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Consultation Paper Feedback Statement: Proposed revisions to International Standards on Auditing (UK and Ireland)

CONSULTATION PAPER: PROPOSED REVISIONS TO INTERNATIONAL STANDARDS ON AUDITING (UK AND IRELAND) TO GIVE EFFECT TO THE FRC EFFECTIVE COMPANY STEWARDSHIP PROPOSALS

FEEDBACK STATEMENT

1. Introduction

1.1 The Financial Reporting Council (FRC) is engaged in a major project to enhance the effectiveness of the stewardship role of boards and audit committees through corporate reporting and audit (the ‘Effective Company Stewardship project’). A key objective is to enhance the relevance and value of the audit for users and the public by stimulating greater transparency about the judgements made by management and auditors in the course of preparing and auditing financial statements.

1.2 In April 2012 the FRC issued a consultation paper setting out proposed revisions to International Standards on Auditing (ISAS) (UK and Ireland):

  • 260 “Communication with those charged with governance”
  • 265 “Communicating deficiencies in internal control to those charged with governance”
  • 700 “The auditor’s report on financial statements” (Revised)
  • 720A “The auditor’s responsibilities relating to other information in documents containing audited financial statements”.

A consultation on changes to the UK Corporate Governance Code and the Guidance for Audit Committees was issued at the same time.

1.3 The proposed changes in both consultations were intended to give effect to the proposals originally identified in Effective Company Stewardship: Next Steps published by the FRC in September 2011. This stated that:

  1. The FRC believes that more needs to be done to demonstrate that auditors are achieving the fundamental purpose of an audit – namely to carry out an independent check into whether a company’s financial statements, including the decisions, judgements and estimates involved, have been properly prepared and are fair and balanced.
  2. The FRC believes that auditors can and should provide increased insight into the audit process so as to reassure users of financial statements that all material matters have been properly disclosed.
  3. To address the need for the contribution by auditors to be more transparent, the FRC proposes to review and consult on revisions to the auditing standards governing reporting by auditors to audit committees (ISA (UK & Ireland) 260) and audit reports (ISA (UK & Ireland) 700 (Revised))."

1.4. The proposed changes to the ISAs (UK and Ireland) set out in the consultation paper were primarily directed at:

  1. Enhancing auditor communications by requiring the auditor to communicate to the audit committee:
    1. information that the auditor becomes aware of in the course of the audit and that the auditor believes the audit committee will need in order to understand the rationale and the evidence relied upon when making significant professional judgments in the course of the audit and reaching an opinion on the financial statements. This will include the auditor’s judgments made in planning the audit and the auditor’s views about the key judgments made by management in preparing the financial statements; and
    2. the auditor’s insights about the entity’s internal control system based on their audit work.
  2. Extending auditor reporting by requiring the auditor to report by exception if:
    1. the board’s statement in the annual report setting out the basis on which the board considers that the annual report is fair, balanced and understandable and provides the information necessary for users to assess the entity’s performance, business model and strategy, is inconsistent with the knowledge acquired by the auditor in the course of performing the audit; and/or
    2. the matters disclosed in the section of the annual report describing the work of the audit committee do not appropriately address matters communicated by the auditor to the audit committee.

1.5 The consultation period closed on 13 July 2012. Twenty one responses to the consultation on the ISAs (UK and Ireland) were received from:

  • Audit firms – 11
  • Professional and public sector bodies – 5
  • Investors and representative bodies – 4
  • Others - 1

Copies of all the responses are available on the FRC website2. A list of respondents is given in Appendix 1.

1.6 All the answers to the specific questions asked in the consultation paper and other comments received have been considered by the FRC. They helped identify areas where the proposed requirements and application material could be clarified and have been taken into account in the final revisions made to the standards. The final revised standards can be obtained from the FRC website. Appendix 2 gives a summary of where changes to the requirements have been included in the revised standards as compared with the extant standards.

2. Summary of responses to the specific questions asked in the consultation paper

Q1 Is the scope of the proposed changes appropriate (entities reporting on compliance with the Code)?

2.1 Most of the proposed changes were intended to be applicable only to UK Code reporting entities. However, it was proposed that the changes to ISA (UK and Ireland) 720A should be applicable to all audits3.

2.2 There was strong agreement overall that the proposed scope was appropriate. However, there were suggestions by separate audit firms that either the scope of the new requirements should not apply to entities that apply the Code voluntarily (because fear of increased costs could prevent such entities adopting the Code) or the scope of the requirements should be restricted to the FTSE 350. These concerns were each identified once by separate audit firms.

