Audit Reform 2014 – A step towards a European level playing field?
After three years of negotiations, the new European audit legislation was final in the spring of 2014. The legal texts, which entered into force in June 2014, bring many challenges for the audit profession and the European business environment at large.
Several parts of the reform raise practical questions that FEE is committed to help solving by providing information and by collaborating with the relevant stakeholders towards the best possible outcome in terms of transposition and implementation.
Background and timing
The European Union (EU) audit market reform began in 2010 with a European Commission consultation Green Paper entitled “Audit Policy: Lessons from the Crisis”. After this consultation process, the European Commission (EC) released its Proposals in November 2011. After nearly three years of discussion, the final pieces of legislation have been published in the Official Journal of the EU on 27 May 2014:
- The Directive 2014/56/EU on statutory audits of annual accounts and consolidated accounts, amending the Directive 2006/43/EC on statutory audits (2006 SAD) and containing a series of amended and new requirements governing every statutory audit in the European Union (hereafter referred to as “the Directive”);
- The Regulation (EU) No 537/2014 on statutory audit of public- interest entities containing additional requirements that relate specifically to statutory audits of Public Interest Entities (PIEs) in addition to the ones stated in the Directive (hereafter referred to as “the Regulation”).
The Directive needs to be transposed by the respective Member States into their national legislation in order to become effective. Member States will have two years after entry into force to adopt and publish the provisions to comply with the Directive, i.e. as from 17 June 2016.The Regulation on the other hand technically already entered into force on 16 June 2014. Nevertheless, most provisions will be applicable as from 17 June 2016, which ties in with the transposition deadline of the Directive.
Both the Directive and Regulation introduce a number of new or modified options whereby Member States and competent authorities will have to choose the way in which they want to transpose and implement the legislation. FEE is committed to informing this choice with the objective of enhancing consistency of application throughout the EU as much as possible.
In this first part of the article, FEE’s intention is not to describe all the provisions of the Directive and the Regulation, but to pinpoint the main changes and challenges, as well as FEE’s contributions in this process. For a complete description of the main provisions included in the new audit legislation, the reader may refer to other materials developed by FEE.
The Directive mainly clarifies and specifies some provisions of the 2006 Statutory Audit Directive (2006/43/ED). The main additions and amendments relate to:
- Certain definitions, including the definition of Public Interest Entities (PIEs). This definition is in line with the one included in the Accounting Directive of 2013. Even though the definition itself has not significantly changed, the identification of PIEs is now crucial to determine the entities which are in the scope of the Regulation;
- The provisions on independence and objectivity of the auditor. The requirement of independence from the audited entity is put not only on the statutory auditor or audit firm, but now also on “any natural person in a position to directly or indirectly influence the outcome of the statutory audit”(Directive, Article 22 (1));
- The overall organisation of the auditor and the audit work;
- Quality assurance and new requirements in connection to penalties and sanctions;
- Public oversight, which requirements are now developed into further detail. Oversight is of special interest to FEE as it involves the functions of its Member Bodies; FEE has therefore published a briefing paper on this subject matter, which is introduced below;
- A new mechanism to adopt international auditing standards (“ISAs, International Standards on Auditing”) at EU level for every statutory audit within the EU to be performed in accordance with international auditing standards adopted by the EC;
- The public auditor reporting, where a series of new measures are included to set minimum requirements that aim at enhancing investors’ understanding of the audit; and
- The Audit committee functioning.
Even though the Directive is relevant for audits of all entities, the provisions related to audit committees are only concerning PIEs.
The Regulation is a new piece of legislation that applies to the statutory audit of PIEs only. However, both texts are linked as the Regulation refers to the Directive in many instances. The main areas of focus relate to:
- Restrictions on the provision of non-audit services to PIE audit clients, especially with the introduction of a list of prohibited non- audit services and the capping of the provision of ‘permissible’ non-audit services to a percentage of the total audit fees;
- New requirements with regard to mandatory audit firm rotation for PIEs whereby the duration of an audit engagement is set at ten years with a possible extension to twenty or twenty four years depending on certain conditions;
- Auditor communication with regard to PIEs – external (to the public) and internal (to the audit committee) – which is now regulated in detail, including the requirement of certain disclosures;
- The oversight of auditors and audit firms at EU level and the set-up of a new body, the Committee of European Audit Oversight Bodies (CEAOB).
