Audit Committee

The article 'Audit Committee' explores the role and significance of audit committees in corporate governance. Audit committees have become a vital component of effective governance structures, providing independent oversight of financial reporting processes and ensuring compliance with regulatory requirements. The article examines the composition, responsibilities, and functions of audit committees, highlighting their critical role in enhancing financial transparency, mitigating financial risks, and safeguarding shareholders' interests.

Introduction

The composition of the Audit Committee is indeed mandated under the Companies Act, 2013, and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 in India. These regulations aim to ensure good corporate governance practices and enhance transparency in financial reporting. 

Additionally, the Act and regulations prescribe certain qualifications and expertise required for the members of the Audit Committee. At least one member of the committee should have accounting or related financial management expertise. Furthermore, the committee should have adequate knowledge and experience in financial matters, including understanding financial statements, auditing, and internal controls.

The specific details regarding the composition, role, and responsibilities of the Audit Committee can be found in Schedule II Part C of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. It outlines the requirements related to the appointment, terms of office, quorum, meetings, and functions of the Audit Committee.

The Companies Act of 1956 was repealed and replaced by the Companies Act of 2013, which governs companies incorporated in India. Section 177 of the Companies Act, 2013 deals with the establishment and powers of the audit committee. The audit committee's powers and functions, as prescribed in Section 177, include overseeing the financial reporting process, reviewing financial statements, recommending the appointment and removal of auditors, and evaluating internal financial controls and risk management systems.

Section 177(1) of the Companies Act, 2013 read with rule 6 of the Companies (Meetings of the Board and its Powers) Rules, 2014 provides that the Board of Directors of every listed public company and a company covered under 4 of the Companies (Appointment and Qualifications of Directors) Rule, 2014 are required to constitute an Audit Committee of the Board. Rule 4 of the Companies (Appointment and Qualifications of Directors), Rules, 2014 provides the following class or classes of companies: 

(i) All public companies with a paid-up capital of 10 crore rupees or more;

(ii) All public companies having turnover of 100 crore rupees or more;

(iii) All public companies, having in aggregate, outstanding loans or borrowings or debentures or deposits exceeding 50 crore rupees or more.

Composition of Audit Committee 

Section 177(2) of the Companies Act, 2013: Every Audit Committee shall consist of a minimum of three directors with independent directors forming a majority. Independent directors should form a majority

The majority of members of the Audit Committee including its Chairperson shall be persons with the ability to read and understand the financial statement.

Regulation 18(1) of the SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015

• Every listed entity shall constitute a qualified and independent audit committee by the terms of reference, subject to the following: (a) Audit Committee shall have a minimum of three directors as members.
• Two-thirds of the members of the audit committee shall be independent directors and in case of a listed entity having outstanding SR equity shares, the audit committee shall only comprise independent directors.
• All members of the audit committee shall be financially literate and at least 1 (one) member shall have accounting or related financial management expertise.
• The chairperson of the audit committee shall be an independent director and he shall be present at AGM to answer shareholder queries.
• The Company Secretary shall act as the secretary to the audit committee.
• The audit committee at its discretion shall invite the finance director or head of the finance function, head of internal audit and a representative of the statutory auditor and any other such executives to be present at the meetings of the committee.

These requirements are aimed at ensuring the independence, expertise, and effectiveness of the audit committee in overseeing financial reporting, internal controls, and audit-related matters within listed entities.

Meetings of the Audit Committee 

SEBI Listing Regulations, 2015 provides for the minimum number of meetings and quorum of the audit committee.

(i) Under Regulation 18(2)(a) the Audit Committee of a listed entity shall meet at least four (4) times in a year and not more than 120 shall elapse between two meetings.

