The new rules will be in the form of a Directive amending the Statutory Audit Directive (Directive 2006/43/EC) (link to Europa website) and a Regulation on specific requirements regarding the statutory audit of public-interest entities (PIEs).  

Under the new rules, the societal role of auditors will be clarified, with the aim of increasing audit quality, transparency and audit supervision.  The new rules will require that audit reports be more detailed and informative and their work will be more closely monitored with strengthened audit committees.

Mandatory rotation of auditors for PIEs will be introduced, requiring such companies to retender at 10 years and change the auditor at least every 20 years. The reforms include a prohibition on the provision of certain non-audit services to PIE audit clients (including tax advice and services linked to the financial and investment strategy of the audit client) and also introduce a cap on the fees that can be earned from the provision of permitted non-audit services to PIEs.

Additionally the rules prohibit the use of restrictive clauses in contracts which limit a company’s choice of auditor in order to promote market diversity.

The Council has indicated that “the supervision of the system will be carried out within the framework of a Committee of European Auditing Oversight Bodies (CEAOB) with assistance from the European Securities and Markets Authority (ESMA)”.

The directive was already approved by the European Parliament on 3 April. Both the Directive and the Regulation will enter into force 20 days after their publication in the Official Journal of the European Union.  The Directive must be adopted by EU member states within 2 years of that date and the Regulation is effective 2 years from that date.  The restriction on fee income from non-auditing services is to take effect within 3 years.

The Competition Commission (now taken over by the Competition and Markets Authority (CMA)), which has been delaying the release of their package of remedies to increase competition within the provision of statutory audit services to FTSE 350 companies in the UK is now likely to review their package in light of the EU announcement in order to consider the implications of the EU rules on their Orders which bring their measures into law.

Click for:

• Press release (link to Council's website)
• Full text of the directive (link to Council's website)
• Full text of the Regulation (link to Council's website).
• Our previous UK Accounting Plus news item on EU audit reform.

Under the Companies Act 2006 ("the Act"), the Conduct Committee of the FRC reviews the reports and accounts of public and large private companies to determine whether they comply with the Act and other reporting requirements. Where it appears that those requirements have not been complied with, the Conduct Committee investigates the position and determines the action to be taken, in accordance with their operating procedures, to address any non-compliance.  

The FRC proposals include:

• Formally reflecting the concept of a ‘Committee Reference’.  Currently, where a Conduct Committee enquiry gives rise to a significant correction or improvement which it considers investors and preparers ought to be aware of but where there is less cause to inform the market at large, it may ask the company to refer to interaction with the Conduct Committee in the annual report and accounts where a change as a result of the investigation is made.  The FRC is now proposing that Conduct Committee operating procedures explicitly refer to Committee References and include the tests that the Conduct Committee applies to ensure that the text included by the company is “fair and balanced”. It also indicates that the Conduct Committee will expect to be given the opportunity to comment on the disclosure that the company makes.
• An amendment to the operating procedures to allow the names of those companies that have published Committee References and a brief description of the issue to be included within the Corporate Reporting Review Annual Report.  The FRC highlights that this change in operating procedures is proposed as currently Committee References are only known to those who read the specific set of accounts to which it appears.  In the consultation paper, the FRC comments: “we believe that investors and potential investors would benefit if we were clearer about our regulatory outcomes” and that “the citing of corrections which the Committee has secured would allow others to appreciate what has been found to be non-compliant and would illustrate what the Committee finds unacceptable in terms of corporate reporting”.
• An explanation within the operating procedures that the Conduct Committee’s letter to a company may include references to aspects of reporting other than compliance with mandatory reporting requirements, such as cutting clutter.
• Amending the operating procedures to clarify how the Conduct Committee manages complaints, including how anonymous complaints are handled and providing a link to the FRC’s reference and advice to whistle-blowers. 

Click for (all links to FRC website):

• Press release.
• FRC consultation paper ‘Revised operating procedures for reviewing corporate reporting’.

The new Directive came into force on 20 July 2013, and European Member States have until 20 July 2015 to incorporate the rules of the Directive within their national law.

The Directive aims simplifying the accounting requirements for small companies and improves the clarity and comparability of companies' financial statements within the Union. The EFAA paper is designed to support governments, standard-setters, EFAA member organisations and other interested stakeholders in their efforts to transpose the new Accounting Directive into national legislation.

