THE ROLE OF THE AUDIT COMMITTEE

The Role of the Audit Committee



The Role of the Audit Committee

Introduction

The role of audit committees in ensuring the quality of corporate financial reporting has come under considerable scrutiny due to recent high-profile accounting scandals or “earnings management” cases (e.g. waste management and WorldCom) and the collapse of Enron. Since the value of a firm is linked to reported earnings figures, it creates economic incentives or pressures for management to engage in earnings management. Former US Securities and Exchange Commission (SEC) Chairman Levitt (1998) expressed his serious concerns over earnings management in his famous “the Numbers Game” speech. He called for a fundamental cultural change for corporate management and strengthening corporate governance, especially improving the effectiveness of audit committee.

Smith Report 2003, Combine code 2008

The Combined Code on Corporate Governance (from here on referred to as 'the code') is a set of principles of good corporate governance and provides a code of best practice aimed at companies listed on the London Stock Exchange. It is overseen by the Financial Reporting Council and its importance derives from the Financial Services Authority's Listing Rules. The Listing Rules themselves are given statutory authority under the Financial Services and Markets Act 2000[1]and require that public listed companies disclose how they have complied with the code, and explain where they have not applied the code - in what the code refers to as 'comply or explain'.[2]Private companies are also encouraged to conform; however there is no requirement for disclosure of compliance in private company accounts. The Combined Code adopts a principles-based approach in the sense that it provides general guidelines of best practice. This contrasts with a rules-based approach which rigidly defines exact provisions that must be adhered to. The Combined Code is essentially a consolidation and refinement of a number of different reports and codes concerning opinions on good corporate governance. The first step on the road to the initial iteration of the code was the publishment of the Cadbury Report (1992). The Cadbury Report was a response to major corporate scandals associated with governance failures in the UK (such as Robert Maxwell's executive abuses). The result of this was the accompanying Cadbury Code; the first explicit guidelines on corporate governance in the UK.

In 1995, the Greenbury committee was set up; intended as a 'study group' on executive compensation; the result of which was the Greenbury Report of 1995. Following this the Hampel report drew upon both Cadbury and Greenbury as well as elaborating on their recommendations and others that it considered to be relevant (including the roles of executive directors, non-executive directors and institutional investors). It is the Hampel Report, that the first iteration of The Combined Code is based upon.

US Enron's case, WorldCom case, Parmalat,(Sarbanes Oxley Act)

The focused and effective management of exposure has been conspicuously absent among companies who, in recent years, have become embroiled in scandals and bankruptcies. This highlights the importance of the quality of corporate governance as a crucial consideration for all organizations, with ...