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FRC issues consultation document on audit reform

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18 Dec 2014

The Financial Reporting Council (FRC) has issued a consultation document on audit reform, "Consultation: Auditing and ethical standards – Implementation of the EU Audit Directive and Audit Regulation". This, in conjunction with the Department for Business Innovation & Skills’ (BIS) discussion paper, proposes change in the UK to implement the EU Audit Directive (‘the Directive’) and Audit Regulation (‘the Regulation’), as well as other changes that may made to enhance confidence and strengthen the audit regime.

In its consultation, the FRC is seeking views on implementation of the mandatory requirements of European law and on which of the optional requirements should be introduced into UK law. The Directive applies to all statutory audits and may, in particular, require changes to financial services law to broaden the application of the law to such companies; the Regulation only applies to the audits of public interest entities.

BIS intends that the FRC should continue to be designated to carry out regulation and oversight of the audit profession, gaining some additional responsibilities. In some cases BIS is proposing to enable the FRC to exercise the member state options in the Audit Directive and Audit Regulation. The FRC’s consultation document consults in these areas; a further consultation in 2015 will ask questions about the implementation of some new requirements for which there are no options.

The key areas covered by the FRC consultation document are:

  • Auditing standards: The FRC proposes to retain the right to set additional standards in areas not covered by International Standards on Auditing (ISAs) as issued by the International Auditing and Assurance Standards Board (IAASB), and to add requirements to those standards where necessary to address national legal and regulatory requirements or add to the credibility and quality of financial statements.
  • Auditor reporting to shareholders and audit committees: The FRC proposes retaining existing requirements which go beyond the IAASB’s requirements, and supplement their standards where additional matters are required by EU law.
  • Proportionate application and simplified requirements for the audit of small undertakings: The FRC believes it does not need to take action on the proportionate application of ISAs. They invite views as to whether the existing approach in the Ethical Standards Provisions Available for Small Entities should be maintained or expanded.
  • Public interest entities: The FRC agrees with the broad suggestion by BIS that the definition of “public interest entities” (PIEs) should not be extended. However, the FRC does believe that some, but not all, of the more stringent requirements applicable to PIEs as defined in EU law should be extended more broadly. These include the existing FRC requirements applicable to “listed” companies for the audit Engagement Quality Control Review to be carried out by a partner, audit partner rotation and more restrictions on non-audit services. Some entities would be PIEs but unlisted (e.g. unlisted banks and insurers), some entities listed but not PIEs (companies traded on AIM), and some may be of public interest without meeting either definition (e.g. major public sector entities). The FRC recognises that this is an area of some complexity and that there are arguments for implementing the minimum changes required by EU law; for aligning requirements; or for using the definition of “major audit” used by the FRC’s Audit Quality Review for inspection purposes.
  • Prohibited non-audit services: The EU Audit Regulation bans certain services for public interest entities, but provides a member state option to permit some tax and valuation services that are immaterial. Some services are banned by current FRC standards but permitted under the EU Audit Regulation and vice versa.
  • 70% cap on non-audit services: The FRC asks some questions on extending the cap. The cap in the EU regulation compares the fees for non-audit services (other than those required by law or regulation) provided by the group auditor to the preceding three years of audit fees. It asks if this should be extended to include services provided by network firms. The restriction only applies after the auditor has been providing both non-audit services and audit services for three years. The FRC asks if a modified cap should apply in earlier years. Finally, the FRC says that it does not believe they should exercise their option to establish a lower cap, but invite views.
  • Audit partner rotation: The Regulation limits key audit partners to seven years’ service followed by three years cessation before they can serve again. This existing FRC regime applies a five year maximum followed by a five year cessation for audit engagement partners; other partners can serve seven years with two years off. The FRC asks if it should retain their existing tougher requirements and whether these should apply more broadly than PIEs.

In their paper the FRC also indicate that they are undertaking a review of the ethical framework for auditors, which may result in further proposals in 2015.

Comments are invited by 20 March 2015.

*The FRC held a consultation event on 11 March 2015 to discuss its plans for implementation of the EU Audit Direct and Regulation in its audit and ethical standards.  The slide pack and transcript from the meeting are available on the FRC website*.                  

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