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Audit Committee: Ready For New Role?

Published on Tue, May 13,2014 | 23:14, Updated at Tue, May 13 at 23:14Source : 

By: Deepankar Sanwalka, Leader & Pankaj Tewari, Associate Director - Risk Advisory Services, PwC India

The Companies Act 2013 intends to significantly raise the bar on corporate governance in India and align it with global standards. It makes a paradigm shift; from a control based regime to a trust based regime. It encourages disclosures and transparency.  

The renewed focus on governance has turned the spotlight on the role of Audit Committee. The new responsibility cast upon the audit committee is not merely an arithmetical addition in terms of elements of scope; it requires a different level of awareness, approach and orientation.

Under the new company law, constitution of Audit Committee is mandatory for listed companies and following classes of companies:- 

       i.   all public companies with a paid up capital of ten crore rupees or more;

       ii.  all public companies having turnover of one hundred crore rupees or more;

       iii. all public companies, having in aggregate, outstanding loans or borrowings or
           debentures or deposits exceeding fifty crore rupees or more.  

There is an important point to be noted here. While it may seem, at a cursory glance, that only public companies meeting prescribed threshold limits are covered above, in reality, even private companies which are subsidiaries of public companies would get impacted.  

Let us analyse some of the new responsibilities entrusted to Audit Committees.

Pre-approval of related party transactions  

Under the Companies Act, 2013, related party transactions are required to be approved by audit committee. Revised clause 49 of the listing agreement mandates a stricter condition for listed companies by prescribing pre-approval of all related party transactions. It is a big transition - from current ‘post mortem’ to a ‘real time’ review.

‘Approving’, it may be appreciated, is not akin to ‘reviewing’ or ‘noting’. It means putting a seal of approval after considering all regulatory, compliance and business aspects. It puts the onus on audit committee.

On the implementation front, pre-approval of all transactions may pose its own practical challenges. It would be onerous to ensure compliance, if there are regular transactions of large volumes. Audit committees meet after a fair gap and business cannot be brought to a standstill. A more viable solution could be to go for ratification of transactions under pre-approved contracts. One hopes that this issue would get addressed through a suitable clarification or amendment.  

Reporting of fraud to the central government

The auditing community is seriously concerned about the statutory obligation of reporting frauds, committed against the company by officers or employees of the company. The concept of materiality, which found a logical place in draft rules, has rather surprisingly, been omitted from the final rules, much to the discomfiture of industry and professionals.    

Prior to reporting to the Central Government, the auditor is required to seek the response of the Audit Committee on his complaint. The auditor has to report not only ‘actual frauds’ but even ‘suspected frauds’.

The audit committee being the first point of escalation has to closely review the fraud prevention framework along with the management, to be able to appropriately tackle such situations and not get caught unawares. It may be pertinent to mention that Audit Committee, is mandated to evaluate internal financial controls, which under the new law, also covers policies and procedures to prevent frauds and errors.       

It may be worthwhile to note that fraud-reporting obligation has also been cast upon cost auditor and secretarial auditor on the same lines as statutory auditor.

Vigil mechanism or whistle blower policy  

Listed and other specified companies have been mandated to establish a vigil mechanism for directors and employees to report concerns about unethical behaviour, fraud, violation of the company’s code of conduct or ethics policy. The vigil mechanism shall provide for adequate safeguards against victimisation and also provide for direct access to the Chairperson of the Audit Committee, in exceptional cases. In case of repeated frivolous complaints, the audit committee may take suitable action including a reprimand. The details of establishment of such mechanism shall be disclosed by the company on its website and in the Board’s report.  

The audit committee has been given the responsibility of overseeing the vigil mechanism. Since this can be used to report fraud as well, it becomes a powerful tool available to the audit committee, to nip potentially dangerous situations in the bud.    

Scrutiny of Inter-corporate loans and Investments  

Inter-corporate loans and investments have come under a scanner in the new regime. Interest free loans are no longer allowed. There are restrictions on limits. Particulars and purpose of loans, guarantees etc have to be disclosed in financial statements. The mandate of audit committee includes scrutiny of inter-corporate loans and investments.

Review the effectiveness of audit process  

Audit committees, both as a matter of convention and good practice; engage with statutory auditors about the nature and scope of audit as well as do a post-audit discussion to ascertain any area of concern. The new company law has added a couple of interesting elements - review and monitor the auditor’s independence and performance, and effectiveness of audit process.

‘Reviewing the effectiveness of audit process’ goes beyond discussions on scope and includes a responsibility to provide inputs to improve the effectiveness of audit process. It could also mean a degree of encroachment on the turf of auditors. The ultimate accountability of statutory auditors is to the shareholders and they are expected to be absolutely independent in performance of their duties.

Lines of Defence / Safeguards

1.       Expert / Professional Advice

2.       Discussion with internal auditors on fraud / control weaknesses

3.       Due Diligence / Training

To discharge their responsibilities, Audit Committees can rely on tools and safeguards available to them. First and foremost, is resorting to expert advice whenever in doubt. This not only brings an independent view but also insulates individuals from charges of bias and indiscretion. Most importantly, it creates an evidence of due diligence which is an important pre-requisite for independent and non-executive directors, to claim immunity from prosecution.     

Discussions with internal auditors on control weaknesses and suspected frauds could give vital clues to help initiate preventive steps.  In a laudable move, under revised clause 49, SEBI has proposed direct reporting of Internal Auditors to the Audit Committee. This requirement, for the time being, is non-mandatory.   

Training for independent directors has been made mandatory. It will help familiarize them with the company, their roles, rights, responsibilities in the company, nature of the industry, business model etc. The importance of staying current with regulatory developments and changing business environment cannot be undermined.   

Company Law and Clause 49 require members of Audit Committee to be financially literate. However, the expectations of the new role and responsibility call for expertise much beyond financial domain. It requires change in mindset, thought process and approach. Professional expertise coupled with business understanding can hold them in good stead.  

An effective audit committee can play a big role in improving corporate governance which in turn can boost the confidence of industry and investor community. The opportunity to make a difference is there; it is now only a question of being able to measure up to the expectations.


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