Audit Firm: Regulation of Audit Firms in UK

The Companies Act 2006 of United Kingdom provides powers to bodies known as Recognised Supervisory Bodies (RSBs) to register and supervise auditors. The RSBs are:

• The Institute of Chartered Accountants of Scotland
• Chartered Accountants Ireland
• The Institute of Chartered Accountants in England and Wales
• The Association of Chartered Certified Accountants
• The Association of Authorised Public Accountants

The regulatory system of RSBs involves the following:

• Registration processes
• Monitoring
• Investigation and discipline

The RSBs are also subject to independent oversight.  The Financial Reporting Council (FRC) has statutory powers delegated to it by Government for the recognition, supervision and de-recognition of the RSBs.  The FRC conducts regular inspection visits to the RSBs to ensure that their responsibilities are being discharged appropriately.  The FRC also has the power to sanction RSBs. In addition to the quality assurance and monitoring undertaken by the RSBs, the Audit Quality Review (AQR) team of the FRC has the responsibility for the monitoring of the audits of all listed and other major public entities. 

The FRC operates an independent disciplinary scheme for accountants and accountancy in the UK. The Accountancy Scheme operates independently of the professional bodies. The FRC deals with cases of potential misconduct which raise or appear to raise important issues affecting the public interest in the UK. All other cases of potential misconduct continue to be dealt with by the professional bodies above.  The FRC Conduct Committee has oversight over the operation of the disciplinary arrangements. The Conduct Committee’s responsibilities in this regard include:

• Operating independent disciplinary Schemes for the investigation of cases which raise or appear to raise important issues affecting the public interest in the UK; and
• Where appropriate, bringing disciplinary proceedings against those whose conduct appears to have fallen short of the standard reasonably to be expected of members or member firms of the relevant professional body.
• Keeping under review the working of the Schemes and the supporting Regulations to ensure that they are operating effectively; and
• Regular publicity for the FRC’s disciplinary activities and achievements as appropriate.

Additional Thoughts

Compliance with local laws and regulations is a matter of utmost care for the audit firms. The audit firms should abide by all the laws and regulations in order to gain the trust of the authorities and the general public.

Reference:      http://goo.gl/1XOfUS

http://goo.gl/7wWT0q

Audit Firm: US PCAOB regulation of US Audit Firms

The Public Company Accounting Oversight Board (PCAOB) is a private-sector, nonprofit corporation established by the U.S. Congress to oversee the audits of public companies in United States in order to protect investors and the public interest by promoting informative, accurate, and independent audit reports. In U.S in early 2000, when the Enron and WorldCom Scandal came to surface, the congress felt the need for more strict regulations for the audit firms and thus promulgated the Sarbanes Oxley Act on July 30, 2002. This act mandated the formation of PCAOB to oversee the audit of public companies that are subject to the securities laws, in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports for companies the securities of which are sold to, and held by public investors.

Before the Sarbanes-Oxley Act of 2002, the audit profession was self-regulated in U.S., but after its promulgation, it required that auditors of U.S. public companies be subject to external and independent oversight for the first time in history. In passing this Act, Congress sought to restore investor confidence and address serious gaps in the U.S. regulatory framework that were identified through the financial scandals of 2001-2002. The PCAOB comprises of five members, including the Chairman and are appointed to staggered five-year terms by the Securities and Exchange Commission (SEC).

The PCAOB has five primary responsibilities:

·         Registration of public accounting firms (including non-US firms) that audit public companies (including non-US issuers) trading in US securities markets;

·         Inspections of registered public accounting firms;

·         Establishment of auditing and related attestation, quality control, ethics, and independence standards for registered public accounting firms; and

·         Investigation and discipline of registered public accounting firms and their associated persons for violations of specified laws or professional standards.

·         Enforcing compliance with Sarbanes-Oxley Act.

