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Deloitte comment letter to the FRC on EU audit reform

Published on: 20 Mar 2015

We have published our comment letters on the Department for Business, Innovation and Skills’ (BIS) discussion document on the implications of the EU and wider reforms to auditor regulation and the Financial Reporting Council (FRC)’s consultation paper on the implementation of the EU Audit Directive and Audit Regulation.

These papers together sought views of stakeholders on the implementation of the EU Audit Regulation and revised Audit Directive. The Regulation applies to the statutory audit of public interest entities, the Directive to all statutory audits. The UK is required to implement the Directive in national law by 17 June 2016, and to make choices about certain member state options in the Regulation by the same date. BIS proposed in many cases to make enabling provisions in the law, allowing the FRC to implement the detailed requirements.

Key points of our responses are:

  • We agree with BIS that the FRC should be designated as the single competent authority. However, the FRC should delegate significant amounts of activity to the professional bodies, to help ensure they remain strong and relevant. Where practicable, detailed requirements should be included in the FRC’s standards, providing a one-stop reference for audited entities, auditors, audit committees and investors.
  • We agree that BIS should not extend the definition of a public interest entity beyond that in the Directive (entities with securities admitted to trading on an EEA regulated market, credit institutions and insurers). However, the FRC should retain the option to extend some of the requirements of the Regulation to other classes of entity where appropriate. For example, we suggest that the degree to which non-audit services apply to AIM companies should reflect the outcome of the FRC’s soon to be published study of AIM and small cap company reporting; the Regulations requirements on tendering and rotation, however, appear disproportionate for AIM companies.
  • We support the idea of a detailed “black list” of prohibited non-audit services, with other services subject to a consideration of threats and safeguards. We prefer this to a “white list” of permitted non-audit services, with all other services banned. In our view, a white list could stifle innovation, for example the introduction of independent assurance over narrative reporting. A “black list” approach is also consistent with that adopted in most other countries, and is familiar to audit committees and investors alike.
  • We suggest that the FRC should take up the option to permit certain tax and valuation services which have no direct, or only immaterial direct impact on the financial statements; by definition, the judgements involved here cannot be material. Whilst the arguments are finely balanced, allowing companies a choice provides more competition in the market for non-audit services.
  • We agree with the FRC that stakeholders may not understand the distinction between the audit firm and the network of which it is part. To that end, bans on non-audit services should extend to all network firms, as well as to component auditors outside the network.
  • The Regulation requires that non-audit fees cannot exceed 70% of a rolling three year average of audit fees. Whilst there is uncertainty as to whether this applies to the audit firm or the wider network, we suggest that the rules should compare like with like – it would be inappropriate to compare non-audit fees charged by the network with only those audit fees charged by the auditor, for example.
  • We welcome the clarifications BIS offered in their supplementary information around rotation and tendering. We suggest that the principle should be simple; no auditor can serve a PIE continuously for more than twenty years, and a tender should be required at least every ten years. We agree with BIS that audited entities should be given credit for tenders carried out prior to 2016, and suggest that the FRC could usefully issue guidance on the application of the rules in situations where a new PIE is closely related to an existing PIE e.g. by merger or division.
  • We recommend that the FRC introduce the changes required to auditor reporting by EU law earlier than required by the Directive. We suggest that they will provide useful information for investors, and prevent changes in consecutive financial years.

Further comments and full responses to the questions raised in both documents are contained within the full comment letter to BIS and the full comment letter to the FRC (available below).

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