Corporate Governance and Audit Committee – An Indian Perspective

The term governance refers to a system by which an organization is run. Corporate governance is the module for fixing a liability on corporate entity. Corporate Governance is the application of best Management Practices, Compliance of Laws in true letter and spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility for sustainable development of all stakeholders.

Studies  have shown that markets and investors take notice of well-managed companies, respond positively to them, and reward such companies, with higher valuations in the long run.

Need of Corporate Governance:

The collapse of international giants like Eronf, Worlcom, Tyco, AOL, financial scams like Satyam and mismanagement in IL&FS in India, have been big eye-openers in the corporate world to make realise the company’s management, ownership and stakeholders the emergent need to comply with Corporate Governance principles in order to prevent themselves from paying huge corporate criminal liabilities in the future. These huge corporate giants paid the cost for lack of good corporate governance practices and corrupt policies adopted by management of these companies and their financial consulting firms.

The significance of good corporate governance solutions has widened because of the increasing conflict between ownership and management disciplines, the non-compliance of financial reporting by auditors which inflicts heavy losses on investors and lack of fair and transparent culture in the company which shocks investor trust in the financial viability of the company and its ethical standards.

History of Corporate Governance in India

Corporate governance initiatives in India began in 1998 with the Desirable Code of Corporate Governance – a voluntary code published by the CII (Confederation of Indian Industry), and the first formal regulatory framework for listed companies specifically for corporate governance, established by the SEBI.

The latter was made in February 2000, following the recommendations of the Kumarmangalam Birla Committee Report.

A 21-member Committee on corporate governance headed by banker Uday Kotak formed on June 2017 also gave its recommendations to improve the functioning of listed organizations on October, 2017

The SEBI Committee on Corporate Governance (the “Committee”) was constituted under the Chairmanship of Shri N. R. Narayana Murthy, Chairman and Chief Mentor of Infosys Technologies Limited.

Some Mandatory recommendation by the committee:

Audit committees of publicly listed companies should be required to review the following information mandatorily:

• Financial statements and draft audit report, including quarterly / half-yearly financial information;

• Management discussion and analysis of financial condition and results of operations;

• Reports relating to compliance with laws and to risk management;

• Management letters / letters of internal control weaknesses issued by statutory internal auditors; and

 • Records of related party transactions.

Report of Naresh Chandra Committee on Corporate Governance:

Recommendations of the Naresh Chandra Committee:

Mandatory recommendation:

Management should provide a clear description in plain English of each material contingent liability and its risks, which should be accompanied by the auditor’s clearly worded comments on the management’s view. This section should be highlighted in the significant accounting policies and notes on accounts, as well as, in the auditor’s report, where necessary. This is important because investors and shareholders should obtain a clear view of a company’s contingent liabilities as these may be significant risk factors that could adversely affect the company’s future financial condition and results of operations.

Mandatory recommendation for CEO / CFO Certification:

For all listed companies, there should be a certification by the CEO (either the Executive Chairman or the Managing Director) and the CFO (whole-time Finance Director or other person discharging this function) which should state that, to the best of their knowledge and belief:

• They have reviewed the balance sheet and profit and loss account and all its schedules and notes on accounts, as well as the cash flow statements and the Directors’ Report;

• These statements do not contain any material untrue statement or omit any material fact nor do they contain statements that might be misleading;

These statements together present a true and fair view of the company, and are in compliance with the existing accounting standards and / or applicable laws / regulations;

• They are responsible for establishing and maintaining internal controls and have evaluated the effectiveness of internal control systems of the company; and they have also disclosed to the auditors and the Audit Committee, deficiencies in the design or operation of internal controls, if any, and what they have done or propose to do to rectify these;

• They have also disclosed to the auditors as well as the Audit Committee, instances of significant fraud, if any, that involves management or employees having a significant role in the company’s internal control systems; and

• They have indicated to the auditors, the Audit Committee and in the notes on accounts, whether or not there were significant changes in internal control and / or of accounting policies during the year.

Kumara Managalam Birla Committee Report on Corporate Governance:

This report emphasis on adequacy and the quality of corporate governance that shape the growth and the future of any capital market and economy. The pivotal role in any system of corporate governance is performed by the board of directors. It is accountable to the stakeholders and directs and controls the Management. Adequate financial reporting and disclosure are the corner stones of good corporate governance. These demand the existence and implementation of proper accounting standards and disclosure requirements. In the opinion of the Committee, the imperative for corporate governance lies not merely in drafting a code of corporate governance, but in practicing it.

Kumar Mangalam Birla Committee gave its recommendations on board of directors, its composition of board, chairman of the board and the audit committee.