Additional Thoughts

Although the Sarbanes-Oxley Act, through establishment of PCAOB, introduced much strict regulations for the audit profession, but the WorldCom and Enron scandal alongwith the dissolution of the then big five firm Arthur Andersen which was found guilty of fudging Enron accounts, brought a great disrepute for the profession. Audit firms need to develop a sense of self-regulation and high ethical standards so that the investors and public in general endow trust upon the profession.

Reference: https://goo.gl/YU1dgc

                  https://goo.gl/mpKGaX

Audit Firm: Changes in the Audit Regulations

Effective financial reporting and auditing is essential for the efficient functioning of capital markets. It supports the development of top quality businesses that attracts investors and also provides the basis for sound commercial decision making along with trust and confidence. Auditing is an essential safety measure to provide independent assurance that the financial reporting of businesses properly reveals their overall condition, and supports the maintenance of the integrity of the business environment.

In UK, the Audit Regulations have been updated with effect from 17 June 2016 to take account of the changes in audit regulation initiated by the European Union Audit Regulation and Directive of 2014. These were transposed into UK law last week by the Statutory Auditors and Third Country Auditors Regulations (SATCAR). The changes apply to various facets of the auditing activity in the shape of eligibility criteria, accounting standards, ethical standards and governance criteria. They also include a restructuring of audit oversight and the enforcement process in the UK, and this restructure has required a number of changes in the audit regulations. The legislation has taken the form of a short new legislation in its own right which recognises the Financial Reporting Council (FRC) as the ultimate competent authority. It also makes a number of amendments to the Companies Act 2006 and Schedule 10 which sets out the role and obligations of the Recognised Supervisory Bodies (RSBs) including ICAEW.

Most firms will observe a very little change in process from the current regime, but in reality the FRC will be exercising a lot more control over the regulatory process. In particular they will be able to apply enforcement sanctions directly without any contact with the RSBs. They can apply these not only to Public Interest Entities (PIE) and AIM auditors but to any audit firm where they have elected to take over the audit inspection and investigation of individual cases.

The powers of the FRC also include the ability to move licences of individual firms between bodies or directly administer them themselves. In such cases the rules of the new RSB can apply to that firm. This requirement is set out in 1.02A.The ARD required some additional sanctioning powers be given to the regulatory bodies, and these have been brought into chapter 6 of the regulations. These include the ability to order repayment of an audit fee in part or whole, and to declare an audit report invalid

Additional Thoughts

Auditing is improving but there is more to do as the future of audit will require a change in thinking from auditors, investors and companies alike.

The complete text of the DIRECTIVE 2014/56/EU OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 16 April 2014 can be found here on this link.

http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32014L0056

Reference: http://goo.gl/OeoMF7

Pure Audit

There were lots of fuss last month over audit business separation from the rest of consultancy. Indeed, The Economist, Accountancy Age and other business media decided to pay attention to this hot topic.

Actually, I can not say I was much surprised by this news. The idea emerged in European Commission (EC) at the end of 2010, when so called Green Paper was issued. In my overview of this discussion paper in February this year I emphasised, that EC used in their report categories like “pure audit firms” and “inspection units”.

In this post I am going to contemplate some aspects of pure audit.

No problems?

There is no problem for existence of pure audit firms except for initial stages of industry restructuring. I am sorry for Big 4 and other audit firms, but restructuring should cause painful changes in their business model.

There are some other issues of interest. For example, are brands for audit and consultancy going to have same name? What it if consultancy business would collapse or in other way would be able to damage the auditors’ reputation? Would the business be allowed mutual investment, e.g. Deloitte consultancy owns audit and audit owns consultancy? So at this point we reach the level of problems which usually attributed to banking business. The idea of banks ring-fencing has been discussed rather massively in UK this autumn and Glass-Steagall act recalled as well.

Would accounting ethical codes change accordingly I wonder? I suggest that previous projects of employee who used to work for consultancy should be checked to avoid independence problems.

