27 March 2012

FEE/Johnson: How best to improve the quality of audit

FEE President, Philip Johnson, gave a speech on some of the key drivers relating to the improvement of the quality of audit at the Legal Affairs Committee of the European Parliament on 27 March, 2012.

According to Mr Johnson, a major driver of quality in auditing is the quality of the standards by which audits are performed. ISAs are high quality auditing standards which are developed using up-to-date best practice and are already used in over 100 countries worldwide They enhance confidence in the reliability, comparability and consistency of financial statements.

The new ISAs address many issues arising from the financial crisis but, unfortunately, they have not yet been fully implemented in all European countries.

Therefore, FEE recommends that the European Parliament supports the European Commission proposal to adopt ISAs for all statutory audits in the European Union, together with the related International Standard on Quality Control for audit firms.

FEE is convinced that independence and expertise form the bedrock of an audit. Therefore, a similar step should be taken regarding independence as is being taken on auditing standards. FEE recommends that the European Parliament requires all EU auditors to apply the principles and requirements of the International Code of Ethics instead of the independence proposals of the Commission.

The European Commission proposals on:

• the introduction of pure audit firms;
• the requirement for mandatory rotation; and
• the total prohibition on the provision of non-audit services to public interest entity audit clients

will isolate Europe on the world stage, will increase administrative burden but, most importantly of all, will reduce the expertise and knowledge within audit firms. This latter point is against the interest of all stakeholders and should be avoided at all cost.

Turning to auditor reporting, Mr Johnson believes there is an information gap rather than an expectation gap. Users of financial statements call for better and more extensive auditor reporting on the financial statement audit not more work. In his view, to provide more information would enhance the usefulness of the audit and thus leverage the quality of the audit. This also relates to reporting internally to those charged with governance and more can be done in this area.

Therefore, FEE recommends that the European Parliament supports the European Commission’s idea to enhance auditor’s public communication for public interest entities, but improves the proposals to make them more practicable and useful. Currently there are a number of matters that are too prescriptive or too detailed. In addition, in relation to internal controls, the proposal is contrary to the agreed European position that auditors should not report on the effectiveness of internal control as prescribed in the Sarbanes Oxley Act in the United States.

It must be remembered that the quality of audit also depends on high quality corporate governance and a high quality financial reporting framework.

In conclusion, Mr Johnson summarises:

• Auditors must communicate more and better, both internally to the client and externally. This is, from his perspective, a key aspect of improving both the quality and the usefulness of audit.
• Both the company and the auditor should communicate more in relation to going concern.
• Audit Committees need to play a bigger role in the reporting and governance process.
• Europe should adopt ISAs for all audits.
• Similarly, regarding auditor independence, Europe should rely on the International Code of Ethics.
• Parliament should reject proposals for excessive and counter-productive regulatory intervention, such as an absolute ban on non-audit services, breaking up of audit firms and mandatory rotation. This action would remove much-valued and much-needed knowledge and expertise from audit firms.

Full paper

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