Please click to access Implementing the New European Accounting Directive - Making the right choices on the EFAA website.

The EFRAG welcomes this initiative by the IASB, which aims to clarify IAS 1 by addressing perceived impediments to preparers when exercising their judgement in presenting their financial reports. The EFRAG supports the changes to the definition of terms in IAS 1 that may have been misinterpreted and believe the changes would put companies in a position to exercise more discretion in the presentation and disclosure of information, and would lead to an improvement of the quality and relevance of information in the notes. However, EFRAG proposes some improvements to the drafting of the proposed changes and recommends consistent use of defined terms relative to the current IASB standards to avoid any future amendments.

Comments are due by 12 May 2014.

For more information, see:

• EFRAG draft comment letter (link to EFRAG website).
• Press release (link to EFRAG website).
• Our 25 March 2014 story on ED/2014/01.
• Our disclosure initiative project page.

IFIAR comprises 50 independent audit regulators from jurisdictions in Africa, the Americas, Asia, Europe, the Middle East and Oceania.  IFIAR provides a forum for regulators to share knowledge of the audit market and share the practical experience gained from their independent audit regulatory activity.   The Financial Reporting Council (FRC) is a member. 

The report summarises the key inspection findings from audits of public companies (including systematically important financial institutions) submitted by 30 of IFIAR’s members.  Findings were submitted from the most recent audit inspection reports of members that ended by July 2013. 

The report highlights that, for listed public interest entities or public companies, the common areas of deficiency relate to auditing fair value measurements, internal control testing and procedures performed to assess the adequacy of financial statement presentation and disclosures. 

For audits of systematically important financial institutions, including global systematically important banks, the common areas of deficiency relate to auditing of allowance for loan losses and loan impairments, internal control testing and auditing of the valuation of investments and securities. 

The Financial Reporting Council published its own report of audit quality inspection work carried out by its Audit Quality Review (AQR) team in May 2013.  In their draft plan and budget, the FRC indicated that in 2014/15 there will be a particular focus on bank audits, especially loan loss provisioning. 

Click for

• Press release (link to IFIAR website).
• IFIAR report ‘International Forum of Independent Audit Regulators – Report on 2013 survey of inspection findings’ (link to IFIAR website).
• Our previous UK Accounting Plus news item on the FRC Audit Quality Inspection Report 2012/13.
• Our previous UK Accounting Plus news item on the FRC draft plan and budget 2014/15

Dr Lim is an Advisor to the Korea Accounting Standards Board (KASB). He previously served as Chair and Vice-Chair of the KASB and Vice-Chair of the Asian-Oceanian Standard-Setters Group (AOSSG). Dr Lim is also Professor of Accounting at the University of Seoul. His appointment to the IFRS Advisory Council commenced on 1 April 2014.

For more information, please see the press release on the IASB website.

The report ‘How diverse should boards be?’ (“the report”) explains that board diversity “has become a corporate governance issue on which there is pressure for change”.  It further notes that the issue of diversity “is not going to go away anytime soon” and “is a natural consequence of questions being asked about companies”.  Currently in the UK, there are non-mandatory targets being set for female board representation and pressure at European Union level for mandatory quotas for women on boards.  

The report highlights that boards now need to “acknowledge the importance of diversity” in order to avoid diversity being created out of initiatives such as quotas, which will only promote diversity in “appearance rather than substance”.  

The report calls for boards to “take the initiative” and identifies four drivers that boards can use to set objectives for diversity that enhance board effectiveness: 

• an apparent lack of diversity raises doubts about effectiveness and the ability of the board to think outside the box;
• diversity can contribute to society’s belief that the company supports social norms or equal opportunity and fairness and will conduct itself in a socially acceptable way;
• diversity can help boards understand internal and external stakeholders and will allow them to “see business opportunities and threats through their eyes”; and
• board diversity will contribute to a culture of better decision making. 

The report notes that “acknowledging and addressing the drivers of board diversity should help boards become more effective in promoting their companies’ long-term success”.  However, the report highlights that the level of diversity within companies will vary and there will be challenges of achieving diversity.  

The press release and full report can be obtained from the ICAEW website.