FRC Response

2.3 In response to these specific suggestions, the FRC has concluded that it is not appropriate to restrict the application of the requirements as they are intended to support related changes in the UK Corporate Governance Code and the Guidance for Audit Committees, which have the same scope as proposed for the revisions to the auditing standards.

Q2 Is the proposed effective date, linked to that for the proposed revisions to the Corporate Governance Code (periods commencing on or after 1 October 2012), appropriate?

2.4 There was a clear majority agreement that the proposed effective date was appropriate, recognising that it was linked to that which had already been established for the proposed revisions to the UK Corporate Governance Code. However, there was some concern that the effective date, although manageable, was very tight with little time for methodologies and training to be updated.

2.5 There was a suggestion from one audit firm that the effective date should be for periods ending on or after 30 September 2013, which is effectively the same calendar period. This would give more certainty as to when the revised standards would first need to be applied; avoiding possible mandatory application of the revised standards when an entity changes its accounting reference date to result in a short accounting period that may end before the audit firm has had the opportunity to implement fully the revised requirements in its methodology and training. This would also be consistent with how changes to the ISAS (UK and Ireland) are ordinarily made effective.

FRC Response

2.6 The FRC has concluded that it is important that the effective date for these particular changes is kept in line with the effective date for the related changes to the UK Corporate Governance Code, which remains periods commencing on or after 1 October 2012. The revisions have been finalised on a timely basis which should assist audit firms to update their methodologies and training before the changes need to be applied in practice.

Q3 Are the proposed changes to ISAs (UK and Ireland) 260 (communication with those charged with governance) and 265 (communicating deficiencies in internal control) appropriate?

2.7 There was overall majority support for these proposed changes, but a significant amount of concern in relation to some matters was raised by representatives of auditors. The main concerns, and the FRC’s response, are:

  1. The FRC should not be adding more ‘pluses’ to the ISAs UK and Ireland). This may be seen as a lack of UK support for the ISAs as issued by the IAASB. Those expressing this view generally propose that the FRC should instead influence the IAASB and wait for the outcome of its Auditor Reporting project and for the EC proposals for audit developments in the EU to be resolved.

FRC Response

The FRC believes addition of the new requirements is appropriate and necessary to implement the FRC’s objectives under the ECS project and to support the changes to the UK Corporate Governance Code and Guidance for Directors – these are UK and Ireland specific matters that will not be addressed by the IAASB.

The FRC’s objectives under the ECS project have previously been consulted on (including the intention to revise the auditing standards) and this course of action was supported by respondents to that consultation.

Adopting the approach suggested by the respondents to this consultation would significantly delay the implementation of ECS by delaying the auditor contribution to the project. The UK has made, and continues to make, its support for the ISAs clear through its involvement with the IAASB’s work. The IAASB is aware that the UK is making these changes and of our desire to have the revisions to the IAASB auditor reporting model (to enhance auditor reporting) accommodate the ECS approach (one that integrates enhanced auditor and governance reporting).

  1. It should not be the auditor who determines what information the audit committee needs to fulfil its obligations, and it is management’s responsibility to explain their judgements to the audit committee.

FRC Response

The enhanced proposed role of the auditor under the proposed revisions to the auditing standards was not meant to supplant either management’s responsibility to explain their judgments to the audit committee or the board’s or the audit committee’s responsibility to determine what information they need to fulfil their reporting responsibilities. It is not intended that the auditor should alone determine what information the directors or audit committee need.

The requirement in paragraph 16-1 of ISA (UK and Ireland) 260 has been reworded to make clear that the auditor is required to communicate information that the auditor has obtained in the course of the audit about matters that the auditor believes will be relevant to the Board or the audit committee in fulfilling their responsibilities (including the information that the audit committee would need in order to understand the auditor’s judgments and the evidence the auditor relied upon in conducting the audit and their views on those matters).

There is nothing to stop the audit committee asking for other information that it may wish to have communicated to it. Furthermore, paragraph 5 of ISA (UK and Ireland) 260, in relation to which no changes are proposed, already addresses management’s responsibility: “Although the auditor is responsible for communicating matters required by this ISA (UK and Ireland), management also has a responsibility to communicate matters of governance interest to those charged with governance. Communication by the auditor does not relieve management of this responsibility."

