ACCA: The future of audit - Towards more transparency, quality and independence

18 October 2012

On 25 September, Sajjad Karim MEP hosted a high-level roundtable, organised by ACCA in partnership with ecoDa, to discuss the various proposals linked to audit quality and transparency, as well as those targeting independence and market structure.

The main conclusions indicate there is a general consensus that any reform needs to improve transparency and audit quality. It must help resolve the gap that exists between what auditors are asked to do and what stakeholders and citizens generally understand under 'audit process'. There are however diverging perspectives on the appropriate tools on how to make auditing more effective and relevant in the 21st Century, especially in the area of auditor independence and market structure. 

The EC believes that promoting independence and healthy competition, and ensuring the enforcement of legislation supervising the audit sector is key to restoring trust in this service, which plays a pivotal role in business by promoting the causes of transparency, accountability and sound financial management. The EU executive believes that confidence of stakeholders in the audits of financial statements is an essential ingredient for growth and competitiveness. With this in mind, and in order to clarify and reinforce the role of audit, the EU executive published its legislative package on 30 November 2011, which comprises new Regulation containing specific requirements for the audit of Public Interest Entities (PIEs) and a Directive to amend the current statutory audit Directive. The co-legislators - the European Parliament and the Council - are currently preparing their respective positions on the package. 

Sajjad Karim, MEP 

• Is the rapporteur in the European Parliament Committee on Legal Affairs (JURI) on two related draft reports on Statutory audits of annual accounts and consolidated accounts and Statutory audit of public-interest entities: specific requirements. 
• He welcomed attendees to the standing-room-only event and introduced the debate with some thoughts following on from the presentation of his draft reports in the JURI Committee. He said that the issue of auditing is entering a critically interesting phase, so the timing of these reports and this event is very apt. 
• His report follows a clear philosophy: audit quality, transparency and independence should be the foremost considerations when designing an audit regulatory regime. After the 2008 financial crisis the finance sector needs to win back the confidence of investors, who are looking for higher quality auditing, improved value of statutory audits, and more competition in the market. 
• By combining greater information and availability of insight into the audit market with a reinforced opportunity to engage, he expects to see a much stronger attitude of involvement from shareholders and investors when it comes to a company's auditor engagement, as they find themselves much better placed to critically assess and comment on what they want to see from their auditors.
• MEP Karim proposes to keep the principle of mandatory rotation to avoid familiarity between the auditor and the audited company, but prefers an engagement limit of 25 years instead of the 6 proposed by the Commission, in order to avoid disruption and high costs. For the rappporteur, mandatory rotation is a backstop, and shareholders should become much more involved in the process through the work of each company’s audit committee, namely through an annual review and the appointment by shareholders of the statutory auditor.
• MEP Karim also considers that robust international standards and international convergence make sense as many of the companies classified as PIEs operate beyond the borders of the EU. On the controversial non-audit services area, looking beyond the 'blacklist' of services, the involvement of the audit committee in the approval of all other non-audit services is essential. MEP Karim also shares shadow rapporteur MEP Bodu’s willingness to open up competition in the area of non-audit services to allow smaller firms to gain a foothold in the upper tiers of the market.
• He recalled that we must remain conscious of the huge variety of domestic companies throughout the EU and the national markets in which they operate, a 'one-size fits all' solution throughout could thus end up representing a 'bad fit for all'. 

Dan Montgomery, Taskforce Chair of the auditor reporting project, IAASB: 