(ii) The quorum for an audit committee meeting shall either be:

(iii) Two (2) members or

(iv) One-third (1/3rd) of the members of the audit committee, whichever is greater; with at least 2 independent directors. [Regulation 18(2)(b)]

Functions of the Audit Committee 

Each audit committee must work according to the written mandates of the board. Some of the tasks include:

• recommendation on the appointment, remuneration and conditions of appointment of auditors of the company.
• review and monitor the independence and effectiveness of the auditor and the effectiveness of the audit process.
• examining the financial statements and the auditor's report thereon.
• confirm related transactions or subsequent changes to the Company.

Provided that the Audit Committee may grant omnibus approval to the proposed related transactions which the company made by the conditions stated in rule 6A of Companies (Meeting Board and its Powers) Rules, 2014

• controlling intercompany loans and investments
• valuation of the assets of the company or the company, as the case may be
• assessment of internal financial control and risk management systems
• monitor the final use of funds collected through public procurement and related matters.

Powers of the Audit Committee 

Section 177 (5), (6) and (7) of the Companies Act, 2013

Section 177(5)

The Audit Committee may call for the comments of the auditors about internal control systems, the scope of audit, including the observations of the auditors and review of financial statement before their submission to the Board and may also discuss any related issues with the internal and statutory auditors and the management of the company.

Section 177(6)

The Audit Committee has the authority to seek information from any employee of the company, obtain external professional advice, and secure the attendance of outsiders with relevant expertise if it deems necessary for the performance of its duties.

Section 177(7)

The auditors of a company and the key managerial personnel shall have a right to be heard in the meetings of the Audit Committee when it considers the auditors report but shall not have the right to vote.

Regulation 18(2)(c) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015

The audit committee shall have powers to investigate any activity within its terms of reference, seek information from any employee, obtain outside legal or other professional advice and secure attendance of outsiders with relevant expertise, if it considers necessary

Vigil Mechanism

Under Section 177 of the Companies Act 2013, your company is required to establish a mechanism that enables managers and employees to raise genuine concerns. This mechanism should have certain features to ensure its effectiveness and protect individuals from victimization. Additionally, it should provide a means for direct access to the chairman of the audit committee in appropriate or exceptional cases.

The Purpose of the Vigil mechanism is to provide a reporting channel for managers and employees with genuine concern about unethical conduct, actual or perceived fraud or violation of the law, code of conduct or policy. The company is committed to the highest ethical, moral and legal standards to perform activities and meet these standards Company encourages its employees who are seriously concerned about suspected misconduct to come forward to communicate and express these concerns without fear of punishment or unfair treatment.

The Policy covers disclosure of any unethical and improper or malpractices and events which have taken place are suspected to take place involving

(a) Violation of Business Integrity and Ethics

b) Violation of working conditions and their rules

(c) Willful financial misconduct, including fraud or suspected fraud

d) willful violation of laws/regulations

(e) gross or willful negligence causing a serious and special risk to health and safety and the environment

f) Processing of company data/documents

g) Looting of confidential/confidential information

h) Gross loss/destruction of the company's funds/assets

Penalty for Non-Compliance 

In terms of the provisions of Sub-section (8) of section 178 read with the Companies (Amendment) Act, 2020 Notification dated 28th September 2020 Amendment. effective from 21st December 2020

“In case of any contravention of the provision of section 177, the company shall be liable to a penalty of five lakh rupees and every officer of the company who is in default shall be liable to a penalty of one lakh rupees”

Laws Applicable to Audit Committee

• The Companies Act, 2013: The Companies Act, 2013 lays down the statutory requirements for the composition, functions, and powers of the audit committee. According to Section 177 of the Companies Act, every listed company and such class or classes of companies as may be prescribed shall constitute an Audit Committee.
• SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015: The SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015, apply to all companies listed on recognized stock exchanges in India. According to these regulations, a listed company must constitute an audit committee comprising of a minimum of three directors, with at least two-thirds of the members being independent directors. The committee's role is to oversee the financial reporting process, review financial statements, and ensure compliance with accounting standards.