  1. The requirement to communicate views on effectiveness of internal control does not fit well within ISA (UK and Ireland) 265, which is a standard on the communication of significant control deficiencies; and there is risk of an expectation gap developing if audit committees and others believe the auditors are providing assurance on effectiveness of internal control.

FRC Response

On reflection, it is agreed that the requirement does not fit well in ISA (UK and Ireland) 265, which is currently limited to addressing communications about deficiencies in internal control. If the requirement were to be retained there, the auditor’s objectives and the title of the standard would need to be revised and this does not seem desirable.

Accordingly, the requirement has been moved to ISA (UK and Ireland) 260, and incorporated into paragraph 16-1(d). This also helps emphasise that this requirement is meant to be more than simply communicating about deficiencies. Wording changes have also been made to that paragraph, to help clarify the requirement, including the need to explain the context and limitations of the communication to the audit committee.

Additional application material has been included in paragraph A20-5, to explain how views on effectiveness of internal control may go beyond communicating deficiencies.

As there are no longer changes of substance to be made to ISA (UK and Ireland) 265, that standard is not being revised and reissued at this time. Editorial changes to update references to the ‘Combined Code’ to the ‘UK Corporate Governance Code’ will be made at a future date.

  1. The auditor should not be determining what should be disclosed by the entity regarding its internal control and business risks.

FRC Response

It was not the intent to imply that the auditor should be making the primary determination in this respect. However, it is consistent with the rationale of the ECS model that, whilst continuing to require the directors to make the primary determination, the auditor should consider whether, in light of their knowledge obtained in the course of the audit, they are aware of any deficiencies in those disclosures and, if so, to report on those deficiencies. In this context, the auditor should communicate to the audit committee the information of which it is aware that it considers relevant to the directors’ and audit committee’s responsibilities.

The requirement has been reworded (now in paragraph 16-1 (d) of ISA (UK and Ireland) 260) consistent with the revisions made in response to issue (iii) above. The reworded requirement also now distinguishes between the auditor’s views about the effectiveness of the entity’s system of internal control relevant to risks that may affect financial reporting and about other risks (and related controls). The auditor is required to obtain an understanding of the former and may, but is not required to, obtain an understanding of the latter. This is further expanded upon in application material in paragraph A20-4.

Q4 Are the proposed changes to ISAs (UK and Ireland) 700 (auditor reports) and 720 (other information) appropriate?

2.8 There was a clear majority agreement that the objectives of the changes were appropriate, but some suggestions as to how the requirements could be improved and clarified. The main concerns and recommendations for improvement, and the FRC’s response, are:

  1. Consistent with their responses to Q3, some respondents commented that the FRC should not be adding more ‘pluses’ to the ISAs UK and Ireland).

FRC Response

As explained in relation to Q3 above, the FRC believes that adding these requirements at this time is appropriate.

  1. Reporting by exception on whether information in the ‘other information’ is apparently incorrect based on, or materially inconsistent with, the knowledge acquired by the auditor in the course of performing the audit may lead to an expectation gap and the belief that auditors are providing assurance on the other information.

FRC Response

Auditors are not required to express a separate opinion on the other information and the scope of the auditors’ work proposed is one that users generally expect auditors are undertaking already.

  1. The changes in ISAs (UK and Ireland) 700 and 720 relating to the auditor’s consideration of whether the ‘other information’ is incorrect based on the auditor’s knowledge do not have regard to materiality.

FRC Response

It is agreed that regard should be given to materiality in this area and changes have been proposed to insert this.

  1. The application material in ISA (UK and Ireland) 700 that sets out matters the auditor reports on by exception is in effect a requirement and should be reclassified as such.

FRC Response

It is agreed that this should be presented as a requirement and accordingly has been moved from paragraph A20 to paragraph 22B.

  1. It should be clear what happens if the entity decides to not comply with the UK Corporate Governance Code and to give an explanation why it is not complying.

The auditor should not be required to disclose ‘other information’ required to comply with the Code, when the directors have decided they have appropriate grounds not to comply in that respect and to provide an explanation as to why not.

FRC Response

It is agreed that this needs to be clarified. This is now presented in paragraph 22B as a requirement that, if the directors give an explanation that they have not given the statement (required by Code provision C.1.1), the auditor considers whether the explanation is consistent with their knowledge and reports by exception if it is not. However, it is believed appropriate to require the auditor to provide the information that they communicated to the audit committee and that they believe should have been disclosed to shareholders if the section of the annual report either omits that information or the directors explain why they are not complying with the requirement (of Code provision C.3.7) to provide such a section.

