Which companies are subject to this obligation and what does it entail?
The Companies Act 2014 (CA14) introduced an obligation to form audit committees on a 'comply or explain' basis that applies to private limited companies meeting thresholds set out in Section 167 CA14 and also to certain PLCs. This article will focus on the new obligation placed upon a private limited company.
The commencement order that brought CA14 into force, provides that the requirements specified under Section 167 for a company, shall come into force for that company, on the first day of its first financial year beginning on or after 1 June 2015.
The audit committee obligation applies to a 'large company'. There are two circumstances in which a company will be deemed a 'large company' for the purposes of Section 167.
The first is where both of the following thresholds are met in each of the previous two completed financial years.
- The balance sheet total for that company in the most recent financial year and in the immediately preceding financial year exceeds €25,000,000 in each of those years; and
- The amount of turnover of that company in the most recent financial year and in the immediately preceding financial year exceeds €50,000,000 in each of those years.
The second is where a company, when taken on a consolidated basis with its subsidiary undertakings, meets the thresholds set out above.
The Minister for Jobs, Enterprise and Innovation has the power to amend these thresholds.
The Comply or Explain Basis
Section 167(2) creates a positive obligation on the board of a large company to either establish an 'audit committee' as defined in that section, or to make a decision not to establish an audit committee.
Section 167(3) requires the board of a large company to state in their directors' report whether the company has established an audit committee or whether it has decided not to do so. If they have decided not to do so, they are further obliged to state in that directors' report "the reasons for that decision".
If any director of a large company fails to take all reasonable steps to comply with the requirement under Section 167(3), shall be guilty of a "category 3 offence". It is an offence where on summary conviction a person shall be liable to a Class A fine – presently limited to a maximum of €5,000 – or imprisonment for a term not exceeding six months or both.
It is worth noting that Section 167 does not specify any test regarding the merit of the reasons stated for a decision not to establish an 'audit committee'. Therefore, the question of the level of merit required for the reasons given for a decision not to establish an audit committee should be considered in a holistic fashion, rather than a purely legal one.
From a legal perspective, if the board of a company has made a decision not to establish an audit committee, which should be recorded in minutes of a meeting or in a written resolution of the board; and has stated this decision, and provided any reasons for that decision in the directors' report; it would appear that they would have complied with the requirement in Section 167.
Responsibilities of the Audit Committee
An audit committee set up pursuant to Section 167 must assume at least the following responsibilities:
- the monitoring of the financial reporting process
- the monitoring of the effectiveness of the company’s systems of internal control, internal audit and risk management
- the monitoring of the statutory audit of the company’s financial statements
- the review and monitoring of the independence of the statutory auditors and in particular the provision of additional services to the company
If an audit committee is established, any proposal of the board of directors of the company with respect to the appointment of statutory auditors to the company shall be based on a recommendation made to the board by the audit committee.
In addition, the auditors are required to report to the audit committee of the company on key matters arising from the statutory audit of the company, and, in particular, on material weaknesses in internal control in relation to the financial reporting process.
Independent Director Requirement
Section 167 sets out a specific requirement for at least one independent director to be a member of such an audit committee.
Specifically, such an independent director must:
- be non-executive, which means that he/she is not engaged in the daily management of the company
- have the requisite independence to contribute effectively to the committee's function, and in particular must satisfy the conditions set out below in this regard and
- have competence in accounting or auditing.
The conditions regarding the minimum level of independence referred to above are that the director does not have, and at no time during the period of three years preceding his/her appointment to the committee had, a position of employment in the company, or a material business relationship with the company; either directly, or as a partner, shareholder, director (other than as a non-executive director); or as a senior employee of a body that has such a relationship with the company.
It is worth noting that the requirement for independence set out in Section 167 does not require that the person is previously unknown to the company. Indeed, the board may already have a member who satisfies the requirements to be appointed as the independent director of the audit committee.
Audit Committees at Group Level and Public Interest Entities
In the context of audit committees, it is interesting to note the position in respect of a 'public-interest entity' pursuant to the Statutory Audits Regulations (SI 312 of 2016). Broadly speaking a 'public interest entity' is one which has its securities traded on a stock exchange, an entity which is a credit institution or an insurance undertaking.
The Statutory Audits Regulations require a public-interest entity to establish an audit committee but also provides certain exemptions from this obligation. In particular, Regulation 115(10)(a) in effect provides that such an entity will be exempt if that entity is a subsidiary undertaking and the requirement for an audit committee is fulfilled at group level.