Introduction – Origins of the Audit Committee
Nowadays, an increasing number of companies are demonstrating concerns regarding the stability of performance and business operations. The issue has become especially acute because of the global interconnectedness of economic actors worldwide and the recent economic crisis. It means that organizations want to have objective information representing their condition both financial and operational and know whether there are any risks and challenges that might endanger their prosperity, risk responsiveness, and competitiveness. In the case of designing ways to reach stability, companies focus on their financial performance.
Altogether, it forged the necessity to establish a special department either within a company or as an external institution that would study the company’s performance and determine whether it faces any significant risks. These structures are known as audit departments. However, there should also be a body, which regulates the activities and operation of such departments. These bodies are usually referred to as the audit committees. Their significance is seen in distinguishing gaps in a company’s performance and estimating the level of its risk susceptibility studying the reports provided by both internal and external auditors.
This paper aims at investigating the audit committees. It will provide some background on functions and criteria for measuring the effectiveness of the audit committees. The goal of this paper is to determine what is the role of the audit committee in the United Arab Emirates, find out what are its strengths and weaknesses, and design an overall conclusion that would point particular ways to improve their operation, if necessary.
Functions of the Audit Committee
The audit committee, an organizational body consisting of a chairman and at least two other members, who have experience in finance and accounting, is responsible for performing a wide range of functions.
Some of them include, but are not limited to, the following: exploring annual plans for audit reports and estimating their accuracy and objectiveness; reviewing the reports provided by both external and internal auditors, studying the proposed measures, and guaranteeing that a company follows them if decided that they might have a positive impact on a company and its performance and competitiveness; assuring that a company operates in conformity with all required rules and regulations as well as recommendations from external auditors and other influential institutions, which are entitled to regulate the business environment; arranging meetings with both internal and external auditors and confirming them with senior management; presents the reports provided by both external and internal auditors to senior managers; is responsible for selecting and appointing external auditors as well as employing or firing internal auditors; in the case of an auditor’s resignation, is obliged to find out the reasons for the resignation and design the action plan for each specific instance, etc. (Al-Saeed and Al-Mahamid 43; Emirates Integrated Telecommunications Company PJLC 1).
Carrying out these functions is what determines the role of the audit committee. However, there are also other aspects of the audit committee functioning determining its role. They will be mentioned later.
Measuring the Adequacy and Effectiveness of the Audit Committee Operation
There are several requirements necessary for assuring that the audit committee operates in an adequate environment, which is healthy and encouraging so that the committee members carry out their functions to the maximum possible extent and provide reports containing objective information about the company’s performance. First and foremost, the chief audit executive should guarantee that the committee will have an opportunity to engage with the executive openly and transparently, i.e. the atmosphere of trust will be established in a team. It is vital in light of creating the platform of cooperation between two structures and developing frameworks for further work.
Second, the chief audit executives should ensure that they are sober and objective in their responses to reports so that the committees know which parts should be improved to determine the strengths and weaknesses of a company. Moreover, there is a need for sufficient resources both financial and human to back up the committee’s efficient operation and functioning. Finally, the audit committee should have an opportunity to meet with the chief audit executive and senior management of a company to present their reports, which should be actionable, so that senior managers guarantee that the recommendations will be put into action to enhance firm’s performance and competitiveness (“The Audit Committee: Internal Audit Oversight” 2).
The effectiveness of the audit committee operation is believed to come straight from its members. The key to high levels of efficiency is that everyone in the committee understands his or her particular role and does everything possible to carry it out. It means that productivity can be reached only through effective corporate governance because it adds to emotional well-being, which, in turn, promotes better job duties performing (Gomes par. 16). What is even more significant, the audit committee should be independent to be effective. Its independence means that the committee is made up of both financial and non-financial people (Al-Saeed and Al-Mahamid 46).
It is crucial because only people with diverse backgrounds can be efficient in making vital decisions and designing ways to enhance a firm’s performance and competitiveness. This detail is significant because the audit committee is responsible not only for controlling the process of financial reporting but also optimizing the operation of other departments and advising senior management on the further development of a company.