• Auditor reporting is of high interest globally, there are many initiatives in the wake of the global financial crisis, including the EC proposed regulation. We can observe common themes in the calls for change, but diverse views on how best to address.
• IAASB endeavours to put together a high quality framework, with extensive discussion and debate among stakeholders. Influences on high quality include values of auditors, training, experience, engagement, exploration of auditors’ reports, reporting of management and reports by audit regulators. The contextual factors are to be considered, but the discussion documents are expected to be approved by the end of 2012 or start of 2013.
• For IAASB, the auditor reporting project is the number one priority. It has issued an Invitation to Comment (ITC), unanimously approved, which sets out the IAASB’s indicative direction and rationale, and describes the IAASB’s perspectives on value and impediments 
• There are currently two key areas of change:
  • Auditor commentary, which would take the form of a new section aimed at improving informational value of the auditor’s report and highlight matters that are, in the auditor’s judgment, likely to be most important to users’ understanding of the audited financial statements or the audit. It would provide a 'roadmap' to help users better navigate complex financial reports, additional context to the matters highlighted and information about key judgments made by the auditor to provide more transparency regarding how the audit was conducted. This call is coming through louder in the EU than in other parts of the world. 
  • On the going concern assumption, he said there are mixed views on the values of statements. Consistent with ISA 570, the ITC suggests a requirement for all auditor’s reports to include a conclusion about appropriateness of management’s use of going concern (GC) assumption and a statement about whether material uncertainties relating to GC have been identified. Clarification of guidance on GC is likely to be necessary, as we need a common understanding of terms such as 'material uncertainty', 'significant doubt', and 'foreseeable future’ and also to better comprehend the relationship (or distinction) between ‘use of GC assumption and ability to continue as a GC'. Suggested improvements included a new section on inconsistencies, an explicit statement of compliance and a robust description of auditors’ responsibilities. These are the building blocks to allow flexibility. More information is also needed on internal controls and fraud
• Coordination with IASB is highly desirable, certain clarifications are to be discussed by IFRIC in November 2012.

Laurent Degabriel, head of investment and reporting unit, ESMA: 

• Greater transparency from auditors and audit firms themselves is necessary, especially for investors. Auditors need to be able to explain their judgement. 
• The independence of the oversight system is key. By issuing guidelines on topics such as best practices, ESMA could play a significant role in promoting a more convergent and integrated supervision of auditors in the EU and in fostering coordination with third countries. 
• ESMA stands ready to fulfil the role that European legislative bodies will define for it on audit related matters.

Nathalie Berger, Head of the Audit unit at the EC indicated that:

• The European Commission very much appreciates MEP Karim’s efforts to bring the audit reform forward. He rightly highlighted that the status quo is not an option. From today's debate, we all seem to agree on the objectives of clarifying the role of auditors and strengthening auditors' independence. Auditors play a societal role. Improved audit quality will enhance the single market, it will be key to strengthen auditors' confidence in order to ultimately enhance financial stability.
• There may still be some opposition, especially on independence and market structure. Some critics have remained consistent, but there had been some interesting options suggested in the session. 
• Merely using corporate governance codes and the comply and explain system is not appropriate for improving the legislative framework in the EU. The Commission welcomes the wish to strengthen audit committees, considering it essential that they have the necessary competence to fulfil their task appropriately. It is also important to improve the auditors’ reporting to the public, to serve its purpose. 
• Rotation is seen as a cornerstone of the audit proposals by the EU Executive, an essential ingredient of enhanced audit quality and independence. It is important to have a maximum duration of audit engagement and the Commission welcomes the rapporteur keeping it within the report, but looks with concern at the proposed backstop of 25 years. To reinforce independence and avoid familiarity, it is not sufficient that audit committees assess the threats irregularly, and a much shorter term should be considered. The Commission does not support either the concept of 'voluntary rotation'.
• On the provision of NAS, the Commission understands that services required under national law should be permitted, but the provision of consultancy and tax services pose a threat to independence (inherent self-review or risk of being in a position where the auditor would need to defend the audited entity’s view on certain issues). 
• The Commission also regrets that the draft EP report does not consider that certain firms above a certain size would only be allowed to provide audit services. 
• Joint audit should be incentivised and appear as an option as it raises audit quality.
• The Commission does not blame the audit sector for having caused the financial crisis, but society as a whole will benefit from the stronger role auditors could play in the prevention of future crises. 

Full paper

© ACCA - Association of Chartered Certified Accountants