The primary purpose of a company’s audit committee is to provide oversight of the financial reporting process, the audit process, the company’s system of internal controls and compliance with laws and regulations. This committee is sometimes set up as the requirement of law and sometimes setting up as adoption of best practices of good corporate governance.
Relevant Sections/Regulation required for Audit Committee
- Section 177 of the Companies Act, 2013;
- Rule 6 and 7 of Companies (Meetings of Board and its Powers) Rules, 2014;
- Regulation 18 of SEBI (Listing Obligation and Disclosure Requirements) Regulations 2019.
Class of Companies required to constitute Audit Committee:
As prescribed under Section 177 of the Companies Act, 2013 and Rule 6 of Companies (Meetings of Board and its powers) Rules, 2014 requires the Board of Directors of following classes of companies shall constitute an Audit Committee:
- Every Listed Company;
- Public Limited Company
- having paid-up capital of Rs.10 Crores or more;
- having turnover of Rs.100 Crores or more;
- having in aggregate, outstanding loans or borrowings or debentures or deposits exceeding Rs.50 Crores or more.
Note: The paid-up share capital or turnover or outstanding loans, or borrowings or debentures or deposits, as the case may be, as existing on the date of last audited Financial Statements shall be taken into account for the purposes of this rule.
Exemption: The Rule of Constitution of Audit Committee would be applicable to following Companies:
- wholly owned subsidiary company
- Joint Venture
- Dormant company under section 455 of the Companies Act, 2013
Composition as per Companies Act and LODR Regulation:
The Audit Committee shall consist of:
- minimum of 3 Directors with majority being Independent Directors;
- the majority of members of Audit Committee including its Chairperson shall be persons with ability to read and understand the financial statement whereas one member should have expertise knowledge of accounting or relating financial management;
- Chairman shall be the Independent Director;
- Requirement of Independent Director is not applicable to Section 8 Companies;
Explanation: “financially literate” shall mean the ability to read and understand basic financial statements i.e. balance sheet, profit and loss account, and statement of cash flows;
a member shall be considered to have accounting or related financial management expertise if he or she possesses experience in finance or accounting, or requisite professional certification in accounting or any other comparable experience or background which results in individual’s financial sophistication, including being or having being a chief executive officer, chief financial officer or other senior officer with financial oversight responsibilities.
The Chairman of the Audit Committee shall be present at every Annual General Meeting of the Company to answer shareholder queries.
The Board’s report under section 134(3) shall disclose the composition of an Audit committee and where the Board had not accepted any recommendation of the Audit Committee, the same shall be disclosed in such report along with the reasons there for.
The Company Secretary shall act as the secretary to the committee.
Meetings of the Committee
Under The Companies Act, 2013:
The Companies Act, 2013 does not provide for frequency of meeting of the Audit Committee. However, as per SS-1, Committees shall meet as often as necessary subject to minimum number and frequency prescribed by any law or any authority or as stipulated by the Board.
The Auditors of the Company and the key managerial personnel shall have a right to be heard in the meeting of the Audit Committee when it considers the auditor’s report but shall not have the right to vote.
Quorum for Audit Committee – as per SS-1, the quorum for meetings of the committee constituted by the Board shall be as specified by the Board. If no such quorum is specified, the presence of all the members of any such committee is necessary to form the quorum.
Regulations framed under any other law may contain provisions for the quorum of the Committee and such stipulations shall be followed.
Under the SEBI (LODR) Regulations, 2015
The audit committee shall meet at least 4 times in a year and not more than 120 gap between two committee meetings.
The quorum for audit committee meeting shall either 2 members or 1/3 of the members of the audit committee, whichever is greater, with at least 2 independent directors.
The chairperson of the audit committee is required to be present at Annual General Meeting.
Functions of Audit Committee:
Section 177(4) of the Companies Act, 2013 provides that every audit committee shall act in accordance with the terms of reference specified in writing by the Board which shall, inter alia, include —
- The recommendation for appointment, remuneration and terms of appointment of auditors of the company;
- Review and monitor the auditor’s independence and performance, and effectiveness of audit process;
- Examination of the financial statement and the auditors’ report thereon;
- The Audit Committee may make omnibus approval for related party transactions proposed to be entered into by the Company subject to such conditions as prescribed under rule 6A of the Companies of the Companies (Meeting of Board and its Powers) Rules, 2014;
- Further in case of transaction, other than transactions referred to in Section 188 (Related Party Transactions), and where audit committee does not approve the transaction, it shall make its recommendations to the Board,
- In case any transaction involving any amount not exceeding Rs.1 crores is entered into by a Director or Officer of the Company without obtaining the approval of the audit committee and it is not ratified by the audit committee within 3 months from the date of transaction, such transaction shall be voidable at the option of the audit committee and if the transaction is with the related party to any Director or is authorized by any other director, the director concerned shall indemnify the Company any loss incurred by it.
- However the provisions of this clause shall not apply to a transaction, other than a transaction referred to in section 188, between a holding company and its wholly owned subsidiary company.
- Scrutiny of inter-corporate loans and investments;
- Valuation of undertakings or assets of the company, wherever it is necessary;
- Evaluation of internal financial controls and risk management systems;
- Monitoring the end use of funds raised through public offers and related matters.
The Role of Committee and the review information by Audit Committee is prescribed under Part C of Schedule II of SEBI (LODR) Regulations, 2015. The role of the Audit Committee under the Regulation 18 is wider than the Companies Act, 2013, which includes:
- Oversight of the listed entity’s financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and credible;
- Recommendation for appointment, remuneration and terms of appointment of auditors of the listed entity;
- Approval of payment to statutory auditors for any other services rendered by the statutory auditors;
- Reviewing with the management, the annual financial statement and auditors report thereon before submission to the Board for approval, with particular reference to:
- Matters required to be included in the Director’s Responsibility Statement to be included in the Board’s Report in terms of Section 134(3)(c) of the Companies Act, 2013.
