Entities affected

By far the most significant changes are for Public Interest Entities (PIEs).  The FRC has, however, taken the opportunity to consider whether some of the changes should be extended to entities where there is significant public interest on the grounds that they are listed on markets outside the European Economic Area (EEA) or unregulated markets within the EEA. Previously, the FRC only applied their “listed” definition in ethical standards to entities with securities traded on a UK or Irish market:

• The list of newly banned services for the audits of PIEs will not apply to such entities; nor will the 70% cap.
• Existing FRC “listed” restrictions will apply to such companies, but these will be relaxed for non-PIEs (e.g. Alternative Investment Market (AIM) companies) where:
  • the listing is a “technical listing” (e.g. where debt is listed on a market but is held by another group company, so it is unlikely or impossible to fall into public hands – typical in many private equity backed companies); or
  • the average market capitalisation is below £100m. The FRC expects that around three quarters of AIM companies will fall into this category.

Provision of non-audit services

The FRC has adopted the EU list of banned non-audit services which cannot be provided to PIEs.  The proposed list of newly prohibited services for PIEs includes certain tax services (including preparation of tax forms and provision of tax advice), services that involve playing any part in the management or decision-making of the audited entity, payroll and bookkeeping services, valuation services and certain legal services.  The FRC proposes that some of these services will be allowed to be performed in certain situations but in those cases will require explanation from the auditor that the principles of independence have been applied and that the auditor has not placed significant reliance on these services as part of their audit.    

In group situations network firms (whether involved in the audit or not) cannot provide prohibited services to EEA PIE audit clients of the firm, nor their EEA parents or subsidiaries

The 70% cap

The EU audit regulation (link to Europa website) contains a 70% cap on non-audit fees to PIEs.

In implementing the cap in the UK the FRC has:

• decided not to reduce the percentage level of the cap – it remains at 70%;
• removed the anomaly whereby if no non-audit services are provided in a year, the clock starts again and the cap will not apply until four more years have passed;  and
• clarified what is meant by services required by EU or member state law or by a rule issued by a regulator in accordance with powers granted by legislation.

Proposed changes to the UK Corporate Governance Code ("the Code")

The FRC is proposing the following changes to section C.3 (Audit Committee and Auditors) of the UK Corporate Governance Code:

• The requirement for an audit committee member to have “recent and relevant financial experience” is changed to a need for “competence in accounting and/or auditing”. More fundamentally, the audit committee as a whole will need competence relevant to the sector in which the company operates. This may affect the composition of some audit committees.
• The FTSE 350 audit tendering provision will be removed as this is superseded by the CMA and EU requirement for mandatory tendering and rotation of the audit firm.
• The audit committee section of the annual report will need to provide advance notice of tendering plans. The Department for Business, Innovation and Skills (BIS) are expected to provide more details in this area.

The FRC is not proposing to take forward the CMA recommendation that there should be an advisory vote on the audit committee’s report, as they believe that shareholders can express views by refusing to re-elect members of the audit committee or table a specific resolution with concerns. They are, however, asking for views.

Proposed changes to the Guidance on Audit Committees

The FRC is also proposing a number of changes to the Guidance on Audit Committees. In addition to changes to bring the Guidance in line with the proposed changes to the Code, the following amendments have been made: 

• An acknowledgement that the remuneration of audit committees (and particularly audit committee chairmen) should reflect the significant responsibility they bear and that a significant extra amount of time needs to be committed.
• A recommendation that the audit committee should consider key matters of their own initiative rather than relying solely on the work of the external auditor. The audit committee must decide whether the sources of assurance and information it is being offered are sufficient and objective.
• There is clarification that the board has ultimate responsibility for an organisation’s risk management and internal control systems, but that the audit committee may play a role in assisting the board to fulfil this function. The audit committee should consider what role it can play and what information it requires to assist in putting in place sound risk management and internal control systems.
• The section on the internal audit process has been updated to reflect existing best practice in this area of the audit committee’s activities. A key part of this is ensuring that the internal auditor has direct access to the board chairman and the audit committee and is accountable to the audit committee.
• Reflecting the recommendations in the CMA Final Order, the external audit process section has been amended to make it clear that the audit committee should have primary responsibility for negotiating the fee and scope of the audit, initiating a tender process, influencing the appointment of an engagement partner and making formal recommendations to the board on the appointment, reappointment and removal of the external auditors.
• On the provision of non-audit services, the audit committee is asked to set and apply a formal policy specifying the types of non-audit service for which use of the external auditor is pre-approved but that such approval should only be in place for matters that are clearly trivial.
• More emphasis is placed on the audit committee’s interactions with the external auditor around the areas of significant judgement and risks to audit quality. 

In addition to these changes in the audit committees recommended activities, there are also a number of additions to the suggested content of the audit committee section of the annual report including the current audit partner’s name and for how long the partner has held the role and, the committee’s policy for approval of non-audit services and the nature and extent of interaction (if any) with the FRC’s Corporate Reporting Review team. 

Other proposed changes to the Ethical and Auditing Standards

Incorporating the changes to non-audit services described above, the FRC is planning that the existing Ethical Standards for Auditors will be rewritten into one FRC Ethical Standard (plus another for smaller entities). This will bring in the EU reforms as well as some areas where the FRC had fallen behind the Code set by the International Ethics Standards Board for Accountants. 

There are also a number of proposed amendments to auditing standards to deal with the EU reforms and International Auditing and Assurance Standards Board (IAASB) changes in respect of auditor reporting and disclosures.  Key changes include:

• The UK has led the way with “enhanced auditor reporting” for companies reporting on their compliance with the Code. This will be extended as a matter of EU law to all PIEs, which will be a change for many companies with only listed debt and unlisted banks, building societies and insurers. It will also be extended to entities listed anywhere in the world, whether on a regulated or unregulated market, as part of the IAASB's auditor reporting project. This will require some changes to existing enhanced auditor reports.
• For those entities to which the enhanced audit report applies,  listed company style audit committee communications will be required.
• Reporting positively on the appropriateness of going concern and lack of material uncertainties in the enhanced auditors’ report will be required.
• A handful of changes to requirements and many changes to application material in a large number of ISAs will be made as part of the IAASB’s disclosure project to clarify that the audit of disclosures is on an equal footing with the audit of the primary statements. This will complement work by the IASB on disclosures for preparers of financial statements.

The effective date for the EU changes can be no later than periods commencing on or after 17 June 2016; at present, the FRC have not provided a firm effective date. They have also not yet clarified what, if any, transitional provisions might be available.

The consultation does not cover other topics, including regulation of the audit profession and rotation and tendering of auditors, which are the key topics for a separate BIS consultation paper due in October.

Comments are requested until 11 December 2015.

The FRC will be holding a meeting to discuss the proposals in the consultation on 2 November 2015.  Details on how to register for the meeting can be found on the FRC website.

Click for:

• Press release (link to FRC website)
• Consultation: Enhancing Confidence in Audit: Proposed Revision to the Ethical Standard, Auditing Standards, UK Corporate Governance Code and Guidance on Audit Committees (link to FRC website)
• Our Governance in brief publication on the consultation
• Our UK Accounting Plus project page on audit reform
• Our UK Accounting Plus news item on the EU Audit Directive and Regulation
• Our UK Accounting Plus news item on the CMA Final Order for audit reform