Q5 Do you agree that it would be inappropriate to extend to all audits the requirement to report an explicit conclusion arising from the work under ISA (UK and Ireland) 720A?

2.9 This was agreed by a clear majority. One audit firm, consistent with its view on not adding ‘pluses’, was against any changes at all to the standards. Another firm suggested that different reporting requirements could lead to confusion with inconsistency in reporting matters by exception.

FRC Response

2.10 The FRC continues to believe that it is not necessary at this time to extend to all audits the requirement to provide an explicit conclusion on whether they have anything to report arising from their work under ISA (UK and Ireland) 720 Section A.

Q6 Do you agree the associated costs of the proposed changes should not be significant compared to total audit costs?

Q7 Do you agree that the benefits of the proposed changes will outweigh any costs?

2.11 A number of audit firms expressed the view that the revisions to the auditing standards that were proposed would result in them performing significantly more work to meet the new requirements, which would result in significant cost increases that they do not believe are outweighed by any benefits. Some firms say they will feel driven to do more, regardless of the limitation in the proposed standards to reporting based on the knowledge gained in the course of the audit. Other respondents, including the representatives of investors, believed that there would be benefits outweighing the costs.

FRC Response

2.12 It is hard to understand the basis for the views that auditors would need to perform significantly more work. The changes to the standards are clearly aimed at communicating information about work auditors are currently performing – they do not require any additional verification work to be performed.

2.13 The FRC recognises that one change that might have been seen as requiring more underlying work to be performed is the new requirement in ISA (UK and Ireland) 720 that explicitly requires the auditor when reading the other information to consider it in relation to the knowledge they have acquired during the performance of the audit. However, the current application material already identifies that the auditor reads the other information in the light of the knowledge they acquired during the audit. The new requirement is in effect an elevation of this guidance to a requirement, and is not expected to change what is understood to already be current practice by auditors.

2.14 The FRC has concluded, taking account of changes that have been made in response to the consultation, that revising the standards is appropriate.

3. Other comments received

Board statement on whether the report and accounts are "fair, balanced and understandable"

3.1 There was a common concern that it was not clear what is meant by the statement the directors have to give that “the annual report is fair, balanced and understandable and provides the information necessary for users to understand the entity’s performance, business model and strategy”, how it differs from the directors’ existing responsibilities for the annual report, and how it is to be evaluated.

FRC Response

3.2 This was a concern that echoed similar comments raised in the responses to the proposed changes to the UK Corporate Governance Code and the Guidance for Audit Committees. In light of the comments the FRC has revised its proposals in a way that it hopes expresses its original intentions more clearly while alleviating some of the concerns raised by respondents. This has been done by:

  • Amending the existing Code requirement for boards to explain in the annual report their responsibility for preparing the annual report and accounts. In addition, boards will be expected to confirm that the annual report and accounts, taken as a whole, are fair, balanced and understandable and provide the information needed for shareholders to assess the company’s performance, business model and strategy. Referring to shareholders rather than users makes this statement consistent with existing statements required under the Companies Act. As noted in the FRC’s Statement of Principles for Financial Reporting, by focusing on the interest that investors have in the company’s performance and position the board should, in effect, also be focusing on the common interest that all users have.
  • Adding a new supporting principle requiring boards to put in place the processes needed for them to satisfy themselves that the report met these tests. It will be left to the board to decide what if any role the audit committee should play.

These changes have also been reflected in the revised ‘Guidance on Audit Committees’.

3.3 The description of the director’s responsibilities in relation to this statement has been amended in the auditing standards where necessary. Auditors are required to report by exception where the statement given by the board is inconsistent with the knowledge acquired by the auditor in the course of performing the audit.

