KPMG hosts Audit Committee Forum to highlight importance of ‘Audit Committee Effectiveness’

In today’s complex and evolving business environment, an effective Audit Committee (AC) can be a key feature of a strong corporate governance culture. As expectations of stakeholders have never been higher, and the scrutiny by regulators and investors never more stringent, the role of the AC has rapidly increased in importance and expanded in scope. To highlight the principles underlying the AC’s role and the processes and practices that help create an effective AC, KPMG hosted the 11th roundtable session of the AC Forum recently.

Setting the platform for discussion, the session featured key presentations from Maithri Wickremesinghe, AC Chairman – Hemas Holdings PLC, on ‘Why Effectiveness is Important,’ Hiranthi Fonseka, Partner – Ernst & Young, on ‘How Effectiveness is Achieved’ and Rasakantha Rasiah, AC Chairman – Ceylon Cold Stores PLC, on ‘Effectiveness in Practice,’ followed by an interactive Q&A session moderated by Suren Rajakarier, Head of Audit, KPMG in Sri Lanka.

Wickremesinghe highlighted that ACs are generally regarded as an indicator of good governance. However, in the recent past, well publicised corporate governance failures have demonstrated that having an AC does not, or itself, guarantee good governance. He further shared the following points on the importance of AC effectiveness:

 

• The AC was a filter, which should help protect the Board and the Company from potentially serious outcomes. The Board was responsible to monitor the working of the AC.
• It was important for the Board to ensure a proper composition of the AC, so it could properly discharge its responsibilities (and individual AC members theirs).
• AC members should not be randomly picked. Thought should ideally be given to their suitability for the role when appointments are made to the Board.
• A balance between continuity and fresh thinking is needed, and perhaps achieved via rotation.
• Independence is essential and needs to be incontrovertibly established where others on the Board happened to be friends or acquaintances.
• Members must be willing to commit the time required. The time commitment required from the AC Chairman was particularly substantial.
• It was important that the AC Chairman should have a line to, and a good relationship with, the Board’s Chairman, so he could count on the Chairman’s support.
• For general acceptance and appreciation of the AC, the AC should demonstrate that it was “adding value”.
• Sufficient remuneration of AC members was necessary to attract good talent, as the role they played was onerous.

Fonseka pointed that effective ACs are supported by fundamental building blocks: an appropriate structure and foundation; reasonable and well defined responsibilities; an understanding of current and emerging issues; and a proactive, risk-based approach to its work.

She shared a number of considerations for building effective ACsincluding:

• A great deal hinged on the AC Chairman.
• Individual AC members could be assigned specific or specialist roles to help effective participation and AC effectiveness generally. 
• Conscious training of AC members was necessary.
• ACs should seriously consider establishing adequate documentation, to serve as proof of diligence and avoid possible liability.

Emerging trends included-

Wider disclosures (going beyond GAAP) in financial statements and related reports.

Short meetings of AC members only, perhaps prior to formal AC meetings, at which any concerns could be discussed and clarified.

Rasiah, presenting on ‘AC Effectiveness in Practice,’ highlighted, how an AC fulfils its responsibilities varies according to the abilities and behaviours of its members, the clarity of the AC’s mission, and the tone set at the top of the governance structure. He shared the following practices that mark a strong and effective AC.

• Agendas must be clearly structured, and minutes and notes on follow-up must be complete, clear and timely.
• AC members must develop adequate understanding of the business.
• Preparation (especially by the AC Chairman) could shorten meetings and avoid questions remaining unanswered at AC meetings.
• AC members should have an inquiring mind-set that provokes investigation when, say, a variance that cannot be understood is seen on the financial statements.
• The AC must ensure answers to questions are forthcoming and the conduct of meetings is not compromised by determined or careless actions of Senior Executive Staff.
• An effective whistleblowing process may require repeatedly returning to the whistle-blower for clarification or information, as necessary.  

Rajakarier facilitated the discussions around criteria used to evaluate effectiveness of ACs and warned that the evaluations were discoverable in litigation and so could provide evidence of the AC’s operations and effectiveness in a court of law.

Time pressures and difficulty of the AC was noted in KPMG’s Global Audit Committee survey, where out of 1500 AC members responding to survey,three out of four said the time required to carry out their responsibilities has increased significantly (24%) or moderately (51%). Half said the job continues to grow difficult given the committee’s time and expertise. 

Responding to a question on ‘how, in practice, could an Internal Auditor be expected to be independent and forthright when he was part of the organisation?’ Rajakarier stated that, this should come from the culture established by the Board, and by ensuring independence of the Internal Auditor by setting his reporting line directly to the AC Chairman, who would have significant input into his remuneration and career advancement. 

Rajakarier also focussed on risk assessment and risk management aspects of AC responsibilities. In discussing whether AC members had enough opportunity and information to review and discuss the process by which risks were managed: It appeared that, while some participants in well-structured environments had no concern on this score, many felt this was lacking in their environments.

The general consensus was that AC members may appreciate additional information or education about risks. For example strategic risks, operational risks, financial risks, compliance risks, etc. impacting the company. The forum decided to focus its next roundtable discussion on this topic.