FEE projects to inform its members and the public at large
Since the publication of the Green Paper “Audit Policy: Lessons from the Crisis” in 2010 by Commissioner Barnier, FEE has informed the public policymaking process and maintained a constructive dialogue with all stakeholders.
As soon as the legislation was finalised, FEE has undertaken a number of projects to both highlight any significant changes between the Directive and the 2006 SAD and to reiterate significant requirements contained in the Directive as well as in the Regulation. These projects are as follows:
A Factsheet 1 on audit policy has been published in April 2014 and provides an overview of the main provisions included in the legislation. As indicated by the title, this document only summarises the factual requirements and does not aim to provide further interpretations or FEE views.
FEE has also prepared a dedicated Factsheet highlighting those aspects which are of specific relevance to SMEs 2. This includes the proportionate application, which is noticeable throughout the whole legislation.
Web Page featuring Frequently Asked Questions
A platform of Frequently Asked Questions (FAQ) has been developed on the FEE website 3, and was launched immediately after the texts were approved by the European Parliament plenary on 3 April 2014. The benefit from the FAQ platform is that it is possible to be regularly updated; as the discussion about the legislation and its implementation continues, more questions and answers will arise and FEE will try to provide the relevant stakeholders with up to date information and expertise.
FEE projects to ensure consistency of application
On the longer term, FEE is committed to providing not only factual information, but also clarification and implementation guidance based on FEE views developed with the assistance of its Member Bodies. FEE aims to contribute to enhancing consistency and aligning application across Member States to the largest extent possible.
FEE Briefing Paper on the Public Oversight of the Audit Profession 4
FEE has recently published a briefing paper on the topic of the public oversight of the audit profession. It includes details relating to:
- Competent authorities, their designation, powers and tasks for which they bear the ultimate responsibility;
- Delegation of tasks and involvement of practitioners: this matter is of particular interest for FEE because it is connected to important Member State options, as described below;
- Quality assurance reviews and imposition of sanctions, where significant specifications were provided; but also
- Communication and cooperation between competent authorities and harmonisation of supervision on international level for example by creating a new oversight body – Committee of European Auditing Oversight Bodies (CEAOB).
In this area, FEE acknowledges the need to enhance independent national public oversight within each Member State. FEE also agrees that cooperation between national oversight bodies on a European and global scale, where possible, is essential to advance the internal market objectives and reinforce credibility and quality of the audit profession at a global level. For FEE, the involvement of all relevant stakeholders, especially experts from the audit profession, is paramount to ensure meaningful oversight that incorporates up-to- date knowledge, expertise and practice. The main Member States’ and competent authority’s options are:
Delegation to professional bodies
According to the options available in Article 32 (4b) of the Directive and in Article 24 (1) of the Regulation, delegation of tasks is possible from competent authorities to professional bodies under certain conditions. FEE supports the use of this option as it allows for practical solutions focused on operational effectiveness and cost efficiency, whilst leveraging the experience of the professional bodies and enabling proper separation of powers, especially in smaller EU Member States.
The involvement of practitioners
According to the option available in Article 32 (3) of the Directive, competent authorities may engage practitioners or contract experts from the audit profession when necessary under the condition that they are not involved in any decision making. FEE supports the use of this option.
In compliance with the option available in Article 24 (1) of the Regulation, delegation of tasks related to inspections of auditors of PIEs is not possible. Nevertheless, according to the option available in Article 21 of the Regulation, competent authorities may consult experts to carry out specific tasks. The use of this option would secure an appropriate mechanism to identify, assess and use relevant up-to-date expertise and experience from practitioners regarding the workings of the audit profession and the conduct of statutory audits.
FEE Briefing Paper on the Provision of Non-Audit Services to PIEs 5
FEE has also published another briefing paper about the independence of the auditor that deals with the audit committee and its role in overseeing the independence of the auditor as a provider of non-audit services, the cap at the level of 70% on the total audit fees received from the provision of NAS which are not included in the ‘black list’ and a list of prohibited non-audit services (NAS) (the so called ‘black list’), which comprises:
- Tax services relating to preparation of tax forms, payroll tax, custom duties, identification of public subsidies and tax incentives, support regarding tax inspections by tax authorities, calculation of direct and indirect tax and deferred tax, provision of tax advice.
- Services that involve playing any part in the management or decision-making of the audited entity.
- Bookkeeping and preparing accounting records and financial statements.
- Payroll services.
- Designing and implementing internal control or risk management procedures or financial information technology systems.
- Valuation services.
- Legal services.
