Harlow Industries' Audit and Risk Committee
Harlow Industries Ltd is an ASX-listed manufacturer with $900 million revenue. Its audit and risk committee has three members: the committee chair, who was Harlow's CFO until 18 months ago; a non-executive director with a marketing background who has declined the financial-literacy briefing; and a director who has served on the board for 11 years. The committee met twice last year, and the minutes record 20-minute meetings with no internal audit discussion. The internal audit manager reports administratively to the CFO, whose budget cut reduced internal audit headcount by 40% after a procurement concern was raised. The external auditor's fee is $600,000, of which $410,000 is for tax and system-implementation advice.
1. Identify the principal deficiencies and rank them by severity, explaining the consequence of each.
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Ranked, most severe first
- Committee chair is the former CFO (18 months ago). A former CFO auditing their own prior judgments destroys the committee's independence and creates a self-review threat on the very estimates they approved. Consequence: the committee cannot credibly challenge management or the auditor.
- Internal audit reports to the CFO, and was cut after raising a finding. The assurance function is captured by the executive it must examine; the 40% cut and headcount reduction after a procurement concern is a textbook retaliation signal. Consequence: no independent assurance over procurement fraud risk.
- No financial-literacy member and 20-minute meetings with no internal audit agenda item. The committee lacks the competence and the time to discharge its oversight. Consequence: the committee's approval becomes a rubber stamp, exposing members to personal liability for want of care and diligence.
- Tenure of 11 years without a skills refresh. Independence in appearance and the ability to challenge entrenched assumptions erode.
- External auditor non-audit fees at 68% of total fees. Independence threat (developed in the next task).
Recommendation: replace the chair within the next twelve months, re-attach internal audit to the committee functionally, and increase the meeting cycle to at least quarterly with a standing internal audit report.
2. The CFO argues the non-audit fees are acceptable because the auditors have issued unqualified opinions for five years. Evaluate this and state what the committee should do.
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The argument confuses outcomes with independence. Five unqualified opinions measure the quality of the audit only in hindsight; independence is assessed prospectively on the threats and the safeguards. Here:
- Self-review: the auditor designed or implemented the systems it then audits, so it is testing the system it configured.
- Self-interest: non-audit fees ($410,000) exceed the audit fee ($350,000), so retaining the client matters more than retaining independence.
- Appearance: the ratio is the kind of figure proxy advisers and regulators use to vote against the auditor's reappointment.
The absence of a detected misstatement does not falsify the analysis; it may simply mean the misstatement was not detected.
What the committee should do
- Adopt a written non-audit services policy: prohibited services, a fee cap, and pre-approval by the committee for permitted services.
- Prohibit financial-system design and implementation outright, and move the implementation work to another provider.
- Require the auditor to confirm in writing the safeguards and the committee's role in approving them.
- Disclose the fee split in the annual report with a statement of the committee's assessment.