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Home > Blogs > Anthony Harrington > Reaffirming the role of the Audit Committee

Reaffirming the role of the Audit Committee

Reaffirming the role of the Audit Committee Anthony Harrington

In the wake of the 2008 crash, with massive public anger over billions in losses caused by reckless trading by bank proprietary desks, the public naturally wanted to see those responsible punished in some way. So far, it has to be said, that hasn't happened, though court actions against some of those responsible may ultimately change this.

While senior bank executives have quite justifiably borne the brunt of public anger, the audit profession too, had its "day in the dock", and the "Big Four" accounting firms which have the monopoly on blue chip audits, including major bank audits, were roundly excoriated by a Lord's Select Committee for their failure to flag up both accounting chicanery in bank accounts and ludicrous trading practices. (See for example Ian Fraser's blog).

Few will feel much sympathy with the Big Four taking a caning from the Lords for not flagging up problems that, with hindsight, should have been obvious to a novice book-keeper. However, with the press, the politicians and the public all in a fiery frame of mind with all things audit related, audit committees in plcs were briefly swept up into the fray. There were suggestions that somehow audit committees should "police" the validity of external audits, as if they were some kind of super auditor standing above the external auditors.

These suggestions were wide of the mark and fundamentally misunderstood the role of the audit committee in plcs. I recently interviewed Ernst & Young audit partner Richard Wilson, for an article in the journal of the Chartered Institute of Management Accountants (CIMA). Wilson is the chair of the joint Ernst & Young/Confederation of British Industry Audit Chair Forum. As the name suggests the Audit Chair Forum draws together chairpersons from audit committees across a wide range of industry sectors, so Wilson is ideally placed to provide a view of how audit committees see things.

First and foremost, the audit committee, which is comprised of independent, non-executive directors, is there to provide oversight and represent the interests of shareholders on all things related to the financial health of the company. This might sound superficially as if it should carry the can for egregious management errors of judgement, but that would be wrong. The audit committee's aim is to ensure that the financial reporting, as prepared by management and verified by the external auditors, presents a reasonable view of the company's activities. It is not there to make operational judgements or to second guess management. Management might well be steering the company over the cliff. The audit committee is there to ensure that the reporting presents a fair view of the ride. At a certain point, however, since the audit committee is concerned with fundamental questions like "going concern" poor decisions by management will impact the audit committee because it will call into question the ability of the company to continue to claim that it is a going concern, ie that it is solvent and can pay its way, finance future trading and so forth. By this stage, however, things will already be looking pretty bleak for the company and there is every probability that the market will be expressing its view by sending the company's share price into free fall. In other words, the markets, rather than the audit committee, will be the first and loudest signal to investors that all is not well.

The audit committee is also there to enhance the independence of the external audit. It will make recommendations concerning the reappointment of the auditors and the level of the audit fee and will ensure that the external auditors are not blocked in any way from seeking any information they require to form their audit opinion. It will also review the findings of the external auditors with a view to ensuring that the process was properly carried out.

Clearly, from this it is tempting, when it later emerges that the organisation has been fundamentally mis-evaluating the degree of risk it is running on any of its positions or operations, to feel that perhaps the audit committee members could have been more challenging in questioning company officials. However, once again, it is important to grasp that the audit committee is not there to second guess the Board on operational matters. It is not a kind of uber-Board, but merely a sub-committee of the main Board with a specific job to do. It will concern itself with management reaction to the work of the auditors and with the auditors' reaction to the way management is providing them with information. Very little in this will stop Boards from making disastrous decisions. The audit committee is not a warning bell and shouldn't be confused with one...

Further reading on audit issues

Tags: 2008 crash , accounting chicanery , audit committees , audit profession , Audit regulations , bank executives , big four , boards of directors , CIMA , Ernst & Young , external audit , going concern , House of Lords , plc
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