Satyam Scandal Case

The Satyam case refers to a major corporate scandal that unfolded in India in 2009. Satyam Computer Services Limited, one of the country's leading IT companies, was at the centre of the controversy. The founder and chairman of Satyam, Ramalinga Raju, confessed to perpetrating a massive financial fraud.

Raju admitted to manipulating the company's financial statements, inflating revenues, and fabricating cash balances. These fraudulent activities had been going on for several years, leading to a significant overstatement of the company's financial position. The actual financial health of Satyam was far worse than what had been represented to investors and stakeholders.

The revelation of the fraud sent shockwaves through the Indian corporate sector and caused a severe loss of investor confidence. Satyam's stock prices plummeted, and the company faced a severe liquidity crisis. To prevent a collapse, the Indian government intervened and appointed a new board of directors to oversee the company's operations.

The aftermath of the Satyam scandal involved several investigations and legal proceedings. Ramalinga Raju, along with other key executives and auditors, were arrested and charged with multiple offences, including fraud, forgery, and criminal conspiracy. The case was eventually taken up by the Indian courts, where the accused faced trial.

In 2015, a Hyderabad court pronounced its judgment in the Satyam case. Ramalinga Raju and several others were found guilty of accounting fraud and other related crimes. Raju was sentenced to seven years in prison, and other individuals involved in the fraud received varying sentences.

The Satyam case highlighted the need for stricter corporate governance and auditing standards in India. It led to significant reforms in the country's regulatory framework and the establishment of new oversight bodies to prevent such fraud in the future. The case serves as a cautionary tale about the importance of transparency, accountability, and ethical business practices.

Role of Audit Committees in Corporate Governance

Independent Auditors: Audit committees select and oversee the work of independent external auditors to ensure their independence, objectivity, and competence. They review and approve the appointment, compensation, and retention of the auditors, as well as assess their performance.

Internal Controls and Risk Management: Audit committees oversee the effectiveness of internal control systems and risk management processes. They assess and monitor significant risks faced by the organization, including financial, operational, and compliance risks. They also review management's response to identified risks and the adequacy of internal control systems to mitigate those risks.

Compliance and Legal Matters: Audit committees review the company's compliance with applicable laws, regulations, and corporate governance standards. They oversee the organization's policies and procedures related to legal and regulatory compliance, including ethics, whistleblowing, and anti-corruption programs.

Ethical Practices and Codes of Conduct: Audit committees play a role in promoting ethical practices and ensuring compliance with the company's code of conduct. They review the effectiveness of the company's ethics and compliance programs, including the handling of internal and external complaints and ethical violations.

Communication and Reporting: Audit committees communicate regularly with management, internal auditors, and external auditors to discuss financial reporting, internal controls, and other relevant matters. They report their findings and recommendations to the board of directors and shareholders through the company's annual report or other required disclosures.

Conclusion

The Audit Committee is established to regularly review processes and procedures to ensure the effectiveness of internal control systems and to ensure that reporting of financial results is always accurate and professional. Therefore, the task of the audit committee is to act as a channel for accurate and transparent financial reporting.

As a result, the penal provisions of the Companies Act, 2013 are now getting tougher on both companies and negligent officers. A detailed audit of the organization's operations and maintenance of internal control systems can help detect and prevent various types of fraud and other accounting errors. Strong audit systems can help reduce various risks that arise in an organization, such as information risk, fraud risk, asset misuse risk and operational risk management. A company cannot prepare accurate financial statements for internal or external purposes without a proper auditing system. Therefore, the audit committee is important for the company.

Contributions from: R Shakthivel And Apurva Neel

References

[1] Audit Committee and Other Board Committees Roles and Responsibilities under the Companies Act 2013, Available Here

[2] All about Board Committees, Available Here 

[3] Audit Committee, Available Here

[4] Audit Committee: Definition, How They're Used, and Purpose, Available Here

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