As the transparence in the financial systems is the core to attract the investors which also leads to the economy growth of the nations some of the recommendations of this committee report on composition of Audit Committee is as follows:

The Committee  recommended that a qualified and independent audit committee should be set up by the board of a company. This would go a long way in enhancing the credibility of the financial disclosures of a company and promoting transparency

the audit committee should have minimum three members, all being non executive directors, with the majority being independent, and with at least one director having financial and accounting knowledge;

the chairman of the committee should be an independent director;

The Committee recommends that to begin with the audit committee should meet at least thrice a year. One meeting must be held before finalisation of annual accounts and one necessarily every six months.

As the audit committee acts as the bridge between the board, the statutory auditors and internal auditors, the Committee recommends that its role should include the following

Oversight of the company’s financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and credible

Recommending the appointment and removal of external auditor, fixation of audit fee and also approval for payment for any other services.

Reviewing with the management, external and internal auditors, the adequacy of internal control systems.

Reviewing the company’s financial and risk management policies.

Looking into the reasons for substantial defaults in the payments to the depositors, debenture holders, share holders (in case of non-payment of declared dividends) and creditors.

SEBI’S Response:

Securities Exchange Board of India (SEBI) considered and adopted in its meeting held on 25 January 2000, the recommendations of the Kumar Mangalam Birla Committee on Corporate Governance appointed by it. In accordance with the guidelines provided by SEBI, the stock exchanges in India have modified the listing requirements by incorporating in them a new clause (Clause 49), so that proper disclosure for ensuing corporate governance is made by companies. SEBI’s Code of Corporate Governance requires that the following information be placed by a company before the board of directors periodically:

Taking into consideration of Audit committee which is the essence to ensure corporate governance in an organization various changes have been made in the Companies Act and the SEBI regulations to make the composition of audit committee in the line with the recommendations suggested by various committees formed by SEBI and the new composition of the audit committee is as follows:

Audit committee

Section 177 of Companies Act, 2013 makes it compulsory for every listed company and public companies

having paid up share capital of ten crore rupees or more or

having turnover of one hundred crore rupees or more or

having aggregate outstanding loans, debentures and deposits exceeding fifty crore rupees

to have an independent audit committee, consisting of minimum three directors with independent directors forming a majority and majority members must have ability to read and understand financial statements.

Regulation 18 of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015

(1) Every listed entity shall constitute a qualified and independent audit committee in accordance with the terms of reference, subject to the following:

(a) The audit committee shall have minimum three directors as members.

(b) Two-thirds of the members of audit committee shall be independent directors.

(c) All members of audit committee shall be financially literate and at least one member shall have accounting or related financial management expertise.

(d) The chairperson of the audit committee shall be an independent director and he shall be present at Annual general meeting to answer shareholder queries.

(e) The Company Secretary shall act as the secretary to the audit committee.

(f) The audit committee at its discretion shall invite the finance director or head of the finance function, head of internal audit and a representative of the statutory auditor and any other such executives to be present at the meetings of the committee:

(2) The listed entity shall conduct the meetings of the audit committee in the following manner:

(a) The audit committee shall meet at least four times in a year and not more than one hundred and twenty days shall elapse between two meetings.

(b) The quorum for audit committee meeting shall either be two members or one third of the members of the audit committee, whichever is greater, with at least two independent directors.

(c) The audit committee shall have powers to investigate any activity within its terms of reference, seek information from any employee, obtain outside legal or other professional advice and secure attendance of outsiders with relevant expertise, if it considers necessary.

The audit committee plays an important role in assisting the board to fulfill its oversight responsibilities in areas such as an entity’s financial reporting, internal control system, and risk management system.

As a representative of the board of directors and main part of the corporate governance mechanism the audit committee is involved in the organizations both internal and external audits, internal control, regulatory compliance and risk management.

The role of audit committee and auditors in current scenario become very crucial. Stakeholders expect loyalty and trust from auditor and auditing committee while resolving financial facts and exposing at all fraud and fault in organization. The audit committee member’s experience, relevant exposures, qualification background and in depth knowledge need to be highlighted and confirmed because if directors are experts, experienced, qualified, financial wizards, then they can have vision and foresightedness to protect stakeholders. If a company has an active and strong audit committee then independent auditors’ working will be supported.

Recommendations of Kotak committee on Audit Committee

Audit committee shall meet at least five times in a year instead to four.

Review the utilization of loans and/ or advances from/ investment by the holding company in the subsidiary exceeding rupees 100cr or 10% of the assets size of the subsidiary, which ever in lower.

Hemant Paliwal

Chartered Governance Professional



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