When it comes to governance, there are many misconceptions. Consider the myth-or-fact statements below.

Fact. Governance practices – such as written policies, a trained and informed board of directors, and strong internal controls – are important for protecting the business and its owners.
Myth. Although not a requirement for privately held companies, a knowledgeable and independent audit committee is a healthy component of good governance for closely held and family-owned businesses of all sizes. An audit committee is particularly important for companies that hire an external auditor to examine the books and validate their financial status.
Audit Committee Setup

6 Common Audit Committee Set-Up Questions and Answers

With those facts in mind, it’s time to consider the answers to some commonly asked questions about an audit committee set-up.

Q: What is an audit committee?

A: An audit committee is a standing committee of a company’s board of directors. It is responsible for ensuring the integrity of financial reporting. In other words, the committee makes sure that financial statements are timely, complete, and reliable. As part of that responsibility, the audit committee confirms that the organization properly follows risk management and internal control practices. Finally, committee members collaborate with a company’s internal and external auditors to suitably fulfill their oversight duties.

Q: Who should serve on an audit committee?

A: One important quality of an audit committee is independence from the company. To provide crucial checks and balances, some, if not all, members of an audit committee should have no financial ownership of or other close relationship with the organization. For instance, they should not receive any fees from the business other than those earned as a result of the directorship.

Another key characteristic is expertise. At least one member of an audit committee should have strong financial expertise – that is, having at least a working knowledge of financial reporting guidelines (including generally accepted accounting principles, or GAAP) and internal controls.

Q: How large should an audit committee be? How often should it meet?

A: An audit committee typically has three or four members. Usually, someone with relevant financial experience — such as a CPA, CFO, or CEO — serves as the committee chair. Whether it meets virtually or face-to-face, an audit committee should meet at least quarterly.

Q: How does an audit committee interact with auditors?

A: An audit committee should have ongoing contact with the company’s internal auditors. This interaction should include a review of the annual internal audit plan, as well as the internal auditors’ reports.

If the company decides it needs an external audit, then the audit committee should be responsible for hiring, supervising, and compensating the external auditors. Ideally, a CPA firm experienced in auditing businesses in the same or a related industry conducts the external audit. The committee communicates with the CPA firm throughout the entire audit process — meeting to discuss a work plan for the audit, ensuring that each party has the necessary materials during the audit, and reviewing the findings before they are presented to the board of directors.

Q: Why does a company need an external audit?

A: In a word: credibility. If a company vets its financial statements through an external auditor, then its banks, creditors, and even potential buyers view those statements in a more positive light. For companies considering a future initial public offering (IPO), an external audit will put them much closer to meeting the compliance expectations of publicly traded companies.

Q: Does an audit committee play a role in fraud prevention?

A: As part of its responsibility to monitor the integrity of the company’s financial statements and internal controls, an audit committee looks for red flags in financial statements that might signal fraud (e.g., unexplained fluctuations in revenues or expenses). Fraud, abuse, or non-compliance with government regulations can all be hidden beneath the surface of day-to-day accounting practices, and these problems can become more pronounced as a company grows.

Of course, having an independent audit committee is no guarantee against corporate fraud, especially when it occurs very often. But there is no denying that when an engaged audit committee asks the tough questions, it is much harder for even the CEO to let fraud happen on his or her watch. An external auditor can also help identify ways in which a company’s books or accounting practices no longer comply with IRS regulations.

Let CRI Help You Implement or Freshen Up Your Governance Practices

Smart governance practices are important for ethically operating your business. If you have questions about audit committees or any other governance-related issues, then contact CRI’s knowledgeable CPAs and advisors. We have years of experience in helping organizations of all sizes establish or improve their governance policies – and we can do the same for your company.