From: Chief Internal Auditor
To: Board of ZX
Subject: Role of Audit Committee
Date: June 2005
(a) Areas where the internal audit department can assist the directors with the
implementation of good corporate governance in an organisation include:
Board reports
Reviewing reports to the board and reports produced by the board to ensure that they do
present a balanced and understandable assessment of the company’s position and
prospects. The internal audit department will have good knowledge of the operations of
the company as well as access to accounting information. The department can effectively
‘audit’ board reports to ensure they are accurate and understandable.
Internal controls
The board need to maintain a sound system of internal control. The internal audit
department will be able to review existing controls and recommend improvements to
ensure this objective is met.
Application of ISA and IASs
The board need to have a policy for applying appropriate International Statements on
Auditing (ISA) and International Accounting Standards (IAS) to the organisation.
Internal audit will certainly be aware of new auditing standards and will have the
technical expertise (especially where internal auditors are professionally qualified) to
identify changes required by accounting standards. Amendments to control systems for
new auditing standards and financial accounting systems for new accounting standards
can therefore be recommended.
Communication with external auditors
Under corporate governance regulations, communications with external auditors will
normally be via the audit committee, although the board must maintain an appropriate
relationship with the external auditors. However, internal and external auditors can also
work together to ensure that the internal control system is sufficient; possibly by external
audit delegating work to internal audit, and each auditor reviewing the work of the other
auditor. The board will therefore receive reports from both sets of auditors which will be
accurate because they have been properly checked.
Communication to the board
The internal auditor can also check that appropriate information is provided to the board
from the external auditor. ISA 260 Communications of audit matters with those charged
with governance provides a list of matters which should be communicated to the board
and the internal auditor can work with the external auditor to ensure that this information
is provided.
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The advantages of an audit committee include:
Public confidence
Providing increasing public confidence in the creditability and objectivity of published
financial information. This will be particularly important for the entity if listing
arrangements go ahead. While an internal audit department is not normally necessary for
incorporated companies, the provision of that department will provide additional
confidence in the accuracy of the financial statements and hopefully make the entityan
attractive investment.
Financial reporting
Supports the directors in fulfilling their financial reporting obligations. The directors have
to prepare financial statements for the entity. The committee can assist by checking the
financial statements to ensure that they comply with appropriate reporting
requirements. This is especially important where the board do not have detailed
knowledge of accounting requirements.
Communication
Enhancing the role of the entity’s external auditors by providing an appropriate channel
of communication. Use of the audit committee will enable the external auditor to discuss
issues with the financial statements with the internal auditor, prior to providing a final
summary of key points to the board.
‘Friend’ of the Board
The audit committee may also act as a ‘critical friend’ to the board by monitoring the
work of the board and providing helpful guidance, where corporate governance
requirements do not appear to be being met. The audit committee should have detailed
knowledge of corporate governance as part of its monitoring function of the company and
can share this with the board who may not have the time to obtain detailed information.
The disadvantages of an audit committee include:
Lack of understanding of function
As directors in an entity do not have much knowledge of corporate governance, they
may see the additional involvement of the audit committee as a threat to their authority or
taking away some of their responsibilities. This memo has hopefully outlined the
advantages of an audit committee in supporting the work of the directors, removing this
as a problem.
Role of non-executive directors
As the audit committee will be made up mainly from non-executive directors, the board
may see this as a means of decreasing their power and possibly letting other people run
the company. Again, the audit committee must be seen as fulfilling a supporting role for
the main board. It will utilise the special knowledge of account production and internal
controls from the external auditor and business non-executives to provide appropriate
review of information being given to the board.
Cost
The audit committee will increase the expenditure of the company as the non-executive
directors will require some remuneration due to their additional responsibilities. While
this cannot be avoided, the benefits of the committee in terms of providing assistance to
the board and raising the profile of the entity ready for possible listing must not be
forgotten.
