Companies may choose to appoint an audit committee as part of a good corporate governance strategy, or they may be required to do so in terms of legislation or other requirements. The King Code of Governance Principles and the King Report on Governance (“King III”) emphasise the vital role of an audit committee in ensuring the integrity of financial controls and integrated reporting, and identifying and managing financial risk and accordingly recommends that all companies should have an audit committee. This is mirrored in the Companies Act, Act 71 of 2008 (“the Act”) which regulates the appointment of an audit committee as part of the enhanced accountability and transparency requirements set out in Chapter 3 of the Act and requires certain categories of companies, such as public companies or state owned companies, to appoint an audit committee. In addition, the Johannesburg Stock Exchange requires listed companies to comply with King III.
In short, an audit committee is a subcommittee of the board of directors that is established to deal with financial reporting and related matters on behalf of the board of directors. The Act states that, where the appointment of an audit committee is required, the audit committee must be appointed by the shareholders at every annual general meeting. In addition, the Act requires that an audit committee must consist of at least three members who must be directors of the company and must not be: (i) involved in the day-to-day management of the company’s business or have been so involved at any time during the previous financial year, (ii) a prescribed officer, or full time employee, of the company or another related or inter-related company, or have been such an officer or employee at any time during the previous three financial years, (iii) a material supplier or customer of the company such that a reasonable and informed third party would conclude in the circumstances that the integrity, impartiality or objectivity of that director is compromised by that relationship or (iv) be related to anybody who falls within the aforementioned criteria.
Having regard to the Act, some of the duties of directors are, amongst others, to act:
- In good faith and for a proper purpose – the director must take decisions that are going to benefit the company;
- In the best interests of the company – this means the director must always take the decision that will benefit the company as a whole, not an individual person or any external party; and
- With a reasonable degree of care, skill and diligence.
In addition, the Act further prescribes a list of specific duties for audit committees, which are, inter alia, as follows:
- Nominate the auditor to be voted for by shareholders, after evaluating the auditor’s independence.
- Determine the fees to be paid to the auditor and the auditor’s terms of engagement.
- Ensure that the appointment of the auditor complies with the provisions of the Act and any other legislation relating to the appointment of auditors.
- Determine, subject to the provisions of Chapter 3 of the Act, the nature and extent of any non-audit services that the auditor may provide to the company, or that the auditor must not provide to the company, or a related company.
- Pre-approve any proposed agreement with the auditor for the provision of non-audit services to the company.
- Prepare a report, to be included in the annual financial statements for the financial year: (i) describing how the audit committee carried out its functions, (ii) stating whether the audit committee is satisfied that the auditor was independent of the company, and (iii) commenting in any way the committee considers appropriate on the financial statements, the accounting practices and the internal financial control of the company.
- Receive and deal appropriately with any concerns or complaints, whether from within or outside the company, or on its own initiative, relating to: (i) the accounting practices and internal audit of the company, (ii) the content or auditing of the company’s financial statements, (iii) the internal financial controls of the company, or (iv) any related matter
- Make submissions to the board on any matters concerning the accounting policies, financial controls, accounting records and reporting.
- Perform any other oversight functions required by the board of directors.
King III furthermore recommends that the audit committee should:
- Manage financial and other risks that affect the integrity of external reports issued by the company.
- Evaluate the design and implementation of internal financial controls.
- Evaluate the effectiveness of the Chief Financial Officer and finance function.
The relatively recently released King IV Report on Corporate Governance for South Africa, 2016, also recommends that the audit committee should make certain disclosures, such as, (i) whether the audit committee is satisfied that the auditor is independent of the organisation and (ii) the disclosure of significant matters that the audit committee has considered in relation to the annual financial statements and how these were addressed by the committee.
In order to discharge the above responsibilities, it is obvious that the audit committee as a whole must have knowledge and experience in financial reporting, external auditing, internal audit and the industry in which the company operates. Moreover Regulation 42 of the Act, requires that at least one-third of the members of a company’s audit committee at any particular time must have academic qualifications, or experience, in economics, law, corporate governance, finance, accounting, commerce, industry, public affairs or human resources management.
The fact that the company has competent management, including a financial director, and an external auditor does not relieve the audit committee of its responsibilities. All role-players in the corporate governance process have to play their part but, while the audit committee can rely on other governance elements, it is the highest governing body of the company as far as financial reporting is concerned. The audit committee should therefore play a key role in ensuring accountability and transparency and, as the company’s independent monitor, the audit committee must ensure the integrity of financial controls, effective financial risk management, and meaningful integrated reporting to shareholders and stakeholders alike.
In the event that a company elects to or is required to appoint an audit committee, it is not, contrary to popular practice, management’s role to appoint the auditors, negotiate fees with auditors or debate audit issues. Management is responsible for directing the company’s resources to maximise profit. This includes cost-saving, which places them in direct conflict with the audit function. Considering that audit findings may reflect badly on certain members of management, it becomes obvious that management, by definition, are too conflicted to appoint, negotiate with and determine the fees payable to auditors. The audit committee is the body that is charged by legislation, the board of directors and shareholders, to ensure that the audit is carried out in accordance with the applicable legislation and without any restriction whatsoever, and that the auditor’s concerns are heard and acted upon.
Being an audit committee member is an onerous and responsible duty. The Act specifically allows the court to hold directors, and audit committee members by extension, personally liable for losses incurred due to their negligence or the contravention of the provisions of the Act. Audit committee members who are concerned about personal liability should reflect very seriously on their responsibilities, specifically those that relate to the independence and appointment of auditors.
Partson Sibanda Henk Heymans Marc Humphries
Audit Senior Head of Audit Regional Divisional Director, Legal