Refocusing reforms

Would this reform change anything in current governance structure? Frankly saying I am in a huge doubt. This is because connection between consulting and audit segments should be totally cut to make changes relatively effective. The questions I set above should be answered by US and European policy makers.

Why not refocus our attention on shareholders? Let me speculate a bit on this subject. Shareholders are major users of auditors’ work, audit reports are addressed to them. It is obvious that shareholders (principals) hire one type of agents (auditors) to check quality of work and truthfulness of other agents (managers). The idea should be simple: shareholders should win or lose from the decision of hiring good or bad auditor. In more broad view this would include stakeholders for public interest entity.

Thus, I would propose idea of introduction mechanism according to which shareholders would be able to participate more actively in the process of selection and approving annual auditor. First, it might include creation of separate audit (governance) expenses reserve/fund, which would be used by shareholders for audits without consent of managers. Second, introduction of information systems in the process of auditor selection and dealing with audit reserve money by shareholders. Third, opportunity of minority shareholders to use resources of audit reserve and appoint additional auditors in case of any need. Yes, I honestly think that possibility of the second opinion is appropriate tool to discipline first auditors and fully appropriate if shareholder wants to have alternative view of professional. Fourth, the arrangements for other stakeholders’ participation should be made. For example, banks might want the opinion to be issued by PwC, government wants to appoint local audit firm, shareholders have more belief in KPMG’s report. You are welcome! If all of these interested (and powerful enough) parties have money to pay different auditors for their independent audit projects (not joined audit) then why not let them embark for this journey. Again, the idea is that stakeholders should bear risks of doing nothing and doing something.      

In Denial? I told you so! J

Here is small anecdote in the end. On 13^th of September UK PwC Twitter account posted following: “Best question about our performance last year wins an iPad. First read our Annual Report?”. Being cautious auditor and willing to get free iPad (probably to do iAudit J ) I read their annual report. As I did not find even a word in their strategy on how PwC UK is going to tackle coming audit regulations I twitted in response:

PwC guys ignored my question… and plans to impose regulations on audit firm rotation revealed at the end of September. I told you so! J   

Ethical Auditor: Independence vs Rotation

Rotation

My previous post on ethics was rather popular, which gives me reasons to suggest that people are interested in auditors’ behavior and their place in business culture. Last week The Economist published interesting article about independence of auditors. Here are very appealing facts in the article:

    “… 1896 was also the year that Barclays, a British bank, chose an ancestor of PwC as its auditor, a relationship unbroken to this day. Fidelity is the norm in auditing. GE, Procter & Gamble and Dow Chemical have also clocked up centuries with their auditors. The average tenure for an auditor of a British FTSE 100 company is 48 years. Two-thirds of Germany’s DAX 30 have had their auditors for over 20 years.”

There are several opinions presented in article, one of which suggests that to address the issue it necessary to impose audit firm rotation. After reading I decided to discuss independence, because it is quite disputable area.

Current Situation: Partner Rotation

The literature on audit states that there is familiarity threat, which could arise between staff of audit firm and client. The risk is that auditor would lose professional scepticism because of too close relations with client. To address this issue official documents like SOX (in USA) and accounting codes like ACCA Code of Ethics and Conduct set specific requirements on audit partners rotation in case of dealing with listed (or public interest) clients. The requirements are as follows:

1.  Engagement partner should be rotated after 5 years;

2.    Other key audit partners should be rotated after 7 years;

3.    Partner responsible for quality control should be rotated after 7 years

However, current talks about rotation of firm suggest that above measures are not enough to provide independent audit opinion.

Who to Decide

Now we are coming to the point of appointing auditors on top management level. As known auditors, which expected to be appointed have to be approved by shareholders on annual general meetings. If shareholders did it for 100 years as in above case with Barclays then it all right. They bear all risks of such appointment and they should have understood it. 