The bulletin ‘Bulletin 4: Recent Developments in Company Law, The Listing Rules and Auditing Standards that affect United Kingdom Auditor’s Reports’ (“the bulletin”) covers: 

The introduction of the Strategic Report;

The option for companies to provide its members with a stand-alone ‘‘Strategic Report with Supplementary Material’’ in place of the company’s full accounts and reports. ‘‘The Strategic Report with Supplementary Material’’ replaces the previous option of providing a Summary Financial Statement;

Amendment of the Regulations that specify the information to be included in a quoted company’s Directors’ Remuneration Report;

Changes in the requirements of the Listing Rules with respect to directors’ remuneration disclosures; and

Changes to ISA (UK and Ireland) 700 ‘‘The Independent Auditor’s Report on Financial Statements’’ made in October 2012 and June 2013 and the issuance, in November 2013, of a Clarification Statement in respect thereof. 

The bulletin provides an explanation of each of these developments and the auditor’s responsibility in relation to the strategic report and the directors’ remuneration report.  The bulletin indicates that the directors have the same statutory reporting responsibility for the strategic report as they currently do for the directors’ report. 

The FRC note that they will update ISA (UK and Ireland) 720 to take into account these new auditor responsibilities “once the International Audit and Assurance Standards Board (IAASB) has finalised the revision of its equivalent standard”.  

The impact of these developments on auditor’s reports is also provided in the form of illustrative examples.  The changes to the director’s remuneration report have no impact on the auditor report. 

The bulletin includes two appendices that illustrate the impact that these developments have on financial statements prepared under the Financial Reporting Standard for Smaller Entities (FRSSE) and those prepared for a publicly traded premium listed group. 

The FRC comment that their bulletins are “persuasive rather than prescriptive, but are indicative of good practice”. 

Click for (all links to FRC website):

• Press release
• FRC bulletin: Bulletin 4: Recent Developments in Company Law, The Listing Rules and Auditing Standards that affect United Kingdom Auditor’s Reports’

In his speech, Mr Hoogervorst looked at the moral hazard that is always present wherever people work with other people's money and he explored the question of what the role of accounting standards is against this backdrop of moral hazard.

According to the IFRS Foundation Constitution, the goal behind accounting standard-setting is to require entities to provide high quality, transparent and comparable information in their financial statements so that investors can make informed decisions. Mr Hoogervorst claimed, however, that the mission of the IFRS Foundation was much more far reaching - according to him it was "building trust in financial markets" and one way to do so would be to minimise moral hazard through discipline and rigour and through eliminating information asymmetry.

In addition to some historical examples of what the IASB has achieved in this area, Mr Hoogervorst pointed at the current battle fought in the leases project. "Stripped bare, the leasing project is all about preventing the understatement of liabilities." He stated that there was huge resistance against bringing these liabilities to the balance sheet and yet he said he had no doubt that discussing leasing liabilities in the boardroom and with investors would soon be as much routine as discussing pension liabilities is now.

However, he also conceded, sometimes the IASB did not manage to do what it set out to do. He cited the incurred loss model for impaired financial assets that was designed to prevent earnings management by banks. However, the global financial crisis showed that that model could actually be used to delay showing the true financial situation of companies. Nevertheless, Mr Hoogervorst refused to connect the financial crisis with the current debate on reintroducing the concept of prudence into the Conceptual Framework:

But I also want to be clear about what Prudence as a concept cannot mean. It cannot mean a return to old-fashioned accounting with hidden reserves. It cannot lead to a systemic bias toward conservatism that is at odds with neutrality. Prudence should not be invoked to create a taboo on using current measurement. There is nothing more imprudent than to measure derivatives at cost or to measure an insurance liability at historic interest rates.

Speaking about governance and moral hazard, Mr Hoogervorst turned to the question of whether the fact that the IASB is privately organised does not make it vulnerable to pressure from private interests. Although he conceded that this question deserves a serious answer and should not be shrugged off lightly, he also pointed out that a public governance structure of standard-setting was in itself no guarantee for avoiding moral hazard. He cited as an example public sector accounting where in most jurisdictions the public accounting standards are set by the public authorities themselves. "Whether these standards always lead to a complete picture of a country's financial position is in doubt," he added. Therefore, he concluded that the key to successful standard-setting was its ability to fend off capture by special interests irrespective of its provenance and the key to preventing moral hazard in standard-setting was to find the right balance between independence and accountability.

Please click for access to the full text of Mr Hoogervorst's speech on the IASB website.