Attributes of an Audit Committee
To create an effective audit committee, it is best to attract members who have a special blend of qualifications and abilities. We believe eight attributes are needed for an audit committee to function most effectively. These are: 
Once the audit committee is formed and its eight essential attributes defined, the committee's attention will be focused more closely on its fundamental responsibilities.
Create the Right Tone at the Top
The committee should ensure that the ethical and compliance of management and employees are understood through the company. The message to all personnel should be loud and clear: financial misreporting is totally unacceptable. If any misreporting is noted, it must be dealt with quickly and appropriately.
Adopting a tough stance
The audit committee must be able to ask probing and often difficult questions about the company's affairs. Audit committees need to be a visible part of the financial fraud prevention process, rather than rely excessively on management and the auditors. Furthermore, the company should expect its audit committee to insist on receiving bad news promptly and fully.
Getting the message across
Communicating the "tone at the top" can be achived through a written Code of Conduct, however, a more effective way of spreading the word through all levels of corporate ranks is through an active reinforcement by management who is committed to leading by example.
Reviewing earnings management
Audit committees should also be alert to any indications that there may be improper earnings management. The audit committee should be sensitive to the pressure on management to achieve earnings targets and the areas in the financial reporting system that are most susceptible to fraud. Committees should also review companies' reports to determine whether management has fairly reflective any negative news or events which should be reported. You should seek input from your BDO advisor in this area.
Acting Sensibly
Discretion is needed when the audit committee handles sensitive or controversial matters that could damage either personal or company reputations. Common sense, good legal advice, and a clear understanding of the parameters of the committee's role are essential in these circumstances.
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Be Independent
A logical extension fo the toughness attribute is the need for audit committee members to be truly objective against fraudulent financial reporting.
Here are some helpful examples of potential conflicts of interest:
- A director who is or has been an employee of the company during the past five years.
- A director who is employed as an executive of another corporation where any of the company's executives serve on that corporation's compensation committee.
- A director who is an immediate family member of someone who has been an executive officer of the company or its affiliates during the past five years.
The audit committee's independence can also be strengthened by ensuring that it is compromised entirely of independent directors and positioned between top management and the external auditor, and remain independent of both.
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Reflect a Balance of Skills
Understanding the Numbers
To be effective the audit committee must have a number of members who are "financially literate." This is a stock exchange requirement in certain countries. This requirement stems from the need to have a range of views and expertise as well as to be albe to manage the workload required of audit committee members. To provide for a balanced committee, at least on member should have specific accounting or related financial management expertise. The remaining members should be able to read and understand fundamental financial statements sufficiently to recognize when the numbers don't make business sense.
Knowing the Business
Audit committee members should clearly understand the company's industry, its operations, its system of internal control, and the business risks and risk management processes in place. Armed with this knowledge, they should be able to be sensitive to areas of the financial reporting process that are the most exposed to breakdowns - intentional or otherwise.
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Make a Time Commitment
The amount of time an audit committee member is expected to spend on committee work depends on the complexity of the company's activities, its stage of evolution, and the magnitude of its issues. However, on average, it could be around eight to twelve days per year.
Most audit committees try to schedule their meetings to coincide with regular meetings of the board, which will result in a more effective use of time, although the committee must ensure that they have set aside enough time to meet so that important matters are given a thorough airing.
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Develop a Clear Charter
To operate properly, a formal written charter strongly backed by the full board should be adopted and annually reassessed. The charter should include the following (NB: some of these characteristics are required by the major exchanges around the world):
- The scope of the committee's responsibilities and how it carries them out.
- A statement that the external auditors are ultimately accountable to the board of directors and the audit committee.
- A statement that the board of directors and the audit committee have the authority and responsibility to select, evaluate and, where appropriate, replace the external auditor.
- A requirement that the audit committee is responsible for ensuring that the external auditors submit a formal written statement regarding relationships and services that may impair independence.
In addition to the above matters, the following areas should be considered for inclusion and tailored to suit the needs of each company:
- Requiring the committee to satisfy the board that to the best of its knowledge:
- The independent audit of the company appears to meet the standards of the accounting profession.
- The annual and interim financial reports of the company fairly present its financial position and operating results.
- Internal controls are reliable, and provide adequate safeguards of the company's assets and proper recording of its transactions.
- Reporting to the board such matters as conflicts of interest; insider stock transactions; the use of company funds for payment of illegal political contributions, bribes, or other unauthorized or illegal payments; and any other questionable business practices that come to its attention.
- Authorizing an investigation of alleged improprieties, including retention of outside legal support or other professional consultants, as needed, in the discharge of its duties.
- Informing the board of significant developments in accounting principles affecting the company, as well as relevant rulings by regulatory bodies.
- Reporting to the board the committee's compensation, expenses, staff support, liability indemnification and other matters pertinent to the committee's interests.
- Informing the board of the terms of appointment, which should be staggered to maintain continuity. Appointees should look to infuse the committee with fresh viewpoints.
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Develop Specific Committee Duties
Once a charter has been developed, the audit committee needs to decide which specific regular assignments it will undertake and then have them approved by the board. These tasks should be communicated in writing to company management and the external and internal auditors to ensure a complete understanding of the committee's role. In setting the scope of their duties, audit committees should tailor them to the company's circumstances and avoid being overloaded with responsibilities that could cause them to lose focus on their key objective.
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Plan the Year's Agenda
The complexity of the company's activities, together with the nature of the duties assumed by the audit committee, will determine its agenda. At least four meetings a year should be considered, although this would depend on the company's particular circumstances. Additional meetings may be necessary if special matters arise.
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Document the Committee's Work
Regulators may require audit committee's to document/report on a range of issues. These could include:
- The audit committee has reviewed and discussed the financial statements with management
- The audit committee has discussed with the external auditor certain findings from their audit of the financial statements.
- The audit committee has received a written report from the external auditor regarding their independence
- Based on discussion items 1-3, the audit committee should make known whether it recommended to the board that the audited financial statements be included in the Annual Report. The audit committee should deep minutes and issue reports to document its conclusions and recommendations.
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