactions, vigil
mechanism, and more importantly for the first time on the monitoring of the end use of funds
raised through the public offers. Chapter X read with Section 139 to Section 148 6 deals with
provisions relating to Audit & Auditors, from their appointment to duties. Section 143 deals with
Powers & duties of auditors and Auditing Standards of auditors.
Thus, it is established that auditors are not required to traverse their area of operation. Whatever
they are expected to contribute towards good governance shall, therefore, be from within their
range or sphere of activity. In other words, it is the quality of their performance that will make all
the difference, which, therefore, needs to be ameliorated to match the requisites of good
governance. It is important that the auditors remain accountable to the audit committee and thus,
strengthen the pillars of corporate governance.
Reports Referred:
Securities and Exchange Board of India, Report of the SEBI Committee on Corporate
Governance (February 2003).
Report of the CII Task Force on Corporate Governance, Confederation of Indian Industry,
Chaired by Naresh Chandra, November 2009.

6 Companies Act, 2013.