- Services related to the audit client’s internal audit function.
The main Member State options connected to this topic are:
Addition to the list of prohibited NAS and imposition of stricter requirements
Various options are available to Member States to apply stricter conditions on and to add to the black list. The use of such options should be carefully considered to avoid unintended consequences, such as regulatory divergence and fragmentation across the European Single Market, which might heavily bear on PIEs operating cross-border.
Allowance of certain prohibited NAS on grounds of immateriality
The Regulation provides Member States with the option to allow a few services of the black list, namely tax services relating to preparation of tax forms, identification of public subsidies and tax incentives, support regarding tax inspections by tax authorities, calculation of direct and indirect tax and deferred tax; and valuation services.
As long as they have no direct impact on the financial statements or any direct effect is immaterial or non-existent, the evaluation of this impact on the financial statements is documented in the additional report to the audit committee and the principles of independence are applied.
Establishment of lower cap on the level of NAS
The Regulation limits the provision of permissible NAS to 70% of the average of statutory audit fees paid in the last three consecutive years. This ‘cap’ of 70% is calculated for the statutory auditor or audit firm; it applies to the audited entity, its parent and controlled undertakings. Services imposed by national or EU legislation shall not be included in the calculation.
Member States are given an option to apply stricter conditions: if Member States take advantage of this option, this will merely add further unnecessary complexity to a provision which is already causing considerable uncertainty.
FEE Briefing Paper on the Appointment of the Auditor and the Duration of the Audit Engagement
The last FEE briefing paper which has been published relates to the topic of the appointment of the auditor and the duration of the audit engagement. Specific provisions discussed in the paper are relevant only for PIEs:
- The detailed conditions of the selection process of the auditor and the involvement of the audit committee in this process ; and also
- The mandatory rotation of the auditor and other related provisions such as rotation of the engagement partner or the transitional arrangements. Article 17 of the Regulation sets the duration of the initial audit engagement to a maximum of ten years. The minimum duration is one year.
The new legislation provides a number of Member State options in connection to the duration of the audit engagement:
Require longer minimum duration of the initial audit engagement
The minimum durations of audit engagements in each Member State are carried forward from a long tradition of a variety of local corporate governance laws and regulations. However a minimum (oftentimes shorter) period of audit engagement which is a divisor of the maximum period (i.e. ten, twenty or twenty four years) could provide higher flexibility to business.
Require shorter maximum duration of the initial audit engagement 6
Setting the maximum duration of the audit engagement differently at the Member State level and therefore diverging maximum durations across the EU may generate significant difficulties and additional costs, especially for businesses operating cross-border.
Introduce tendering or joint audit in order to prolong the maximum duration of renewed engagement
As Member States are given two options for prolonging the maximum duration of an audit engagement – via ‘tendering’ (adding up to ten years up to a total of maximum 20 years) or ‘joint audit’ (up to a total of maximum 24 years) – and although it is not realistic to expect all Member States to adopt the same approach, FEE would like to point out that Member States not taking up these options significantly limit the choice and flexibility for companies, their audit committees, boards and shareholders. The Transitional arrangements of the mandatory auditor’s rotation vary depending on the length of the audit appointment at the date the new legislation comes into force:
- If the auditor has been in place for 20 years or more, the rotation applies after six years.
- If the auditor has been in place for between 11 and 20 years, the rotation applies after nine years.
- Otherwise, the new regime will apply two years from the legislation implementation date.
Other subject matters of interest
The new legislation pays significant attention to auditor communication both externally – by the external audit report – and internally – by the internal report to the audit committee of the PIE and mainly includes:
- New requirements applicable to all entities, aiming at enhancing investors’ understanding of the audit, i.e.:
- A statement on any material uncertainty relating to events or conditions that may cast significant doubt about the entity’s ability to continue as a going concern;
- As referred to in the Accounting Directive, an opinion on the management report of consolidated accounts on:
- Whether the management report is consistent with the financial statements for the same financial year; and
- Whether the management report has been prepared in accordance with the applicable legal requirements;
- A statement on the management report.
- In addition, for PIEs, the audit opinion should be supported by a description of the most significant assessed risks of material misstatements;
- The additional report to the audit committee where the key issues identified during the audit have to be included.
According to FEE, the informative value of both internally and externally auditor communication should be enhanced. Widely accepted general principles for the content of these reports will benefit all stakeholders.