- Changes, if any, in accounting policies and practices and reasons for the same;
- Major accounting entries involving estimates based on the exercise of judgement by the management;
- Significant adjustment made in the financial statements arising out of audit findings;
- Compliance with listing and other legal requirements relating to financial statements;
- Disclosure of any related party transactions;
- Modified opinion(s) in the draft audit report;
- Reviewing with the management, the quarterly financial statement before submission to the Board for approval;
- Reviewing with the management, the statement of uses / application of funds raised through an issue (public issue, right issue, preferential issue, etc.), the statement of funds utilized for purposes other than those stated in the offer documents / prospectus / notice and the report submitted by the monitoring agency monitoring the utilization of proceeds of a public or right issue, and making appropriate recommendations to the Board to take up steps in this matter;
- Reviewing and monitoring the auditor’s independence and performance, and effectiveness of audit process;
- Approval or any subsequent modification of transaction of the listed entity with related parties;
- Scrutiny of inter-corporate loans and investments;
- Valuation of undertakings or assets of the listed entity, wherever it is necessary;
- Evaluation of internal financial controls and risk management system;
- Reviewing, with the management, performance of statutory and internal auditors, adequacy of internal control systems;
- Reviewing the findings of any internal investigations by the internal auditors into matters where there is suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the matter to the Board;
- Discussion with the statutory auditors before the audit commences, about the nature and scope of audit as well as post-audit discussion to ascertain any area of concern;
- To look into the reasons for substantial defaults in the payment to the depositors, debenture holders, shareholders (in case of non-payment of declared dividends) and creditors;
- To review the functioning of the whistle blower mechanism;
- Approval of appointment of chief financial officer after assessing the qualifications, experience and background, etc. of the candidate;
- Carrying out any other function as is mentioned in the terms of reference of the audit committee;
- Reviewing the utilization of loans and/or advances from/investment by the holding company in the subsidiary exceeding Rs.100 Crores or 10% of the assets size of the subsidiary, whichever is lower including the existing loans / advances / investments existing as on date of coming into force of this provision.
- Consider and comment on rationale, cost benefits and impact of schemes involving merger, demerger, amalgamation etc., on the listed entity and its shareholders.
The Audit Committee shall mandatorily review the following information:
- Management discussion and analysis of financial condition and results of operations;
- Statement of significant related party transactions (as defined by the Audit Committee), submitted by management;
- Management letters / letters of internal control weakness issued by the statutory by the statutory auditors;
- Internal audit reports relating to internal control weakness; and
- The appointment, removal and terms of remuneration of chief internal auditor shall be subject to review by the audit committee;
- Statements of deviations:
- Quarterly statement of deviation(s) including report of monitoring agency, if applicable, submitted to stock exchange(s) in terms of Regulation 32(1) of the SEBI (LODR) Regulations, 2015;
- Annual statement of funds utilized for purposes other than those stated in the offer document/prospectus/notice in terms of Regulation 32(7) of the SEBI (LODR) Regulations, 2015
Powers of Audit Committee:
The Audit committee shall have the following powers under the section 177(5) of the Companies Act, 2013 and have similar powers under SEBI (LODR) Regulations, 2015 –
- To call for the comments of the auditors about internal control systems, the scope of audit, including the observations of the auditors and review of financial statement before their submission to the Board
- To discuss any related issues with the internal and statutory auditors and the management of the company.
- To investigate into any matter in relation to the items specified in terms of reference or referred to it by the Board and for this purpose the Committee has power to obtain professional advice from external sources
- To have full access to information contained in the records of the company.
Disclosure in Board Report
The Board’s Report of the Company is required to disclose the composition of Audit Committee and where the Board has not accepted any recommendation of the Audit Committee, the same shall be disclosed in such report along with the reasons therefor.
Penalty for non-compliances
If any Company contravene the provisions of Section 177 of the Companies Act 2013, the Company would be liable to pay fine of Rs. 1 lakh to Rs 5 lakh and officers who are in default will be liable to pay fine Rs. 25,000 to Rs. 1,00,000 or imprisonment up to 1 year or both.
Establishment of Vigil Mechanism
Sub-section (9) of (10) of section 177 of the Companies Act, 2013 read with rule 7 of the Companies (Meeting of Board and its Power) Rules, 2014 provide that:
Every listed company and the companies belonging to the following class or classes shall establish a vigil mechanism for their directors and employees to report their genuine concerns or grievances:
- the companies which accepts deposits from the public;
- the companies which have borrowed money from banks and public financial institutions in excess of Rs.50 crores.
The companies which are required to constitute an audit committee shall oversee the vigil mechanism through the audit committee and if any of the members of the committee have a conflict of interest in a given case, they should rescue themselves and the other on the committee would deal with the matter on hand.
In case of other companies, the Board of Directors shall nominate a director to play the role of audit committee for the purpose of vigil mechanism to whom other directors and employees may report their concerns.
The vigil mechanism provides adequate safeguards against vicitimization of director(s) or employee(s) or any other person who avail the mechanism and also provide for direct access to the Chairperson of the audit committee or the director nominated to play the role of audit committee, as the case may be, in appropriate or exceptional cases.
In case of repeated frivolous complaints being filed by a director or an employee, the audit committee or the director nominated to play the role of audit committee may take suitable action against the concerned director or employee including reprimand.
The details of establishment of such mechanism are required to be disclosed by the Company on its website, if any, and in the Board’s Report.