The Role of the Audit Committee
Except for the functions of the audit committee mentioned above, its role in a company has a broader context. First and foremost, the audit committee serves as a link between the auditors, both internal and external, and a firm’s senior management. Being such a link is responsible for establishing and maintaining effective channels for exchanging information between different departments of an organization whether it includes reports or various recommendations on improving the company’s performance (Muqattash 30).
That said, it is the audit committee that establishes the atmosphere of trust and openness, i.e. emotional well-being, which is vital for effective performance and positive functioning. More than that, it is in charge of fostering communication between external and internal auditors (Emirates Integrated Telecommunications Company PJLC 3). It is what helps a company to reach higher levels of quality of audit reports and as well as handle challenges and develop risk resistance mechanisms.
Moreover, because the audit committee is responsible for reviewing the auditors’ reports, it plays a significant role in guaranteeing objectivity of all documents provided by this department as well as external institutions. That said, because auditors are aware that their work will be checked for relevance and accuracy, the audit committee serves as a motivator for the higher levels of performance.
It can be supplemented with the fact that it is the audit committee that appoints an auditor, so the auditors are interested in being objective. Together with it, for the same reason, it helps restore the confidence of senior management as well as the public in the quality of the issued reports. It means that the audit committee is of paramount importance for creating a positive image of a company in the eyes of national and even international audience as well as the competitors (Al-Zarouni 53-54). Altogether, it contributes to higher levels of corporate governance, which has a positive impact on all employees and the audit committee as such.
In addition to it, the audit committee contributes to minimizing the risks of financial information disclosure because of its responsibility for tightening control over auditors and applying external as well as employing internal auditors, i.e. people, who would obtain access to a company’s most valuable resource – its financial information (Al-Zarouni 91). Such a role of the audit committee helps a firm avoid losses and scandals arising from disclosures.
Furthermore, it is impossible to underestimate the role of the audit committee in strengthening the significance of internal auditors (Muqattash 30). It is true not only because of helping them reach higher levels of performance but also because it is the audit committee that is responsible for providing internal auditors with all necessary resources – informational, financial, and human (Emirates Integrated Telecommunications Company PJLC 4). That said, it aims at developing this department, and by obtaining more resources it becomes easier. Moreover, because it approves the reports, the audit committee improves the quality of the published information (Al-Saeed and Al-Mahamid 45). It, again, leads to creating a better image of a company and as well its competitiveness and performance.
Finally, the audit committee optimizes the operation of other departments of a company because it is responsible for reviewing financial and control systems as well as procedures for risk management (Emirates Integrated Telecommunications Company PJLC 3). In this case, it monitors the procedure of financial reporting and helps the Board of Directors in designing tools for diminishing risks and minimizing losses.
Only the audit committee can play this role in a company because, first, it has enough information and checks its quality and, second, its members are highly educated and are obliged to have rich experience in auditing and finance. Furthermore, companies, which have created the audit committees, have the right to be listed in Abu Dhabi and Dubai Stock Exchanges (Gebba 52). So it contributes to enhancing their competitiveness and can become a key to financial success.
Everything mentioned above is a theoretical approach to the operation of the audit committees in the United Arab Emirates. The next two sections will provide insight on the practical side of the issue to determine the strengths and weaknesses of the audit committee functioning in UAE.
The Strengths of the Audit Committee
In the United Arab Emirates, the issue of creating audit committees is granted to companies. It can be considered as the strength of the legislative system as the whole because only those firms, which feel the need for such organizational bodies, establish them.
Researches are highlighting the existence of a positive correlation between the audit committee operation and cutting expenses for covering both audit and non-audit fees (Odeh 67). It can be easily explained by the fact that the committee is responsible for financial reporting. Moreover, it is obliged to control the working process of auditors. Being efficient in performing these two tasks helps decrease the time and external resources necessary for audit revisions. That is why the existence of the audit committee positively influences the level of expenses. However, it should be noted that it is true only in the case of big companies, for which it is easier and less expensive to create and maintain the operation of the required body than for small enterprises.
Furthermore, the strength of the audit committees is that it enhances communication with regulators (Odeh 115). This statement is true in the case of the United Arab Emirates. The justification for such a correlation is that if a company established such a committee, then it runs under the national regulations because guaranteeing legal operation is one of the primary functions of the audit committee. Finally, studies show that the audit committee is efficient in carrying out its role of guaranteeing the safety of a company’s financial information because, in the case of the United Arab Emirates, these are the committees that preclude financial disclosures. Even though such instances exist, they are rare (around 5 percent), which proves the initial statement (Al-Zarouni 194).