FEE Briefing Paper on the Adoption of ISAs 7
This subject matter has been in the centre of the attention of the profession for a long time. In FEE’s view, the adoption of ISAs should be promoted across the EU as these standards are developed with a high level of expertise and due process and provide appropriate requirements and guidance. This is particularly important as, although the ISAs have been adopted nationally in many EU Member States like Malta, the ISAs have not been formally adopted in countries Austria, France, Germany, Italy, Poland, Portugal and Spain. The Directive explicitly specifies that the ISAs are to be adopted by the EC, however also adds the following conditions that have to be met before each standard is adopted:
- Developed with proper due process, public oversight and transparency;
- Generally accepted internationally;
- Contributing to a high level of credibility and quality to the annual or consolidated financial statements;
- Conducive to the Union public good; and
- Not in conflict with any of the requirements of the Directive.
In the next part of the article Mr Jens Roder, Secretary General & CEO, Nordic Federation of Public Accountants, identifies some major causes for concern in the latest legislative publications.
The Cost of European Audit Legislation
The Treaty of Lisbon, which came into effect in 2009, was designed to make the European community more effective, taking into account the perceived benefits accruing from full integration of the internal market. In addition, European businesses, including service providers and institutions, were to become more effective and efficient and able to operate seamlessly within the European Union.
These were great visions, which European legislators were committed to following, the purpose being to make Europe more competitive in the global arena.
Alas, the latest legislation impacting the auditing and accounting profession, as well as the entities using the services of the profession, has largely failed to realize these lofty ideals. The audit policy directive and regulation are intended to improve audit quality and increase market efficiency in the provision of audit and audit related services. Although this legislation will not become applicable until June 2016, it is becoming increasingly clear that these objectives are unlikely to be achieved to the extent originally envisaged by the legislators. While not all are bad, there are nevertheless some major causes for concern.
Options in the regulation allow Member States considerable flexibility regarding the length of time that an audit firm can provide audit services to a listed company, before it must rotate off the engagement. Likewise, the extent to which an audit firm within the Union can provide non-audit services to its listed audit client will depend very much on the options adopted in the EU Member State where that client is registered. In addition, there are transition provisions regarding a number of areas, such as audit firm rotation and the calculation of the cap on the provision of allowable non-audit services that are obtuse and difficult to interpret and hence observe. These uncertainties place extra burdens on audit committees and costs to comply. These uncertainties run counter to the concept of a seamless market and risk increasing fractionalisation of the audit services market in the EU.
The EU decision to defer, pending further review and consultation, the adoption of ISAs on auditing and quality assurance for audits within the European Union is understandable but nevertheless, disappointing. Several Member States have adopted ISAs but by no means all. The adoption of ISAs will contribute to improving the consistency of audit oversight in the EU, because they can be applied as European benchmarks. The use of ISAs will strengthen the original objective of heightening audit quality within the EU.
The continuing concerns, expressed by the European Parliament and the European Commission about the governance arrangements and independence of the IAASB, must inevitably lead to questioning the general acceptance of the current governance and oversight structure in the form of the Public Interest Oversight Board (PIOB) and Monitoring Group. In recent years all the recommendations, designed to strengthen independence from the accounting profession and governance in the public interest, as suggested by the PIOB and the Monitoring Group, have been implemented by the IAASB. Yet neither body is apparently able to convince European legislators, despite the European presence on both these bodies.
A recent market survey (published in May 2014), carried out by the Danish Competition Authority, in connection with a merger between the partners in the Danish firms of KPMG and E&Y concluded that there is a risk of further market concentration in the top tier audit market segment and a reduction in choice of service provider in this segment as a result of the application of the new EU legislation. This can hardly be the intent of the legislators.
In the final part of this article Mr Yves Nicolas, President, and Mr Cedric Gelard, Technical Director, CNCC outline some positive aspects of the audit reform.
Some Positive Aspects of the Statutory Audit Reform in Europe
We would like to refer to the recent article by Jens Røder. First, we share the concerns of Jens as to:
- The ability for the Regulation, due to its many options, to be the proper instrument to achieve a minimum degree of harmonisation across Europe;
- The risk of increasing concentration of the market rather than decreasing it; and
- The EU decision to defer, pending further review and consultation, the adoption of ISAs at European level.
Those concerns are serious and founded. We would nevertheless also wish to express what we consider to be positive aspects of the Regulation and the Directive:
- Improvement of the communicative value of the auditor’s report;
- The enhanced role of the audit committee; and
- Recognition that the audit can be adapted to serve the needs of SMEs.
