Audit Committee is one of the several committees that has been recommended by the Companies Act, 2013. This committee has a remarkable role to perform in today’s environment and not merely an ornamental one.
If duly constituted, this committee has the ability to act as guard against the unintentional illegal transaction and thereby widen the prospect of the Company and enhance the value of the stakeholders.
Of late financial turbulence of some well reputed companies has further increased the scope and importance of this committee.
As per Companies Act, 2013 and Rules framed there-under the Board of Directors of the following types of public companies shall compulsorily constitute an audit committee:
(i) every listed company
(ii) every public company having paid-up capital of Rs. 10 crore or more;
(iii) every public company having turnover of Rs.100 crore or more;
(iv) every public company having in aggregate outstanding loans or borrowings or debentures or deposits exceeding Rs. 50 crore or more;
While calculating the paid-up capital, turnover, deposit, outstanding debentures data available in the last audited balance sheet shall be taken into consideration.
Constitution of Audit Committee in other companies is voluntary in nature and depends upon the outlook and requirement of the Board.
Composition of Audit Committee:
The Companies Act, 2013 has elaborated the composition of Audit Committee. Also, SEBI (LODR) Regulation 2015 has prescribed the composition for every listed company. Therefore, listed company should compose their Audit Committee in such a manner that the provisions of Companies Act, 2013, as well as SEBI (LODR) Regulation 2015 are complied with.
♣ Composition in case of Unlisted Company:
(1) As Per Section 177 of The Companies Act, 2013 the Audit Committee shall consist of a minimum of three directors with independent directors forming majority.
(2) Majority members shall be able to read and understand financial statements;
(3) Chairman of the Audit Committee should be able to understand financial stamens;
♣ Composition in case of Listed Company:
(1) Minimum number of members of a Audit Committee of a listed company shall have minimum three directors as members;
(2) Two third members of the committee shall be independent directors;
(3) All members shall have financially literate and at least one member shall have expertise in financial management expertise.
(4) Chairman of the Audit Committee shall be an Independent Director and shall present AGM to answer the shareholders queries;
Meaning of the term financial understanding:
In common parlance ‘financial understanding’ means having understanding of Balance Sheet, Profit and Loss Account prepared as per standard accounting system. Here, it is not required to have expertise on financial or accounting matters. The Companies Act 2013 has not defined the meaning of the term financial understanding or extent of financial understanding.
However, SEBI (listing obligations and disclosure requirements) regulations 2015 provides that financial literate shall mean the ability to read and understand basic financial statements s i.e. balance sheet, profit and loss account, and statement of cash flow.
The explanation of of SEBI (LODR) Regulation 2015 further states that a member shall be considered to have accounting or related financial management expertise if he posses experience in finance or accounting or requisite professional certification in accounting or other comparable background.
Difference of Composition of Audit Committee in Listed and Unlisted Company;
|Un-listed Company||Listed Company|
|1. Minimum number of members is three;||1. Minimum number of members is three;|
|2. Majority members (i.e. at least 51%) should be independent;||2. Two Third of the members should be independent;|
|3. The act has not particularly mandates to keep an Independent Director as its Chairman.||3. The Chairman should be Independent Director;|
|4. Though the Secretary of the Company normally act as Secretary of the Committee by virtue of his position, but the act has not mandated this.||4. The Secretary of the Company should be the Secretary of the Committee.|
Charter of Audit Committee:
It is the responsibility of the Board of Directors to constitute and decides the charter of the Audit Committee. Among other activities, the charter should include the following:
(i) the recommendation for appointment, remuneration and terms of appointment of auditors of the company;
(ii) review and monitor the auditor’s independence and performance, and effectiveness of audit process;
(iii) examination of the financial statement and the auditors’ report thereon;
(iv) approval or any subsequent modification of transactions of the company with related parties;
(v) scrutiny of inter-corporate loans and investments;
(vi) valuation of undertakings or assets of the company, wherever it is necessary;
(vii) evaluation of internal financial controls and risk management systems;
(viii) monitoring the end use of funds raised through public offers and related matters.
Meeting of Audit Committee:
An unlisted company should conduct meeting of the committee as and when required and as per the charter of its constitution.