The Weaknesses of the Audit Committee
KPMG recently researched the effectiveness, concerns, and challenges of the audit committees of companies located in the Persian Gulf region. The survey covered three countries – UAE, Bahrain, and Qatar. As of the United Arab Emirates, findings of this investigation were less than satisfactory. First of all, members of the UAE audit committees are not confident in high levels of financial reporting provided by their institutions thinking that the reports are not understandable, fair, and accurate enough. That said, they do not provide a relevant presentation of their company. Second, most respondents believe that the quality of the internal audit is low in the UAE.
However, they are confident in the quality of the external audit. Third, corporate governance of the audit committee in the UAE is also rated as low, and mandatory rotation is not seen as a tool for internal audit quality improvements. Finally, respondents estimated the quality of governance of the audit committee as low (KPMG 4).
This survey highlights that the audit committee in the UAE has particular weaknesses. They include not only low confidence in the relevance and quality of the information provided by the auditors but also by the fact that, in truth, it means the lack of knowledge and skills of the members of committees themselves. It should be stressed that if they possessed enough experience or were morally responsible for the quality of information they approve for publishing, it would be possible to deal with this weakness. Moreover, within the framework of research, it is impossible to obtain information regarding their qualifications and thus independence (Al-Zarouni 93). It means that the audit committee system is not open and transparent. Altogether, these factors might hurt the image of any company creating such bodies.
In conclusion, it is paramount to note that the role of the audit committee in enhancing the company’s performance and competitiveness cannot be underestimated. However, when it comes to studying the experience of the United Arab Emirates, it turns out that the theory is far from practice because even though companies are aware of the committee’s significance, the level of effectiveness of such organizational bodies is low and their weaknesses outweigh their strengths. Of curse, they contribute to cutting the expenses and avoiding financial information disclosure, but these benefits cannot be compared to the inefficiency of financial reporting systems and insufficient attention to the significance of corporate governance.
The most crucial problem with the audit committee is the fact that it is impossible to obtain information about the qualification of members and the independence of committees. It leads to lower levels of confidence in and satisfaction with the quality of the issued reports. It also explains why chief people are more willing to trust external auditors. That said, there are still a lot of improvements to be made to increase the positive influence of the internal audit committee and make it stronger.
For example, it would be beneficial to guarantee that the members of these committees are reshuffled on a timely basis so that new people with a higher level of knowledge and skills could have a chance to change the situation for the better. Moreover, it might be advantageous to establish some control over the operation of the audit committee because it would serve as a motivation for thorough job duties performed and ensure the high quality of information. Finally, it is recommended to guarantee the independence of the committee by choosing people with both financial and non-financial backgrounds.
Al-Saeed, Motaz Amin, and Soud M. Al-Mahamid. “Features of an Effective Audit Committee, and Its Role in Strengthening the Financial Reporting: Evidence from Amman Stock Exchange.” Journal of Public Administration and Governance 1.1 (2011): 39-63. Print.
Al-Zarouni, Abdulkareem. Corporate Financial Disclosure in Emerging Markets: The Case of The UAE. Diss. Griffith University, 2008. Web.
Emirates Integrated Telecommunications Company PJLC. Audit Committee – Terms of Reference. n.d. Web.
Gebba, Tarek Roshdy. “Corporate Governance Mechanisms Adopted by UAE National Commercial Banks.” Journal of Applied Finance & Banking 5.5 (2015): 23-61. Print.
Gomes, Ian. Audit Committee Effectiveness Comes from Members Understanding Their Roles. 2015. Web.
KPMG. Audit Committee Survey: GCC Countries. 2014. Web.
Muqattash, Riham Suleiman. “Audit Committees Effectiveness and its Impact on the Objectivity of the Internal Auditors: Evidence from United Arab Emirates.” Research Journal of Finance and Accounting 4.16 (2013): 23-31. Print.
Odeh, Ahmad Abdul Fattah. Exploring the Quality of SME Audits in the UAE. Diss. United Arab Emirates University, 2015.