However, in current stakeholder theory – shareholders are not the only persons who are affected by activity of listed Company. If it is “public interest entity” then the potential effect on other members of public gives right to public to interfere in the process of auditor appointment. I wrote about it in previous post considering proposals of European Commission on extra audit regulations.

The appointment of auditor becomes especially significant in case of financial institutions in our days as panic on market related with bankruptcies might jeopardize whole economy.

More Regulation – Better Results?

The above article gives example of number of studies which founded that rotations do not necessary results increase of audit quality. On the contrary, because of lack of client knowledge the quality might deteriorate. On the other hand, then it would be necessary to establish special rules for information transfer between auditors to provide better client understanding. The third point is that all these regulation might become too huge for auditors and add much more to existing bureaucracy in our profession.

What are your ideas in this issue, please share your thoughts in comments.  

New Audit Order: Take 1

There would be demand for independent assessment of products made by humanity as long as human beings are not perfect. The Audit Society is a term used by Michael Power to name his book about role of audit in our life. So the major question I would address these days is as follows:

«Can audit of financial  statements accomplish its objectives

effectively and efficiently and still be profitable business with 

active competitive market?»

For productive discussion it would be useful to remind some elements of agency theory in illustration below:

Source: http://maaw.info/ArticleSummaries/ArtSumTiessenWaterhouse83.htm

As  recognized in previous post auditors were given  specific ‘societal mandate’, but stakeholders (principals) of auditors' (agents) activity are not satisfied with the work done.

I have some ideas, which I would like to share.

Addressing Independence Threat

Audit business is not only attesting business in the world. There are lots of firms around evaluate, assess and make opinions. Examples? Here are they:

·        Knowledge tests for students: GRE, GMAT, EITLS, Toefl;

·        Exams for professionals: US CPA exams; ACCA exams;

·        University system assessment of knowledge;

·        Peer reviewed journals: review of scientific articles

·        And so on, there are lots of them!

All of these businesses do similar thing – express opinion about quality/level of something. The key thing in independence here that markers (evaluators) do not know their concrete client (personalities) and clients do not know concrete people who check their  workings. In audit of financial statements it is not an easy to do thing.

However, we can eliminate influence of board of directors decision to switch an auditor on independence of audit firm. How?! I would  propose following model. For example, we are going to pay special attention on audit of global multinational companies (MNC) by audit firms. Given that assets and performance of MNCs are spread across the world it is difficult enough to observe independence of audit firms on local level.

Global (National) Audit Fund (GAF)

GAF could be established by G20/G40 countries to tackle the problem. The function of GAF would be to appoint external auditors for MNCs and pay remuneration to auditors. There would be list of MNCs which activity has national and global impact (addressing partly “too big to fail” issue). Criteria to include MNC in list are not a problem and could be easily established. GAF would be funded through following sources:

·        investor/shareholder tax, which could be withdrawn at the moment of purchase shares or could be part of dividend tax;

·        government budgets (with inevitable increase of MNC and/or individual taxes).

Thus, in our model we would align practice with theory: principals pay agents to act for their benefit. Agents care about their business and prosperity and would do anything to satisfy their customers-principals. MNCs’ financial statements (FS), which audit firm would have to audit under the contract are only subject of an agreement – more precisely it is kind of product produced by other agents (management of company) of principals. To say more allegorical FS are just peace of paper with student’s workings which are needed to be assessed.

Issues to concern about        

I would suggest following problems of model:

·        process of external auditor appointment: inevitable ‘red tape’, threat of corruption;

·        competition on audit market;

·        quality and nature of service rendered by audit firm.

I would be glad and grateful if guys reading my blog would provide their suggestions in comments and participate in discussion.

In the next post I am keen to address the expectation gap issue and nature of services provided by auditor. I suppose it might be partial solution to the problems of model identified above.

References:

Power, M. (1997). The Audit society: rituals of verification. Oxford: Oxford University Press.