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FRC completes implementation of the EU Audit Regulation and Directive

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04 May 2016

The Financial Reporting Council (FRC) has issued “final drafts” of the 2016 UK Corporate Governance Code ("the Code"), the revised Guidance on Audit Committees, the Ethical Standard 2016 and revised International Standards on Auditing (UK and Ireland). These complete the FRC’s implementation of the EU Audit Regulation and Directive, together with parts of the Competition & Markets Authority’s (CMA’s) final Order.

Both the FRC and The Department for Business, Innovation and Skills (BIS) consulted on matters requiring changes to the Code, Guidance on Audit Committees, the standards for auditors and changes to legislation respectively during 2015. BIS is expected to lay updated legislation in Parliament soon.

Although the 2016 UK Corporate Governance Code, Guidance on Audit Committees, ISAs (UK & Ireland) and Ethical Standard are marked as “final draft”, no further changes other than minor errata are anticipated before they take final effect.

2016 UK Corporate Governance Code

There are few changes to the Code and those are restricted to the Preface and to section C.3 (Audit Committee and Auditors). There is now a provision indicating that the audit committee as a whole will need competence relevant to the sector in which the company operates. In addition, the audit committee report within the annual report is now required to provide advance notice of any plans to retender the external audit, whilst the previous provision on FTSE 350 companies tendering the external audit every ten years has been removed.

Guidance on Audit Committees

More extensive changes to the Guidance on Audit Committees bring the Guidance up to date, reflecting the updates to the Code since this Guidance was last published and the FRC’s Financial Reporting Lab’s work on the Reporting of Audit Committees.

The changes affect both the activities of the audit committee and the disclosure in the audit committee report within the annual report.

The key revisions affect: the role and composition of the audit committee; the interaction with internal audit; the relationship with the external auditor regarding the audit and non-audit services; the disclosures on areas relating to those changes and disclosures around the FRC’s interaction with the company’s financial reporting or external audit.

Ethical Standard

There is now one FRC Ethical Standard which covers the independence requirements for auditors as well as reporting accountants (previously in the Ethical Standard for Reporting Accountants) and for engagements to report to the Financial Conduct Authority (FCA) on client assets.

The Ethical Standard incorporates the EU reforms as well as certain areas where the FRC wanted to align more closely with the Code set by the International Ethics Standards Board for Accountants (IESBA) or where they felt changes were needed.

This is a principles-based standard, which nevertheless contains a lot of detailed rules. Auditors are required to consider the broad principles even if they think they have complied with all of the rules.

Key revisions to the Ethical Standard relate to incorporating the EU reforms for public interest entities (PIEs) for non-audit services. A “PIE” is a public interest entity, defined in EU law as being an entity governed by Member State law with securities (debt or equity) admitted to trading on an EEA regulated market (including those with a Premium or Standard Listing on the main market of the London Stock Exchange but excluding those traded on AIM), a credit institution (in the UK, a bank or building society) or insurance undertaking (those insurance companies, friendly societies and Lloyd’s syndicates that apply the Solvency II regime). There are additional changes over and above the EU changes affecting existing rules on providing tax services to listed entities on a contingent fee basis – a term covering a listing on any exchange worldwide – as well as a general clarification of the principles relating to advocacy in respect of tax.

In addition, the new EU rules on applying a cap of 70% cap on fees for non-audit services when compared to a three year history of statutory audit fees are explained in detail.Care will be needed in applying the Ethical Standard to multi-jurisdictional group situations as the rules around extraterritoriality are complex.

In addition to changes relating to non-audit services, there are also changes for auditors relating to personal independence – a broadening in scope of “covered persons” and persons connected to engagement team members who cannot have certain prohibited financial, business or employment relationships, and a clarified rule on gifts and hospitality offered to or accepted by the auditor. .

ISAs (UK & Ireland)

The FRC has made changes to reflect the EU reforms throughout their standards and has also implemented three major IAASB projects – the disclosures project (which stresses the importance of the audit of disclosures), auditor reporting, and the auditor’s responsibilities for other information accompanying financial statements.

Key changes include the requirement for enhanced auditor reporting for all PIEs and all listed companies; this is a change from the existing UK enhanced auditor reporting regime which only applied to those companies required to or choosing to comply with the Code. The change will affect UK and Irish companies with listings outside the UK and Ireland, including entities with listed debt, together with unlisted banks, building societies and insurance undertakings.

There will also be some changes to the contents of the enhanced audit report which may add to the length of reports, including:

  • An expansion of the auditor’s description of significant risks and their response to include key observations, where necessary;
  • a description of the extent to which the audit was considered capable of detecting irregularities including fraud;
  • disclosure of the auditor’s tenure, including previous reappointments and renewals; and
  • a declaration of the auditor’s independence including confirmation that no prohibited services were provided.

Some changes are also made to auditor’s reports on all entities, whether listed, PIE and/or neither:

  • an amendment to the auditor’s reporting on the going concern basis of accounting;
  • a revised description of the scope of an audit; and
  • for statutory audits, an opinion as to whether the directors’ report and any strategic report have been prepared in accordance with the legal requirements. This is not an audit of the content of these reports and is limited to confirming that the relevant information has been produced.

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