Enhancement of the communicative value of the auditor’s report, which is embedded in article 28 of the Directive and article 10 of the Regulation, is part of a worldwide movement launched at the dawn of the 2008 financial crisis to respond to the demand of stakeholders to get more information from the auditor through the auditor’s report. Stakeholders know that the auditor has a deep knowledge of the entity and its environment and want to leverage that knowledge to get more information themselves.
The IAASB has been responsive to that demand and is expected to finalise its new auditor’s report by the end of the year. The US Public Company Accounting Oversight Board (PCAOB) is also in the same process and is designing a new auditor’s report that is globally in the same vein. So the lines are moving and we are definitely entering new territories here.
We are very glad to see that move, not only because we think it is positive for the usefulness of the auditor’s report and the perception of the audit, but also because the Key Audit Matters were inspired originally by a requirement in a 2003 French law that requires the auditor to “justify his/her assessments” in the auditor’s report.
The enhanced role of the audit committee is also further recognition that the audit and the auditor is but one link in the financial reporting supply chain. But it also recognizes that properly setting the responsibilities of the audit committee is a very important element of the chain in that it serves the quality of the audit, protects the independence of the auditor, and, ultimately, leads to better financial reporting.
The recognition that EU Member States may adapt the audit of SMEs is also a crucial point of the Directive. The French profession supports the audit of SMEs and considers that the audit is the proper service for SMEs as long as it is adapted to their context. The French profession issued a standard in 2009, which was endorsed by the Ministry of Justice and which recognized the proportionate application of the standards in the context of the audit of SMEs.
Finally, having focused in this Viewpoint on some of the most positive aspects of the EU audit reform, we would nevertheless want to conclude with a certain regret.
One of the main objectives of the Commission in launching this reform was to “learn the lessons from the crisis” and, consequently, to clarify and define more precisely the role of the auditor.
This was the point on which we had the most hope: the expression of a vision for a new role of the auditor in the twenty-first century. And we consider that the audit reform has forgotten this original objective. It has worked on the market, the independence, the supervision, the rules, etc… But it has not shaped a forward-looking vision for the future role of the auditor in light of the usefulness of the audit in a changing environment where the acceleration of the provision of information is dramatic and the need for trust and reliability acute. By not tackling this issue, the EU audit reform will not contribute to the reduction of the expectation gap.
The new EU audit legislation provides improved requirements in some areas such as the auditor communication and the organisation of the audit work, but also raises a number of questions that need to be clarified. It also creates various challenges and implementation issues for the audit profession and business at large. In FEE’s view, it is instrumental to realise that the dialogue between all relevant stakeholders has not ended with the publication of the new legislative texts, but on the contrary has to continue and even be effectively enhanced in order to help create an as level playing field as possible while applying the new legislation in the 28 EU Member States.
- 1 http://www.fee.be/images/publications/auditing/Factsheet_Audit_Policy_1404.pdf
- 2 http://www.fee.be/images/publications/auditing/Factsheet_Audit_Policy_SMEs_1404.pdf
- 3 http://www.fee.be/index.php?option=com_content&view=article&id=1410&Itemid=396
- 4 http://www.fee.be/images/BP_140825_-_Public_Oversight_of_Audit.pdf
- 5 http://www.fee.be/images/BP_140825_-_Provision_of_NAS.pdf
- 6 http://www.fee.be/images/publications/auditing/BP_140825_-_Appointment_of_the_Auditor.pdf
- 7 The deadline for the adoption of these standards is not clearly set.
“The Cost of European Audit Legislation” and “Some Positive Aspects of the Statutory Audit Reform in Europe” originally appeared on the IFAC Global Knowledge Gateway: www.ifac. org/Gateway. Visit the Gateway to find additional content on a variety of topics related to the accountancy profession.
Copyright July 2014 by the International Federation of Accountants (IFAC). All rights reserved. Used with permission of IFAC. Contact [email protected] for permission to reproduce, store, or transmit this document.
FEE (Fédération des Experts-comptables Européens – Federation of European Accountants) is an international non-profit organisation based in Brussels that represents 47 institutes of professional accountants and auditors from 36 European countries, including all of the 28 EU member states.
FEE has a combined membership of more than 800,000 professional accountants, working in different capacities in public practice, small and large accountancy firms, businesses of all sizes, government and education – all of whom contribute to a more efficient, transparent and sustainable European economy.