COMPANY LAW PROVISIONS OF AUDIT COMMITTEES - TOOL TO EFFECTIVE CORPORATE GOVERNANCE

[Dr. Sanjiv Agarwal]

Audit Committee Statute in India

Section 292A of the Companies Act, 1956 (inserted w.e.f. 13/12//2000) contains a provision relating to establishment of audit committee by every public company having paid up capital of Rs. 5 crores or more

Clause 49 of the uniform listing agreement prescribed by Securities and Exchange Board of India is applicable to all listed companies. Clause 49 of listing agreement deals with corporate governance and prescribes for setting up of a qualified and independent audit committee.

As per section 292A of Companies Act, 1956, audit committee should have discussions with the auditors periodically about internal control systems, scope of audit including the observations of auditors and review of the half yearly and annual financial statements before submission to the board and also ensure compliance internal control systems. It shall have authority to investigate into any matter in relation to such matters and shall have full access to information contained in records of the company.

As per clause 49 of the listing agreement, audit committee is empowered to investigate any activity within terms of reference, seek information from any employee and recommend appointment and removal of external auditor, fixation of audit fees, approval for payment for other services, review with the management the annual financial statements before submission to board, review adequacy of internal control system, oversight of company's financial reporting process and disclosure of its financial information to ensure that financial statements are correct, sufficient and credible, reviewing adequacy of internal audit function, reviewing company's financial and risk management policies etc.

Summary of Provisions of Audit Committees

Companies Act, 1956

As required by section 292A of the Companies Act, 1956, every public limited company (listed or unlisted) having a paid-up capital of at least Rs. 5 crore shall constitute a Committee of the board to be known as Audit Committee. The provisions in respect of the same are as follows:

1. The Committee shall have at least three (3) members (directors).
2. Two-third (2/3) of the members shall be non-executive directors.
3. The Board of Directors shall prescribe the Committee's terms of reference in writing.
4. The statutory auditor, the internal auditor and director in-charge of finance shall attend every meeting of the audit committee but shall not have the right to vote.
5. Half-yearly and annual accounts should be discussed by the audit committee with auditors before presenting the same to the Board.
6. The Audit Committee shall have to right to investigate any matter covered under the broad terms of reference.
7. The recommendations of the Audit Committee will be binding on the Board. Though the Board is a superior body, yet it cannot override the recommendation of the committee.(subject to (8) below)
8. In case the Board does not accept the recommendations of the Audit Committee, it will have to record the reasons and communicate the same to the shareholders.
9. The Chairman of the Audit Committee shall attend the annual general meeting to provide clarifications on matters relating to audit
10. The constitution and composition of the Audit Committee is required be disclosed in the annual report of the Company.
11. Auditors - internal and external and Director (Finance) shall attend the meeting but not have right to vote.
12. Audit Committee should discuss internal controls, scope of audit, observations of auditors, review of periodic financial statements etc. and compliance of internal control system.
13. The minutes of the Audit Committee are required to be placed before the next Board Meeting.
14. In the absence of any provision made in this section regarding quorum of the Audit committee, the same needs to be laid down by the Board while constituting the Committee. SEBI guidelines stipulate a quorum of two members or one-third of members of committee, whichever is higher with minimum two independent directors.

If not spelt out, the whole of the committee, it appears must meet. [Re - Liverpool Household stores Association Ltd.[1890] 59 LJ Ch 616]

15.  Any default in complying with the provision of section 292A may attract imprisonment up to one year or fine up to Rs. 50000 or both. The prosecution lies against the company and every officer of the company who is in default. The offence is compoundable under section 621A.
16. The provisions in clause 49 of the Listing Agreements as required by the Stock Exchanges are not identical with the above provisions. All listed companies having a paid-up capital of minimum 5 crore will also have to follow the requirements as per Clause 49.

Cost Auditor not be a part of Audit Committee

Unlike statutory auditor and internal auditor, cost auditor can not be a member of the audit committee. Department of Company Affairs has clarified this vide General Circular No. 2/2003, dated 9-1-2003.

 The Department has examined whether the cost auditor appointed under section 233B of the Companies Act, 1956, could or should be invited to the audit committee constituted in compliance with section 292A. It was clarified vide Circular No. 6/2001, dated 20-8-2001 that the cost auditor, wherever appointed, shall also attend and participate at the meetings of the audit committee, but shall not have the right to vote.

It has been mentioned in the circular that the presence of cost auditor in such committees will ensure overall cost management besides proper pricing of inter-unit / inter-company transfer and valuation of inventories. The intent of the Department was to impress upon the need for the presence of 'cost auditor' in audit committee meetings, as an auditor, but not as a member. The legislative intention is to constitute audit committees only from directors. As such the usage of these phrases should not be construed to mean that cost auditors are to be members of audit committees.

Sub-section (5) of section 292A provides that the auditors, internal auditors, if any and the directors, in charge of finance, shall attend and participate a the meeting of audit committees without voting rights, The intention of providing for attending the meetings by auditors and internal auditors is to give an opportunity to the audit committee to here their views. The cost auditor in this capacity as internal auditor can similarly participate in the meetings of the audit committee. Department has, in its Circular dated 09/01/2003 reiterated that the cost auditor cannot become a member of audit committee and wherever appointed, can only attend and participate in the meeting without voting rights. Any other interpretation will be outside the purview of section 292A and incorrect.

