2.1
An audit committee is a committee of the public entity. It is simply a group of advisers set up to give advice to the highest level of governance. Therefore, for example, the advice is given:

• in a Crown entity, to the board;
• in a local authority, to the council; and
• in a government department, to the chief executive.

2.2
In public entities where the governing body is separate from management, the audit committee is usually a subcommittee of the governing body.

2.3
In a government department, although there are independent oversight mechanisms such as select committees, there is no governing body for the chief executive to report to. The chief executive can form an audit committee by inviting people with the necessary skills and experience from outside the government department to be on the audit committee.

The legislative context

2.4
In New Zealand, there are no specific regulatory or legislative requirements for setting up audit committees in the public sector. However, there are a number of explicit and implicit expectations of good governance that require or strongly suggest that public entities should set up and operate an effective audit committee.

2.5
For example, significant pieces of public sector legislation¹ refer to a “system of internal control designed to provide reasonable assurance as to the integrity and reliability of financial reporting” (for example, section 155 of the Crown Entities Act 2004). The legislation does not define “internal control”, but there are several international best practice models² that include audit committees as a crucial component of the internal control environment.

2.6
The Treasury set out explicit internal control expectations for government departments in its 2001 document Financial Management - Departmental Internal Control Evaluation. The document sets out the broad actions the Treasury expects departments to take to provide the chief executive with enough confidence to sign the statement of responsibility. Section 21 on internal assurance mechanisms sets out the control criteria designed to provide assurance about the reliability of internal assurance mechanisms, individually and collectively. It covers criteria for the internal control environment, internal control monitoring, risk management, internal audits, audit committees, and quality management.

2.7
There are other best practice publications, including the Institute of Internal Auditors’ position statement The Audit Committee in the Public Sector, encouraging the effective use of audit committees. For companies, the Institute of Directors’ corporate governance material³ and the Securities Commission of New Zealand’s corporate governance principles⁴ set out relevant expectations for audit committees.

Benefits of audit committees

2.8
Depending on its constitution, an audit committee’s mandate varies between focusing primarily on providing assurance on financial and compliance issues and having more of an advisory role oriented at performance improvement and assurance as well as financial and compliance issues.

2.9
Audit committees in the more commercial public entities tend to focus primarily on financial and compliance matters, because their governing bodies more often deal with strategic and performance matters.

2.10
Audit committees operating in non-commercial public entities (for example, in government departments) tend to act in more of an advisory and improver role for the governing body or chief executive, with more of a focus on performance improvement, financial, and compliance matters.

Assurance benefits

2.11
There are four main assurance benefits from operating an audit committee:

• increased scrutiny;
• efficient use of resources;
• increased focus on internal assurance; and
• increased focus on accountability.

Increased scrutiny

2.12
Audit committees increase the scrutiny of certain aspects of a public entity’s governance, risk management, assurance, and financial management practices. This additional scrutiny provides the governing body or departmental chief executive with assurance that these areas have been independently reviewed.

2.13
The more commercial public entities with complex financial transactions that we spoke to when preparing this guide saw a clear benefit in having an audit committee with appropriately qualified and experienced members focused on financial and reporting matters. They saw the additional time and attention that the audit committee could give to these matters as enabling them to efficiently make better decisions.

2.14
A number of chief executives that we spoke to commented on the “peace of mind” they derive from knowing that certain aspects of the organisation’s activities (in particular, the risk management and control frameworks, and external reporting matters) have been subject to thorough scrutiny:

The main benefit of the audit committee to me is that it gives me assurance that financial issues, risks and compliance matters have been properly scrutinised.

Chief executive of a Crown entity

Having this additional layer of scrutiny [of compliance matters] provides me with comfort that the basics have been covered.

Chief executive of a State-owned enterprise

Efficient use of resources

2.15
Audit committees can help public entities use resources efficiently. People that we spoke to commented that there can be a number of efficiencies at both the governing body and management levels from the individuals on the audit committee applying their specific expertise to the subject matter:

Having an audit committee enables board members to use their time more effectively, with members contributing in areas specific to their expertise. The increased level of scrutiny allows for more efficient and better quality decision-making.

Chief executive of a State-owned enterprise

Using independent members with financial skills on the audit committee provides assurance to the Council that financial compliance issues have been taken care of. As a consequence management’s time is used more effectively as matters relating to complex financial areas are reviewed between management and the audit committee and are rarely relitigated at full Council level.

Chief executive of a local authority

Increased focus on internal assurance

2.16
An effective audit committee often strengthens the existing internal audit function. Organisations we spoke to had found that the audit committee enforced the disciplines of having risk-based strategic audit plans and regularly reporting audit results and progress against the plans.

2.17
Audit committees had also been influential in increasing auditing resources where required and helping to ensure that internal and external auditing resources were put to best use. During our interviews for this guide, public sector managers and several internal auditors commented that the existence of an effective audit committee had forced more discipline into developing annual internal audit plans and reporting progress against those plans.

Increased focus on accountability

2.18
Audit committees can improve accountability mechanisms throughout the organisation. They require the management team and internal auditor to report on aspects of organisational activities and to be prepared to provide the rationale for their actions in an open and transparent environment. During our interviews for this guide, public sector managers commented that having an audit committee provided discipline and structure to management reporting, which helped to reinforce accountabilities.

Advisory benefits

2.19
There are two main advisory benefits from operating an effective audit committee. They are:

• a fresh perspective; and
• a range of experience and of expertise.

A fresh perspective

2.20
An audit committee can provide a fresh perspective at an organisation-wide level, drawing attention to possible threats, opportunities, and emerging issues that the organisation might otherwise miss.

Range of experience and expertise

2.21
Audit committee members provide the public entity with a helpful range of experience and expertise. For example, chief executives might not have wide governance, legal, assurance, or financial expertise. They would have staff with this expertise reporting to them. However, an independent audit committee is in a stronger position to provide free and frank advice, and to challenge practices and processes, than employees are. This was reinforced by comments made during our interviews:

Issues are really debated and management views tested.

[…]

Independent audit committees can add huge value to CEOs in the public sector - any kind of external advice is a benefit, and they really add value in the identification of emerging risks.

[…]

The committee keeps you on your toes, which is really important. It will make you feel defensive sometimes but you need to “get over it” and be prepared to justify the decisions you make. It is important to be transparent.

Chief executive of a government department

1: The Public Finance Act 1989, Crown Entities Act 2004, and Local Government Act 2002.

2: One example is the Committee of Sponsoring Organizations of the Treadway Commission (or COSO, a voluntary private sector organisation set up to improve the quality of financial reporting - see www.coso.org).

3: See www.iod.com/corporategovernance.

4: Securities Commission of New Zealand (2004), Corporate Governance in New Zealand - Principles and Guidelines, Wellington.