As part of its ongoing work to enhance justifiable confidence in audit the Financial Reporting Council (FRC) has published a consultation on revisions to Ethical and Auditing Standards, the UK Corporate Governance Code and related Guidance on Audit Committees.
Audit underpins public confidence in corporate governance and reporting by UK companies. Since the financial crisis, the FRC has introduced measures to enhance confidence in the quality of audit and increase the value of auditor reporting to investors. The measures include retendering, enhanced and extended auditor and audit committee reporting, and increased transparency of the results of the FRC’s audit quality inspections.
In April 2014, the FRC announced that to enhance confidence in the quality of audit, its work would include a focus on recommendations from the then Competition Commission’s review of competition in the FTSE 350 audit market; the implementation of the new EU Regulation and Directive on statutory audit (ARD); developing best practice guidance for audit committees; and assessing whether ethical standards for audit remain fit for purpose.
The FRC is now consulting on proposals in connection with those elements which it considers should be introduced at the same time as the ARD is implemented into the UK. In developing its proposals, the FRC has sought to follow underlying principles and objectives:
- Building a clear and sustainable framework and clear lines of accountability (so that companies and audit firms know the exact role of all UK regulatory bodies);
- maintaining market confidence in the independence of regulation (so that investors and potential investors remain confident in the quality of financial statements);
- applying the rule of proportionality, and delivering implementation that can be justified and defended; and
- serving the public interest.
The FRC’s proposals reflect responses received to its earlier consultation Auditing and ethical standards implementation of the EU Audit Directive and Regulation, and include an impact assessment of the costs and benefits arising from decisions taken by the FRC.
Stephen Haddrill, FRC Chief Executive said,
“The Audit Regulation and Directive is large and complex. We are working closely with professional bodies to make sure the new regulatory regime works as effectively as possible. We must ensure that it builds on the progress made in the UK in recent years in terms of the quality of audit, that competition in the audit market is strengthened in a way that supports innovation and that the regulatory regime that emerges provides confidence to investors and to firms by being fair, understandable and independent.”
The FRC’s consultation includes:
- A revised Ethical Standard for audit and other public interest assurance engagements incorporating changes required by the ARD. The FRC is a principles-based regulator and has developed an approach where principles are supported by more detailed requirements. This is intended to mitigate the risk, which has been identified through FRC’s audit quality inspection work, that auditors treat standards (and the Ethical Standard in particular) as a rule book where behaviour is driven by a series of prohibitions rather than an assessment of what behaviours or actions are appropriate. The standard covers matters such as how independence of the auditor might be judged, the role of the firm in ensuring ethical conduct; and prohibitions and limits on non-audit services in line with the ARD requirements. In line with feedback from the FRC’s December consultation that investors’ confidence is enhanced by existing, more stringent UK requirements and/or practices, the FRC proposes to retain those requirements where possible.
- Revised quality control and auditing standards incorporating where necessary, specific requirements of the ARD, and guidance to address UK and Irish legislation, and cultural and business issues. The International Audit and Assurance Standards Board (IAASB) has recently issued revised auditor reporting standards. As auditing standards in the UK and Ireland are based on international standards issued by the IAASB, the FRC is taking the opportunity to consult on revisions to the auditing standards. The FRC led the way with the introduction of extended auditor reporting and in revising the reporting standards it has sought to retain those requirements which drove innovation. Similarly, the FRC has led the way in respect of providing a longer term view of business viability and differentiating reporting for stewardship purposes from the reporting of accounting judgements. The FRC is of the view that auditor reporting related to going concern is in the public interest and is valuable to investors. The FRC therefore proposes, in addition to the enhancements made by the IAASB, to include additional UK requirements on the reporting of the going concern basis of accounting and related uncertainties.
- Changes to the UK Corporate Governance Code (the Code) which are being kept to the minimum required to align with the ARD and to limit the regulatory burden. The changes relate to the tenure of the auditor where the 2012 Code change introducing ten year retendering is now redundant; and to changes in the composition and role of the audit committee. The FRC is consulting on recommendations of the (now) Competition and Markets Authority (CMA) relating to increasing shareholder engagement on audit matters through changes to both the UK Corporate Governance and the UK Stewardship Codes. The FRC considers that sufficient coverage is already given to this topic in both codes. The CMA also recommended that the Code introduces an advisory vote for shareholders to indicate their satisfaction with the audit committee’s annual report. The CMA considered that its introduction would increase the audit committee's incentives to discharge their responsibilities in the interests of shareholders. The FRC considers that shareholders already have sufficient rights to express their opinion on the audit committee report.
- Rewritten ‘Guidance on Audit Committees’ to take account of amendments to the Code and regulatory framework, and recommendations put forward by the CMA, many of which coincide with amendments made by the ARD. There are changes to the composition of the audit committee covering sectoral competence; removal of references to audit retendering; changes covering new rules around the prohibition of non-audit services; and consequential changes, reflecting amendments to the Ethical and Auditing Standards for Auditors. Further, the FRC wishes to increase transparency of its audit quality inspection findings and corporate reporting review findings. The guidance includes reporting by audit committees of significant matters arising from FRC inspections and reviews. The guidance builds on the approach developed following the CMA recommendations in respect of audit quality inspection findings and announced by the FRC in November 2014.
- The proposed changes to the Code and the revised Ethical Standards and Auditing Standards will apply to financial periods beginning on or after 17 June 2016, the implementation date of the ARD.
Notes to editors:
- The FRC is responsible for promoting high quality corporate governance and reporting to foster investment. We set the UK Corporate Governance and Stewardship Codes as well as UK standards for accounting, auditing and actuarial work. We represent UK interests in international standard-setting. We also monitor and take action to promote the quality of corporate reporting and auditing. We operate independent disciplinary arrangements for accountants and actuaries; and oversee the regulatory activities of the accountancy and actuarial professional bodies.
- In April 2014 the FRC set out a programme of work to enhance justifiable confidence in the quality of audit, which also included a thematic review of the quality of bank audits and a review of the audit firm governance code. The FRC also outlined its advice to audit committees on how they should report on audit quality inspection findings in November 2014.
- On 20 July 2015 Government announced its intention that in implementing the ARD it proposes to designate the FRC as the UK competent authority and its responsibilities would continue to include setting relevant UK standards. Further details of the UK implementation of ARD may be found here.
- Comments on the questions set out in this consultation document are requested by 11 December 2015. Responses should be sent by email to ARDconsultation@frc.org.uk. or in writing to:
Financial Reporting Council
125 London Wall
The FRC will hold open meetings with stakeholders to discuss the consultation and to seek input to its outcome.