The Audit Committee

Roles and Responsibilities of the Chief Audit Executive

• Stakeholder Relationship Management:

  • A central responsibility of the Chief Audit Executive (CAE) is managing critical relationships with key internal and external stakeholders.

  • Effective stakeholder management is essential to the success of the internal audit function.

  • Maintained relationships enable the CAE to inform organizational change, execute strategic change, and keep leadership informed regarding unmitigated and impending risks.

• Key Stakeholders Identified:

  • Board of Directors: Represents organizational ownership and serves as the primary board of control.

  • Audit Committee: A specialized subcommittee of the board of directors overseeing audit activities.

  • Management: Responsible for executing the board's strategic vision by operating business processes, business models, and internal control systems.

  • External Auditors: Responsible for attesting to the veracity of external reporting, primarily the financial statements and accompanying financial statement notes.

  • Shareholders: Represent the underlying ownership of the organization.

  • Regulators: External government or industry bodies responsible for enforcing compliance with applicable laws, regulations, and rules.

Audit Committee Composition and Requirements

• Definition and Structural Role:

  • The audit committee is a formal subcommittee of the board of directors designed to oversee financial reporting and auditing processes.

• Director Classifications:

  • Inside Directors: Board members who simultaneously serve as full-time employees or senior executives within the organization (e.g., an executive serving concurrently as Chief Executive Officer and Chairman of the Board).

  • Outside Directors: Board members who are independent of the organization and not employed by the company.

• Composition Rules and Standards:

  • In the United States, established best practice for publicly traded entities mandates that every member of the audit committee must be an outside director.

  • At least one member of the audit committee must be formally designated as a financial expert.

• Financial Expert Qualification and Profile:

  • Typically possesses significant prior experience in public accounting or financial accounting.

  • Commonly fulfilled by an active or retired partner from a major public accounting firm (e.g., George Straw).

  • Corporate and institutional examples with dedicated financial experts on their governing audit committees include:

    • Southern Company

    • Regions

    • Hewlett Packard

    • Chevrolet

    • Ford

    • University of Alabama System Board of Trustees (where faculty representation, such as the elected faculty representative for UAB, interacts directly with board governance).

Audit Committee Oversight of Internal Audit

• Insulation and Tension Point:

  • The primary role of the audit committee is promoting the independence of the internal and external audit functions by insulating them from management influence.

  • Serves as a formal guardrail, backstop, and check-and-balance system against management caprices.

  • Prevents management from exerting undue influence over internal audit scope, engagements, or findings.

• Internal Audit Governance Mechanics:

  • Direct Reporting Line: The Chief Audit Executive reports directly to the board of directors/audit committee.

  • Hiring and Firing Authority: Only the board of directors holds authority to hire or fire the Chief Audit Executive, preventing executive management retaliation.

  • Internal Audit Charter: The board approves the internal audit charter based on recommendations from the audit committee, establishing the breadth and depth of permitted internal audit activities.

  • Audit Plan Approval: The audit committee reviews and approves the annual audit plan, which dictates the schedule of audit engagements for the upcoming year.

  • Budgeting Control: The audit committee approves the internal audit budget, including total funding, salary structures, and auditor headcount.

  • Dispute Escalation: Resolves formal disputes between internal audit and management, particularly surrounding management's assumption of risk. Unresolved risks escalated by the CAE are decided by the audit committee, whose decision is final.

Audit Committee Oversight of External Audit

• Selection and Oversight:

  • The audit committee holds sole authority to select and retain the outside public accounting firm performing the external financial statement audit.

  • Monitors and oversees the execution and progress of external audit engagements.

• Reporting and Compensation:

  • External auditors report directly to the audit committee, bypassing management.

  • The audit committee reviews all external audit reports and disclosures.

  • The audit committee takes point on negotiating fees and total compensation structures for external audit services.

• Management Dispute Resolution:

  • By removing selection, compensation, and direct reporting authority from management, the audit committee insulates external auditors from undue pressure.

  • Serves as the primary authority responsible for resolving technical or reporting disputes between management and external auditors.