Audit Committee:

1:Corporate Governance and Financial Reporting:The responsibility of the Board:

The company's board of director are accountable and responsible to the shareholders.It is important and legal requirement to present an annual report and accounts to the public.

 

The UK corporate governance code(combined code) states that the board should present 'a balanced and understandable assessment of the company's position and prospects'.In addition,it requires the directors to explain in their annual report their responsibility for the presentation  of the financial statments.The annual report of a UK listed company might include a statement from the directors as follows:

'The directors are required by law to prepare financial statments for each accounting period that give a true and fair view.'

This is the director duty to check the appropriate accounting policies have been used and applied consistently,and reasonable and prudent judgements and estimates have been made in the preparation of the accounts.The directors also confirm that applicable accounting standards have been followed,any material departures being disclosed and explained,and that the financial statements have been prepared on the going concern basis.

 

• The directors are responsible for ensuring proper accounting records are kept which disclose with reasonable accuracy at any time the financial position of the company and the group.They are also responsible for taking steps to safeguard the assets of the company and the group and to prevent and detect fraud and other irregularities.Having made such a statement of responsibilities,directors should expect to be liable for any failure in carrying out their responsibilities with due care.

 

Example:

The collapse of US corporation Enron has already been mentioned.However,it is also interesting for the attitude of the financial reporting methods that were used:

• In october 2000,about one year before the collapsed,the finance committee of the board was informed that the company had about $60 billion of assets of which nearly half were held in unconsolidated affiliates in other words  'Off-balance Sheet'.

• The board was informed in 2000 that one of these affiliates,LJM had made $2 million profits in just six moths.This was a hughe amount of money,even for a company the size of enron.The board apparently didnot question the fiqure.

 

It could therefore be argued that the directors of Enron failed to fulfil their responsibility for ensuring the reliability of the financial statements.

 

2:The need for an audit committee:

Many directors on company boards have only understanding of accounting and financial reporting,but the board is nevertheless responsible for the reliability of the financial statements.

 

In the past,the board has relied on the advice and assurance that it receives from:

• executive management,and in particular the CEO and finance directors and 

• the external auditors

 

The history of corporate governance has shown that when a corporate scandal occurs:

• misleading financial statements have been used to disguise the wrongdoing and misdemeanours.

• senior executives(the CEO and finance director) are to blame for the misleading accounts and;

• The company's auditors failed to spot the problem:

   -possibly because they were mislead by the company's executives or 

   -possibly because the quality of the audit was not as good as it should have been,or

   -possibly because the auditors were willing to accept assurances from executives management when they should perhaps have asked more questions.

 

An audit committee can provide a check on the risks of misleading reporting,by providing an additional line of communication to the auditors and by ensuring that the auditors remain independent from executive managers and perform the audit effectively.