New guidance note on terms of reference for the audit committee

Relevant to – all company secretaries working in the corporate sector

This new guidance note reflects the requirements of the UK Corporate Governance Code (the Code) as revised in April 2016 and the updated FRC Guidance on Audit Committees (the FRC Guidance), also published in April 2016. It also includes appropriate references to the FRC Revised Ethical Standard published in June 2016. The revisions to these documents implement the EU Statutory Audit Directive 2014/56/EU and Regulation (EU) No. 537/2014.

The new guidance note reflects the additional responsibilities for audit committees contained in the EU Directive and Regulation, including oversight of the auditor’s appointment and audit tendering, and enhanced reporting requirements.
The audit committee’s responsibilities now include oversight of the relationship with the external auditor, as well as the relationship between internal and external audit. In addition to assessing the effectiveness of the external audit process, the audit committee also has responsibility for the external auditor’s remuneration, including fees for both audit and non-audit services. 

The audit committee will need to carry out an annual appraisal of the qualifications, expertise and resources of the auditor, together with an assessment of the auditor’s independence. The independence assessment will include a report from the external auditor on its own internal quality procedures, its independence and objectivity. It must take any threats to independence into account, including the provision of any non-audit services, and the safeguards in place. The audit committee must also ensure there are no relationships between the auditor and the company that could affect the auditor’s independence, and review the auditor’s processes for maintaining independence – including the rotation of audit partner and staff. Additionally, the committee must develop a policy on the employment of former employees of the company’s auditor. 

The audit committee is now subject to additional reporting requirements too. The Code requires the audit committee to report to the board on how it has discharged its responsibilities. It also now states that the work of the committee in discharging its responsibilities should be described in a separate section of the annual report. It sets out the contents requirements for the committee’s report. The annual report should also include a statement from the audit committee explaining its recommendation in relation to the appointment, reappointment or removal of the external auditor, if the board has not accepted that recommendation. Additionally, if an external auditor resigns, the audit committee must investigate the issues leading to this and decide whether any action is required. 

The expertise required on the audit committee has also been enhanced and, in addition to the requirement that at least one member has recent and relevant financial experience, the board should now satisfy itself that at least one member of the committee has competence in accounting and/or auditing, and that the audit committee as a whole has competence relevant to the sector in which the company operates.  

The new guidance note for audit committee terms of reference also reflects current corporate governance thinking regarding the need for board committees to avoid working in ‘silos’. It recognises the links and overlap between the responsibilities of board committees and, consequently, the need for each board committee to have full knowledge of the deliberations of other committees through reports to the board and, if possible, by appointing one audit committee member to the remuneration committee and one to a separate risk committee, if there is one. It also highlights the need for terms of reference for all board committees to be read together when allocating responsibilities to the committees, to avoid overlap or gaps and to ensure clear coordination between the board and the various committees. 

The model terms of reference, which are intended as a guide for companies to adapt to their needs, are designed for companies wishing to comply with the provisions of the Code and the FRC Guidance. Audit committees are not required to follow the FRC Guidance, but it provides a useful framework when implementing the provisions of the Code. It is recognised that audit committee arrangements need to be proportionate to the task, and will vary according to the size, complexity and risk profile of the company. However, the list of duties included in the model terms of reference are those which all audit committees should consider in line with good practice. 

The new guidance note on terms of reference for the audit committee can be found here.

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