In Your Face

Characteristics of an Effective Audit Committee

I read with interest the “goings on” at Shell last week. The Chairman, Sir Philip Watts, was forced to resign on Wednesday. This was the culmination of a chain of events that started when Shell announced, on 9th January, that it had reduced its proven oil and gas reserves by 20%.

Various groups and events led to the departure of Watts. However, it is reported that the final push came from the internal audit committee; which advised the board that management changes were needed.

During my career (see my resume), I have set up a number of audit committees around the world, and have been involved with others. I was therefore pleased to see an audit committee proactively asserting itself, and being listened to.

I would like to take this opportunity to remind those less proactive audit committees, and less supportive boards, as to what in my opinion (based on my experience) constitutes the top ten characteristics of an effective audit committee:

1. The audit committee must be independent, members should not have previously held executive positions in the company for which they sit on the audit committee; eg the chairman of the audit committee should not have previously been the finance director. The company should not use the audit committee as a paid retirement home for previous directors.

2. The audit committee should be suitably qualified and experienced, at least one member should hold a relevant financial qualification; so that they can at least understand the intricacies of the company’s accounts.

3. The audit committee should present a report in the year end accounts, as to the quality and effectiveness of the internal controls and risk management process.

4. The audit committee should be prepared to take a stand against the board on matters of significance, and resign if the board does not take the appropriate corrective action.

5. The members of the audit committee should be up to the job, they should not hold an excessive number of other positions. Those that, through age, fall asleep during the meetings should be retired. Do not think that this is an exaggeration, I personally have witnessed this occurrence.

6. The audit committee should have free and unfettered access to the internal auditors and external auditors of the company, as well as the board and management of that company.

7. The role and scope of the audit committee should be laid down in a charter, which should be signed by the board and distributed within the company.

8. The internal audit department should report directly to the audit committee. Dual reporting lines, to eg the Finance Director, do not work.

9. The audit committee should be responsible for assessing the quality and effectiveness of the internal audit department and external auditors. The committee should be able to make changes, as and when required, to the scope and providers of the audit (both internal and external) coverage.

10. The audit committee should be responsible for the budget of the internal and external audit coverage. I have witnessed a situation where neither the board nor the audit committee held the budget; needless to say this did not work.

This list is not intended to be exhaustive. However, it can be used as a starting point to establish an effective and respected audit committee that adds value to the business.