Part 1: Overview of the Recommendations
This is the first part in a series of articles on the 1-2-3 of audit committees. The recommended responsibilities of the audit committee as contained in the King IV Report will be explored in the next part
With the issuance by the Institute of Directors in Southern Africa of the King IV Report on Corporate Governance for South Africa (2016) (King IV Report) on 1 November 2016, it became evident that the audit committee is still considered to be one of the most useful and necessary board committees in any organisation.
Several authors have noted that there is little difference between the King Report on Governance for South Africa (2009) (King III Report) and the King IV Report and that the majority of audit committees will continue to function as they have under the King III Report. Although this may be the case, it is important that the requirements of the King IV Report, including the difference in approach between the two reports, be taken into consideration timeously to ensure that audit committees are aware of their duties and responsibilities as contained in the King IV Report. The King IV Report is effective for financial years commencing from 1 April 2017 and replaces the King III Report in its entirety.
In assisting organisations to be King IV ready, it is important to look at who should have an audit committee; the composition of the audit committee and its required qualifications; and enhanced disclosure requirements.
Who should have an audit committee?
Whereas the King III Report recommended that every organisation appoint an audit committee, the King IV Report recommends that the governing body1 of an organisation that issues audited financial statements should consider the need for such a committee as deemed to be necessary to fulfil the role of providing independent oversight of:
The effectiveness of the organisational assurance functions and services, with a particular focus on combined assurance arrangements, and
The integrity of the annual financial statements and other external reports issued by the organisation.2
The King IV Report further acknowledges that the establishment of an audit committee is a statutory requirement for some organisations.3 The Companies Act 71 of 2008 requires a public company, a state-owned company or other company that is required by its Memorandum of Incorporation to have an audit committee. Furthermore, the JSE listing requirements require listed companies to have an audit committee.
Composition of the audit committee and required qualifications
The King IV Report recommends that all members of the audit committee, including the chair, be independent, non-executive members of the governing body.4 The King IV Report further recommends that the audit committee should, as a whole, have the necessary financial literacy, skills, and experience to execute their duties effectively.5
This principle does not provide detailed guidance on the qualifications and skills of the audit committee. Regulation 42 of the Companies Regulations, 2011, however, does provide guidance on the qualifications for members of the audit committee for companies. This regulation indicates that at least one-third of the audit committee members should have academic qualifications, or experience, in economics, law, corporate governance, finance, accounting, commerce, industry, public affairs or human resource management. The skillset needed will be determined by the specific needs and risks of the organisation and the industry in which they function. The establishment of an audit committee comprising members with the right skillset and suitable qualifications is fundamental to the effective functioning of the committee.
Enhanced disclosure requirements
A significant adjustment for audit committees will be the changes in the enhanced disclosure recommendations contained in the King IV Report. Principle 8, paragraph 59 of the King IV Report contains the detail disclosure recommendations for audit committees. To apply the ‘Apply AND Explain’ approach of the King IV Report, each audit committee will be required to explain how they performed their duties and functions during the year. With this shift from the ‘Apply OR Explain approach contained in the King III Report, audit committees are no longer required to explain why certain principles are not applied, resulting in a change in the focus of disclosures to a positive approach. In practice, it may be a good idea for governing bodies to match this positive disclosure approach to the terms of reference of the audit committee to ensure the completeness of disclosures.
In addition to the required statutory disclosures applicable to the audit committee of a particular entity and the general disclosures for any committee of the governing body on an entity (as per principle 8, paragraph 50), the King IV Report also recommends that the audit committee disclose their satisfaction that the external auditor is independent. It is recommended that this statement confirming the audit committee’s satisfaction with the independence of the external auditor address:6
Policies and controls regarding non-assurance services provided by the external auditors
Tenure of the external audit firm
The rotation of the designated external audit partner, and
Any significant changes in the management of the organisation during the external audit firm’s tenure
Any significant audit matters that the audit committee considered during the external audit should also be disclosed, together with the committee’s view on the quality of the external audit.7 Other disclosure requirements include:8
Arrangements regarding the combined assurance model with the audit committee’s view on the effectiveness of this model
The audit committee’s views on the effectiveness of the Chief Audit Executive (CAE) and the arrangements for internal audit
The audit committee’s view on the effectiveness of the design and implementation of internal financial controls
The audit committee’s views on the effectiveness of the Chief Financial Officer (CFO) and the finance function
Although the recommendations on who should have an audit committee and the composition, functions, and duties of such a committees have not changed significantly from the King III to the King IV Report, there are additional requirements that audit committees need to consider. A significant adjustment for most organisations about the changes affecting the operation of an audit committee will probably be the enhanced recommended disclosure practices in the King IV Report.
1 The governing body is the structure that has primary accountability for the governance and performance of the organisation; the board of directors in the case of a company, the board of a retirement fund, the accounting authority of a state-owned entity and a municipal council.
2 Principle 8, paragraph 51.
3 Principle 8, paragraph 51.
4 Principle 8, paragraphs 56 and 57.
5 Principle 8, paragraph 55.
6 Principle 8, paragraph 59(a)
7 Principle 8, paragraphs 59(b) and (c).
8 Principle 8, paragraph 59(d)–(f).
author: Cornelie Crous CA(SA), Senior Lecturer: School of Accountancy at the University of the Free State