08 August 2013

FEE: Audit policy under the Lithuanian Presidency

FEE has issued an article analysing in depth whether the European debate on audit policy will find a better way forward under the Lithuanian Presidency of the Council of the European Union.

The Lithuanian Presidency is taking over from the Irish Presidency at a time when the Member States struggle to find an agreement whilst the European Parliament has already managed to find a compromise. The debate to reach a compromise in the proposed legislation on audit policy is mainly concentrated on the following topics, being also the ones which are of most concern to EU Member States:

1. The definition of Public Interest Entities (PIEs), determining the scope of the proposed Regulation;
2. The threats to the auditor's independence and the provision of non-audit services to audit clients being PIEs;
3. The possible obligation for mandatory audit firm rotation for audits of PIEs;
4. Cooperation at EU level of national authorities competent for audit oversight;
5. The requirements for the auditor's public reporting on PIE audits;
6. The role of accountancy professional bodies; and
7. The choice of legal instrument, namely a Directive and/or a Regulation.

1. Definition of Public Interest Entities (PIEs) 

The extension of the definition to include any entity involved with the provision of financial services may seem to make sense for supervisory purposes or for protecting the interests of investors. However, some of the entities added to the extended definition of PIEs in the proposed Directive may in reality be small or medium-sized, low risk or low complexity entities with limited impact on the public interest.

The report voted in the JURI Committee proposes to keep the 2006 Statutory Audit Directive PIE definition, mainly including listed entities, financial institutions and insurance undertakings. FEE agrees with this analysis and recommends therefore that the EC proposals are amended in order to exclude these low risk entities from the definition. Member States could nevertheless be authorised to designate as PIEs entities that are of significant public relevance because of the nature of their business, their size or the number of their employees.

2. Threats to auditors' independence and provision of non-audit services to audit clients being PIEs 

The Council of the EU is still split on this issue. FEE nevertheless notes the vast support expressed by the Council for an approach where the text only mandates a closed list of prohibited non-audit services. However, FEE highlights that a majority of Member States question the extensive list of prohibitions proposed by the EC. FEE finds it unfortunate that the proposed list of prohibited services does not include the concepts of materiality and relevance to the financial statements of the audited entity which are embedded in the IESBA Code of Ethics. A significant number of Member States are also against the principle of capping or limiting the provision of other services as a percentage of audit fees. When the time to compromise will come, it will be important that Member States remain attentive to the content of this list and do not turn it into something that would be impracticable, disproportionate or an international anomaly.

3. Possible obligation of mandatory audit firm rotation for audits of PIEs 

FEE has studied the very limited evidence available on the practical effects of mandatory audit firm rotation and has weighted the pros and cons of the proposal. The majority of FEE Members concluded that such a measure would be unhelpful as it would have limited benefits from an independence standpoint and may lead to further concentration in the audit market and therefore oppose the principle of making auditor's rotation mandatory as it is detrimental to audit quality and, as shown by experience, will increase – not reduce – concentration on the audit market. 

4. Cooperation at EU level of national authorities competent for audit oversight

The Commission proposal envisages EU-wide cooperation on auditor oversight between the national competent authorities takes place within the ESMA. This committee would assume functions previously undertaken by the European Group of Auditors' Oversight Bodies (EGAOB), an expert group chaired by the Commission.

The report of the JURI Committee supports that ESMA be the coordination body for public oversight of the audit profession on European level, but curtains the regulatory and other powers of ESMA to a certain extent. In the Council, a number of EU Member States do not agree with the compromise put forward by the Irish Presidency to set up a Committee of European Auditing Oversight Bodies (CEAOB) within ESMA, composed of the members of EGAOB and having decision making powers. A majority of EU Member States seem to support the proposition to set up an alternative to ESMA.

FEE strongly supports public oversight of the profession as it is crucial to enhance audit quality and the long-term sustainability of auditors and audit firms. Nevertheless, an appropriate balance between independence and competence within supervision should be sought and this balance may not be easy to find within ESMA.

5. Adaptations to the auditor's public reporting on PIE audits 

FEE supports the European Commission's idea to enhance the auditor's public communication for PIEs, especially on:

• Qualitative information on the significant audit risks;
• More reporting on going concern assumptions based on information provided by management.

Nevertheless, in the EC Proposals, there are a number of matters that are too prescriptive or too detailed, like auditor's reporting on methodology, on materiality, on identification of each member of the entire engagement team, on the length of the audit report, etc. In its report, the EP JURI Committee has improved the Commission's proposals to make them more practicable and useful.

FEE very much appreciates this approach even if some further thoughts could be given to some amendments that will not really be practicable in reality.

6. Role of professional bodies 

FEE agrees with the amendments put forward by the EP Committee and therefore recommends that delegation to professional bodies, under the supervision of the competent authority, means at least:

• Approval and registration of auditors including the whole process of education, initial qualification and continued professional development;
• Quality assurance reviews for non-PIEs.

7. The choice of legal instrument, namely a directive and/or a regulation 

The EC has issued two legal instruments: (a) a revision of the Statutory Audit Directive setting 'minimum harmonisation requirements' for all statutory audits, requirements which would require transposition by EU Member States into their national legislation, as well as (b) a new regulation regarding statutory auditors of PIEs within the EU, setting 'maximum harmonisation' requirements which are directly applicable in EU Member States.

The EP JURI Committee proposes to transfer a number of stipulations from the regulation to the directive, the major ones being: (a) on the 'Internal Organisation of Auditors and Audit Firms', (b) on 'Independence from the Audited Entity' and (c) on 'Performance of the Statutory Audit', making them applicable to all entities. The article of the regulation on 'Audit Committee' is also proposed to move to a new article of the directive, but applicable to PIEs only.

The Council is understood to consider those and even further shifts from the Regulation to the Directive.

Full article

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