Assessing Audit Committee Performance

(First of two parts)

By Rebecca Go Sarmenta

First Published in Business World 6/25/2012)

For companies listed on the Philippine Stock Exchange (PSE), it is mandatory that an Audit Committee be present to steer the company along the path of good corporate governance.

To be effective, an Audit Committee must understand its responsibilities, monitor its effectiveness, and identify improvement needs and opportunities. A regular performance assessment allows the Audit Committee to ensure that it is meeting the expectations of its members, the full board and regulators. With an effective self-assessment process, the Audit Committee can prioritize its agenda and meeting structure and focus on critical issues; determine the committee composition considering the company’s current and future strategy and challenges; and identify areas for continuing education.

Audit Committees grew out of the increasing focus on governance which has gained ground in the corporate consciousness over the last decade. In fact, in 2002, the Securities and Exchange Commission (SEC) issued the Code of Corporate Governance (Memorandum Circular [MC] No. 2, Series of 2002) to cover registered corporations in the Philippines including branches and subsidiaries of foreign corporations. SEC MC. No. 2, series of 2002 required corporations to constitute Audit Committees, which shall consist of at least three directors (preferably with accounting and finance backgrounds) one of whom shall be an independent director and another with audit experience. The Audit Committee chair should be an independent director. The Code was subsequently refined with the promulgation of the Revised Code of Corporate Governance or SEC MC. No. 6, series of 2009.

Recognizing that the Audit Committee is one of the crucial committees to assist in good corporate governance, the SEC more recently issued SEC MC No. 4, series of 2012 (which takes effect on June 30, 2012) further reinforcing the importance for an Audit Committee to assess its own performance in promoting good corporate governance.

SEC MC No. 4, series of 2012 prescribes the rules on assessing the performance of the Audit Committee of companies listed on the PSE. The Audit Committee must assess its effectiveness in carrying out its oversight responsibilities over financial reporting disclosures, risk management activities, internal control systems, compliance with laws, rules and regulations, internal audit activities, and external audit.

The Audit Committee Charter is the baseline for assessing the effectiveness of the Audit Committee in performing its oversight responsibilities. The Charter governs the operations of the Audit Committee. It defines the Committee’s purpose, authority, composition, structure, oversight responsibilities, reporting responsibilities, resources, and other relevant information. This charter should strictly take into consideration the requirements of the Revised Code of Corporate Governance and other applicable laws, rules and regulations as well as leading practices. In fact, the charter is so important that SEC MC No. 4, series of 2012 specifically requires it, and the presence or absence of one is considered a required disclosure. When there is no charter, the Audit Committee is required to disclose the reason for its absence and its plan to address this deficiency.

SEC MC. No. 4, series of 2012 also provides a self-assessment worksheet that covers leading practice attributes of effective audit committees, as well as the relevant minimum legal and regulatory requirements. These leading practice attributes are grouped into the following five categories:

1. Audit Committee composition, structure and activities;
2. Oversight over the financial reporting process and financial reporting disclosures;
3. Oversight over risk management and internal controls;
4. Oversight over management and the internal audit function; and
5. Oversight over the external audit activity

Audit Committee Composition, Structure, Activities

The composition of the Audit Committee is critical to its effectiveness, which is why it is vital that members have the requisite skills, knowledge, and degree of independence. The expertise and competence requirements of the committee members, as well as a succession plan, should be evaluated in the context of the company’s current strategy and expected risk profile over the next three years.

The members’ level of commitment and availability should also be considered when evaluating the committee’s ability to carry out its responsibilities effectively. In addition, trainings that address relevant topics to the company’s needs and in specialized or regulated industry matters and trends should be provided regularly to ensure that committee members maintain and update the knowledge and skills required by their duties.

Oversight over the Financial Reporting Process

One of the primary responsibilities of the Audit Committee is to oversee the integrity of the company’s accounting and financial reporting process and financial statements. It must make sure that financial statements are understandable and transparent, which means that:

• The committee should have a good understanding of the company’s operations and its significant risks;
• It should be able to understand complex accounting and reporting issues and what management is doing to address them;
• It should continue to focus on financial statement issues affected by economic conditions such as asset impairments, earnings, cash flows, and liquidity positions;
• It should review significant financial reporting and regulatory developments, including their effect on the financial statements and on the company resource requirements; and,
• It should be able to assess the quality of the accounting principles and the appropriateness of significant accounting policies, considering alternative treatments of generally accepted accounting principles.

These are the first two of the key items covered by SEC MC No. 4, series of 2012.
In next week’s column, we will look at the Audit Committee’s oversight duties over risk management and internal controls, oversight over management and the internal audit function, and oversight over external audit activities.

Rebecca Go Sarmenta is a Partner of SGV & Co.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.