Guidance for audit committees


read timeRead time: 35 mins

The Government consultation on restoring trust in audit and corporate governance means stakeholders are focusing more on the make-up and oversight of audit committees. How should you prepare?

The structure and oversight of audit committees differ between entities. This may depend on size, industry and the specific market on which the entity trades, among other factors.

As a direct result of the Government’s intervention, the FRC has held consultations on how best to implement minimum standards for audit committees in their role on external audits.

Their purpose is both to enhance performance and to ensure a consistent approach across the committees. Although initially directed at FTSE350 companies, it’s likely to be extended to other entities in the future. So we would advise taking action in your business ahead of time.

We summarise the key areas for consideration, and suggest other areas of good practice:

Oversight of auditors and audit

It is the responsibility of the audit committee to oversee and assess the entity’s audit and its auditors. The committee should not only aim to work with and challenge the auditors, but also create an open environment for the auditors to appropriately challenge management. What’s more, it should review the effectiveness of the audit process regularly.

This review can be undertaken by focusing on four key areas:

  • Audit quality (with particular emphasis on auditor’s mind-set and culture)
  • Skills, character and knowledge
  • Quality control
  • Auditor robustness on key areas of management judgement and estimation uncertainty, and the ability to respond to questions from the committee.

In this assessment of the effectiveness of the auditor, the audit committee should:

  • ensure the auditor explains the risks to audit quality they’ve identified, and how these have been addressed.
  • discuss the controls the auditor is using to address risks to audit quality and check their findings from internal and external inspections of the audited firm.
  • discuss any reasons why the auditor has not met the original audit plan, including any changes in assessed risks.
  • hold discussions with key people internally (such as the finance director) for feedback regarding the audit team.
  • review formal communications from the auditor to assess their understanding of the business and whether their recommendations are appropriate and have been acted upon.

This review process will help the audit committee to satisfy itself that the quality of the audit is of a sufficiently high standard. But regular open communication with the auditor and with the management is also vital.

Internal assessment and quality

The audit committee receives at least two separate reports from the external auditors each year. These provide an overview of the audit plan and the findings from the audit.

As mentioned, the committee reviews the audit plan and the findings to judge the auditor and audit. But it is equally important to use this information to assess the effectiveness of internal controls and quality assurance.

Examples of this assessment include:

  • the number and size of both adjusted and unadjusted misstatements, which provide a good overview of the quality of financial reporting. This not only affects the audit and year-end statutory financial statements but also internal reporting.
  • a review of the number and significance of deficiencies in internal control briefed by the auditor, management’s response to these deficiencies, and a post-audit check on whether a solution has been implemented.
  • getting regular updates from the auditor throughout the audit process.
  • requesting an ‘off camera’ session between the audit committee and the auditor, without management or the finance team present, for open questioning and feedback.

Audit committees and the annual reporting

The annual report should include a description of the roles and responsibilities of the audit committee and its work (including any relevant corporate governance code requirements).

Where relevant, these disclosures can be enhanced to provide the stakeholders with a greater understanding of the business and the committee’s role.

Disclosure examples include:

  • any significant issues the audit committee considered and how they were addressed
  • explanation of why certain matters requested for inclusion by shareholders were rejected
  • explanation of how the committee assessed the independence and effectiveness of the external audit process
  • explanation of how auditor independence and objectivity are safeguarded, if the external auditor provides non-audit services
  • details of the criteria for selection and process followed for any tender process undertaken during the year.

The audit committee should also report on the activities it has undertaken to meet the expectations of their role.

The audit tendering process

The audit committee, rather than the entity’s executive management, should lead the tendering process. This includes initiating the process, influencing the appointment of an engagement partner, negotiating the fee and scope of the audit, and making formal recommendations to the board on the appointment, reappointment and removal of the external auditors.

The committee should take the following into consideration during the tendering process:

  • The selection criteria should be transparent and non-discriminatory.
  • All tendering firms must have the necessary access to information and all tenders must be given fair and objective consideration.
  • The decision should be made on quality, independence, ability to challenge and technical competence, and not on the quoted fee nor the cultural fit (the committee should also consider running a ‘blind tender’.
  • All members of the committee should be involved throughout the tendering process.
  • The committee should submit two possible audit firms for the engagement to the board, with a justified preference for one of them.

A typical tendering process may involve three or four audit firms. But in some industries there may be a limited number with the necessary expertise that makes it difficult to identify more than two. Companies should manage their relationships with audit firms to allow them sufficient choice in a future tender, and to take account of the need to expand market diversity and follow any ‘market opening’ measures that may be introduced.

If some eligible audit firms are unwilling to tender for an audit, the committee should communicate with them to understand why they are unwilling and whether there is anything that could be done to change that.

The committee should also consider asking those firms how such action is in the public interest, and ensure that it has not excluded other firms from tendering without good reason to believe they would not be able to perform a high-quality audit.

If you would like more information about issues raised in this article, please contact Nicholas Joel.