The Role of an Audit Committee in Corporate Governance

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Corporate governance sets the parameters of how the firm conducts business.
Corporate governance sets the parameters of how the firm conducts business. (Image: corporate office building image by Jake Hellbach from Fotolia.com)

Corporate governance is the structure, or the template that houses the set of rules that regulate the operating practices, procedures, processes and ethics, assuring that the firm conforms to best practices and the law across the spectrum of all its activities. It also assures that the best interests of the firm’s stakeholders are protected.

Stakeholders

The firm’s stakeholders are generally defined as its stockholders, its financiers, its board of directors, its management, its employees, its suppliers, its customers, the end-use consumer, the communities in which it operates and the government.

The firm's stakeholders are a mixed breed.
The firm's stakeholders are a mixed breed. (Image: group of people hand waving image by Accent from Fotolia.com)

Corporate Governance vs. Rules

Corporate governance is considered to be the “structure” or the framework containing the rules, as opposed to corporate governance being the rules themselves. This builds in flexibility to adapt to the environment in which the firm operates. Corporate governance is like a house with furniture. It is possible to rearrange the furniture without compromising the integrity of the house itself. Corporate governance is the house. The rules are the furniture inside the house. Obviously, one would want the furniture to be compatible with the house itself.

Responsibility for corporate governance is vested with the firm’s board of directors.

Rules can change.
Rules can change. (Image: breaking the rules image by Gina Smith from Fotolia.com)

Audit Committee

The audit committee is a creation of the board of directors of the firm. Its membership is comprised of members of the board of directors. The primary role of the audit committee in most publicly traded companies is to assist the board of directors with its corporate governance oversight responsibilities in the areas of: (1) external auditing processes to assure the independence of the firm’s external auditors and the integrity of the firm’s financial statements, (2) internal auditing processes to assure that the firm’s internal controls are usefully efficacious, (3) regulatory and legal compliance to assure that the firm’s code of conduct is in compliance with all regulatory and legal requirements at all levels of government and (4) risk management to assure that the allocation of the firm’s resources (financial, human, tangible assets and goodwill) are optimized and conform with the firm’s goals and objectives.

The role of the audit committee, as a central facet in the execution of first-rate corporate governance, is continually evolving. From time to time, the audit committee may be called upon to address specific issues that fall outside of its primary role.

The audit committee helps the board of directors with corporate governance.
The audit committee helps the board of directors with corporate governance. (Image: meeting room image by Oleg Kulakov from Fotolia.com)

“Qualifying” Audit Committee

A major requirement for any firm to be listed on any U.S. stock exchange is that the audit committee must be a “qualifying” audit committee. That is, the audit committee must be composed of independent outside directors with at least one committee "qualifying" as a financial expert. An independent outside director is defined as a person who is not an employee of the company and is not affiliated with the company in any way.

Audit committees must have outside directors as members.
Audit committees must have outside directors as members. (Image: group of business men and women image by Steve Johnson from Fotolia.com)

“Qualifying” Financial Expert

In the final rules issued by the Securities and Exchange Commission pursuant to Section 407 of the Sarbanes-Oxley Act of 2002, the “qualifying financial expert” must have the following abilities: (1) an understanding of GAAP (Generally Accepted Accounting Principles) and financial statements; (2) experience in the preparation or auditing of financial statements of generally comparable issuers, and the application of such principles in connection with the accounting for estimates, accruals and reserves; (3) experience with internal accounting controls; and (4) an understanding of audit committee functions.

The audit committee must have at least one qualifying financial expert.
The audit committee must have at least one qualifying financial expert. (Image: financial dollar image by Nicemonkey from Fotolia.com)

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