Financial Expertise of Members of Audit Committee

The Audit Committee is formed to regularly review processes and procedures to ensure the effectiveness of internal control systems so that the accuracy and adequacy of the reporting of financial results is maintained at high level at all times. To discharge to responsibility, it is important for the members of Audit Committee to have formal knowledge of accounting and financial management or experience of interpreting financial statements.

The Listing Agreement requires  directors having financial and accounting knowledge to be  members of Audit Committee. Section 292A(5) of the Act specifies that Director-in-charge of Finance shall attend and participate at meetings of the Audit Committee but shall not have the right to vote.

Functions of Audit Committee under Section 292A

The Audit Committee constituted under this section shall act in accordance with terms of reference to be specified in writing by the board. The Audit Committee should have periodic discussions with the auditors about the following matters:-

(a)    Internal Control System.

(b)   Scope of audit including the observation of auditors.

(c)    Review the half yearly and annual financial statement before submission to the board.

(d)   Compliance of internal control system.

The audit committee shall also have authority to investigate into the matters in relation to the items specified in this section or matters referred to it by the board of directors. To carry out such investigation the Audit Committee will have full access to information contained in the records of the company and external professional advice, if necessary.

The recommendations of the Audit committee on any matters relating to financial management including the audit report shall be binding on the board. In case the board does not agree with the recommendations made by the Audit committee, the board shall record the reasons for disagreement and communicate the same to the shareholders to be reported in Annual General Meeting. The view of shareholders on such matters shall be final.

Penalty for contravention of section 292A

For default in complying with the provisions of this section the company and every officer who is in default shall be punishable with imprisonment for a term, which may extend to one year or with a fine, which may extend to fifty thousand rupees or with both.

Checklist for Professionals / Advocates/Corporate Executives/Directors for Constitution and Working of  Audit Committee of Company under Section 292A

1.      It should be checked whether the company is public limited company.

2.      It should be checked whether the paid-up capital of the company is Rs. 5 crores and above.

3.      Public limited company as aforesaid may be listed or unlisted or a banking company.

4.      It answer to (1) and (2) above is yes, the company is required to constitute a Committee of the Board known as 'Audit Committee'.

5.      The Audit Committee should consist of not less that 3 directors and such number of other directors as the Board of Directors of the company may determine.

6.      While constituting an Audit Committee, it must be ensured that two-thirds of the total number of members of the Audit Committee to be constituted should be directors other than managing or whole-time directors. If there are three directors in a committee, two should be non-whole time directors

7.      A Board Meeting of all the directors of the company should be convened to decide upon and constitute the Audit Committee of the Board through a Board Resolution, duly passed.

8.      Audit Charter should be in place.

9.      Board resolution should convey the constitution of committee and written terms of reference of Audit Committee.

10.  It should be ensured that the Audit Committee constituted acts in accordance with terms of reference specified by the Board. It should contain authority, membership, duties, reporting procedure meetings, tenure etc.

11.  Agenda papers should be in conformity to terms of reference.

12.  The members of the Audit Committee will elect a Chairman of the Committee from amongst themselves in their first meeting.

13.  The composition of the Audit Committee should be disclosed in the company's Annual Report.

14.  The auditors of the company, the internal auditor, if any, and the director-in-charge of finance are allowed to attend and participate at meetings of the Audit Committee but they do not have any right to vote in the meetings of the said Committee.

15.  Cost auditor will also be treated as internal auditor and allowed to participate in the meetings.

16.  Secretary should send proper notice to auditors etc. for participation in meetings of Audit Committee.

17.  The Audit Committee should have discussions with the auditors periodically about internal control systems, the scope of audit including the observations of the auditors and review the quarterly, half-yearly and annual financial statements before submission to the board and also ensure compliance to internal control system. This is their legal obligation.

18.  The Audit Committee has authority to investigate into any matter in relation to the items specified in section 292A or referred to it by the Board of Directors of the company.

19.  Audit Committee will have full access to information contained in the records of the company and seek external professional advice, if necessary.

20.  The recommendations of the Audit Committee constituted by the company on any matter relating to financial management including the audit report will be binding on the Board of Directors.

21.  If the Board of Directors does not accept the recommendations of the Audit Committee, it should record the reasons for the same and communicate such reasons to the shareholders.

22.  The Chairman of the Audit Committee should attend the Annual General Meetings of the company to provide any clarification on matters relating to audit.

23.  It must be ensured that all financial statements are reviewed by Audit Committee before presented to full board.

24.  Audit Committee should ensure independence of auditors and hold frequent discussions with them on issues concerning audit.

25.  Audit Committee should meet at least four times in a year in case of listed company to review quarterly/annual statements.

26.  Secretary should prepare draft securities and get them approved and signed by Chairman of Audit Committee.

27.  Secretary/Chairman should ensure that corporate governance report included in Board's report covers constitution, composition, attendance, frequency of meetings and terms of reference of Audit Committee

28.  Secretary should ensure that if any of the Audit Committee recommendations have not been accepted by board, this fact should be disclosed to shareholders.

29.  If default is made in complying with the provisions of section 292A, the company, and every officer who is in default, will be punishable with imprisonment for a term which may extend to one year or with fine which may extend to Rs. 50000/- or with both.

30.  In case of a listed company, setting up of a qualified and independent audit committee is mandatory as per clause 49.II of the Listing Agreement.

 

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