However a Listed company must conduct minimum four meeting in a year and 120 days shall not elapsed between two meetings.
Role of Audit Committee in Related Party Transactions (RPTs):
Regulation of RPT transactions being crucial activity for good governance, the Companies Act, 2013 contains elaborate requirements in respect of RPTs. Every company has to follow the prescribe set of procedures in respect of RPTs. Audit Committees can play significant role in determining the RPTs and designing the internal procedure of the Company to be followed so that related non-compliances can be avoided. It is advisable to refer each RPT to the Audit Committees for testing the transactions in terms of legal and internal compliances point of view.
The SEBI (LODR) Regulation 2015 mandates to refer all the related party transaction to the Audit Committee and to design the RPT policies.
The Audit Committee shall oversee the vigil mechanism process of the Company. Every listed company and other companies which accept deposits from public or the companies which have borrowed monies from banks and public financial institutions in excess of Rs.50 crore shall compulsorily establish vigil mechanism process and disclose it in the Boards Report.
The vigil mechanism shall provide safeguard to the employees and directors who avail such mechanism and shall provide direct access to chairman of the audit committee in required cases.
Outside Professional Advice:
Audit Committee of un-listed companies, as well as a listed companies can obtain outside professional advices from eternal sources as and when it is require. This committee shall have full access of books and records of the company.
Disclosures in Board Report:
If the boards of directors of the company fails to follow the recommendations of Audit Committee then it is the responsibility of the Board to mention the same along-with justification in the Boards Report.
Boards Report should also disclose the composition of the Audit Committee.
Voluntary Audit Committee:
If a company, where the constitution of Audit Committee is not obligatory, yet the company has established an audit committee then it will be the responsibility of the board of that company to properly constitute the same and follow necessary provisions of the act. Also, the Committee shall be liable to perform accordingly.
Past Trend Vs Current and Future Trends:
Of late majority of the small and family based business organization, constitution of Audit Committee was merely a paper work and an ornamental one. However, shift of governance paradigm changed this mindset of these companies. The role of an Audit Committee, now-a-days, is a well-accepted fact.
Importance of Audit Committee:
Importance of an audit committee is enormous. Especially in Indian context, where corruption is rampant and legal awareness and compliances culture has long route to go this committee has a remarkable role to play.
(a)Importance to the Board:
(1) This committee being formed by the Board of Directors itself it enjoys the confidence & trust of the Board.
(2) As the Committee being manned by financially literate person this committee is well equipped to keep track with the integrity of the complicated financial transaction in terms of legality as well as companies outlook and thereby protect the Board from unintended non compliances;
(3) This committee acts as a first and most important point to judge the legitimacy of the financial activity/transaction of the Company.
(4) The Audit Committee regularly keeps track of the audit activities and maintain regular interaction with the auditors, both statutory and internal, and thereby it helps the Board to devout their time in other development activities;
(b) Importance to the Shareholders:
(1) Audit committees have a pivotal role to play in enhancing audit quality;
(2) A well designed Audit Committee increases the trust of shareholders towards the Company, as it enhance the integrity of the financial transactions of the Company;
(3) Audit Committee enhance value of investment of the shareholders;
(c ) Importance to the Auditors:
(1) As the Audit Committee is manned with financially literate person, Auditors find it comfortable to explain their views to the Committee. Moreover as the Committee enjoys the trust of the Boards of Directors they can provide immediate response to the Auditors views and can act as bridge with the board and auditors.
(2) Regular interaction of Audit Committee and Auditors add value to the audit system and financial disclosures.
The Companies Act, 1956 had also provided to establish a Audit Committee in case a public company where paid up share capital is 5 crores or more. The Companies Act, 2013 provides that a company existing immediately before the commencement of this act shall within a period of one year shall reconstitute the committee.
Note: I this article its is mentioned as ‘SEBI (LODR) Regulation 2015’ , should be read as ‘SEBI (listing obligations and disclosure requirements) regulations 2015’.
(Author is Associated with ‘RRR Compliance Services (A division of PJ LAW SOLUTION) and can be reached at firstname.lastname@example.org)