APPENDIX 1

RESPONDENTS TO THE CONSULTATION

Professional and public sector bodies

  • ACCA
  • The Chartered Institute of Public Finance and Accountancy (CIPFA)
  • The Institute of Chartered Accountants in England and Wales (ICAEW)
  • The Institute of Chartered Accountants of Scotland (ICAS)
  • NAO

Audit Firms

  • Baker Tilly UK LLP
  • BDO LLP
  • Crowe Clark Whitehill LLP
  • Deloitte LLP
  • Ernst & Young LLP
  • Grant Thornton UK LLP
  • Kingston Smith
  • KPMG LLP
  • Mazars LLP
  • PKF (UK) LLP
  • PwC LLP

Investors and representative bodies

  • ABI
  • Hermes Equity Ownership Services
  • International Corporate Governance Network (ICGN)
  • Legal & General Investment Management

Others

  • GC 100 Group

APPENDIX 2

SUMMARY OF CHANGES TO REQUIREMENTS IN THE REVISED STANDARDS COMPARED TO THE EXTANT STANDARDS

The table below indicates where changes to requirements have been included in the revised standards. It is necessary to read the standard to see the full text of the requirements. New application material supporting these requirements has also been included in the standards.

The original proposed revisions to the standards included changes to ISA (UK and Ireland) 265 Communicating deficiencies in internal control to those charged with governance and management. Those revisions, modified taking account of the comments received on consultation, have been incorporated in the new requirement in ISA (UK and Ireland) 260 (see below). Accordingly ISA (UK and Ireland) 265 has not been revised and reissued.

ISA (UK and Ireland) 260 Communication with those charged with governance

Paragraph New requirement to communicate particular matters to the audit committee. This is applicable in the case of entities that are required, or choose voluntarily, to report on how they have applied the UK Corporate Governance Code, or to explain why they have not.
16-1 New requirement to communicate particular matters to the audit committee. This is applicable in the case of entities that are required, or choose voluntarily, to report on how they have applied the UK Corporate Governance Code, or to explain why they have not.

ISA (UK and Ireland) 700 The auditor's report on financial statements

Paragraph
16(c) Expansion of the description of the scope of audit to identify that the auditor also reads the other financial and non-financial information, that is included in addition to the audited financial statements, in the annual report to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by the auditor in the course of performing the audit.
22A New requirement, applicable in the case of entities that that are required, or choose voluntarily to report on how they have applied the UK Corporate Governance Code, or to explain why they have not, to report by exception if when reading the other financial and non-financial information included in the annual report, the auditor has identified information that is materially inconsistent with the information in the audited financial statements or is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by the auditor in the course of performing the audit.
22B New requirement specifying matters that the auditor shall report on by exception in accordance with paragraph 22A. The auditor is required to include a suitable conclusion on these matters in the auditor’s report. In addition, if a section of the annual report describing the work of the audit committee does not appropriately disclose any matters communicated by the auditor to the audit committee that in the auditor’s judgment should have been disclosed, or if the annual report does not contain such a section, the auditor’s report shall also include any such information.

ISA (UK and Ireland) 720A The auditor's responsibilities relating to other information in documents containing audited financial statements

Paragraph
6-1 New requirement, applicable in all audits, that the auditor shall also read the other information to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by the auditor in the course of performing the audit.
14-1 New requirement, applicable in all audits, that if, on reading the other information for the purpose of identifying any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by the auditor in the course of performing the audit, the auditor becomes aware of an apparent misstatement of fact, the auditor shall discuss the matter with management.

  1. Further information about the Effective Company Stewardship project can be obtained from: http://www.frc.org.uk/Our-Work/Headline-projects/Effective-company-stewardship.aspx ↩

  2. The consultation paper on the ECS Proposed additions to ISAs (UK and Ireland), and the responses received, can be obtained from: http://frc.org.uk/Our-Work/Publications/APB/Consultation-paper-ECS-proposed-additions-to-ISAs.aspx The consultation on the proposed revisions of the UK Corporate Governance Code and the Guidance for Audit Committees, and the responses received, can be obtained from: http://frc.org.uk/Our-Work/Publications/Corporate-Governance/Consultation-Document-revisions-to-the-UK-Corporat.aspx ↩

  3. The proposed changes to ISA (UK and Ireland) 720A required the auditor to read the other information, presented in the annual report in addition to the audited financial statements, to identify any information that is apparently incorrect based on, or materially inconsistent with, the knowledge acquired by the auditor in the course of performing the audit. ↩

  4. ‘Other information’ in the context of ISA (UK and Ireland) 720 is "Financial and non-financial information (other than the financial statements and the auditor’s report thereon) which is included, either by law, regulation or custom, in a document containing audited financial statements and the auditor’s report thereon." ↩

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Name Consultation Paper Feedback Statement: Proposed revisions to International Standards on Auditing (UK and Ireland)
Publication date 28 September 2023
Type Feedback paper
Format PDF, 241.7 KB
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