In these past few weeks, a number of important decisions have been taken at EU level, which developments affect our profession at its heart, in particular audit.
The first matter I would like to refer to is the outcome of the plenary vote in European Parliament on 3rd April 2014 which affects the audit sector. The legislation approved is in the form of a Directive and a Regulation. The Directive, which amends the text of the Statutory Audit Directive (2006/43/EC), contains a series of new and amended requirements governing every statutory audit in the European Union whereas the Regulation contains a series of additional requirements that relate only to the statutory audits of PIEs, in addition to the general ones stated in the Directive.
To come into effect, the Directive will need to be transposed by the respective Member States into their national laws in order to become effective law. There is a two year timeframe in this respect. The Regulation on the other hand comes into effect within 20 days from the publication of the Official Journal of the European Union although implementation of certain parts of it may be delayed until the Directive is transposed into national law.
The key elements of the Regulation, among others, include:
- Mandatory firm rotation for PIEs – (Audit firms required to rotate after an engagement period of 10 years. Member states have the option to extend this period by a further maximum period of 10 years, if tenders are issued, and by up to 14 additional years in case of joint audit)
- Restriction on provision of non-audit services to PIE audit clients.
These regulatory reforms, which were the source of many contentions within the profession and business spheres, are significant. They were put forward with the primary objective to better protect and enhance the public interest. Whether this objective will be achieved or whether it will result in some sort of musical chairs amongst the big four one has yet to see. What is certain is that audit firms outside of the big four have to rise to the occasion and prove that they are fit for purpose as no business wants to end up with auditors that do not have the necessary competencies and depth of experience to execute their work well.
The audit reform pronouncements add on to the list of EU regulation that needs to be adopted by the Member States. The Accounting Directive (2013/34/EU) that was approved by the European Parliament in June 2013 and which also needs to be transposed by all Member States is likewise going to effect the local profession perhaps in an even more profound manner. The Directive aims at simplifying the accounting requirements for small companies and improves the clarity and comparability of companies’ financial statements within the Union. Locally a working group has been set up by the Accountancy Board in which our Institute is actively participating, together with MFSA, to ensure a proper and effective transposition.
The Directive is based on a ‘think small first’ approach. This approach imposes basic requirements on small companies and / or groups and gradually imposes additional requirements on medium-sized companies and / or groups, with the most onerous requirements being imposed on large companies and / or groups, as well as Public Interest Entities. This approach differs from the current 4th and 7th Directives where the largest company types were the norm, with various derogations and exemptions for small and medium sized companies.
It is not my intention to go into the detail of this Directive. I will leave that to our most capable technical professionals amongst us. I would however like to outline some factors to put things in context and outline how, in my view, these changes could affect our profession and the economy in general.
These changes contemplate a micro-entity regime wherein the entities so classified are not required to prepare elaborate financial statements or to have these audited. It the Member State believes that the micro-entity regime needs to be introduced and opts to adopt all the simplifications that are envisaged by this regime, then the financial statements of those entities that fall within the micro-entity parameters could be prepared to include a simple balance sheet with no notes to the accounts. If the Member State does not opt to have a micro-regime then these entities will automatically fall into the small category, which is one of another three categories (small, medium and large) contemplated in the Accounting Directive. Entities that fall to be categorised as Medium or Large have to prepare financial statements that are more or less along the lines we are used to today. If a Member State chooses to adopt all the simplifications for small entities that are forseen in the Directive then small entities would need to prepare financial statements that could include only an abridged profit and loss account, an abridged balance sheet and certain notes to these financial statements. These financial statements may not need to be audited. In fact Member States have to ‘opt in’ if they require the entities within the small regime to have their financial statements audited. Member States also have practically no say in setting the thresholds for definition of a small entity. One has to apply those set by the EU Directive which has put forward minimum or maximum thresholds that Member States may choose from. Based on information at hand the micro and small categories in Malta would probably include more than 90% of companies registered.
What does all this mean when put in the local context? To my mind a number of main policy decisions are necessary including whether to ‘opt in’ with respect to audit.
Naturally being a matter of policy it is the Government of the day that needs to make the decisions required. It is not my remit or competence to tell Government what to do. Government’s policies in these past years however have always been such as to retain an audit regime as this is considered to be one of the factors that has contributed, amongst other things, to improved fiscal morality and has a positive effect on the collection of government revenues. In fact in interviews made during our past two biennial conferences the view expressed by the then Minister and shadow Minister for Finance was that audits were to stay and if for some reason they had to be removed they would need to be replaced with some other form of assurance.
We as a profession of course maintain that an audit has other benefits and the engagement of an auditor helps to provide a source of professional contact to the SMEs which can prove invaluable. We are also aware that there are categories of owner managed businesses that do complain that the audit is a financial burden for them with little or no value added. Naturally it is important to put matters in context and as a country we should have empirical data to be able to decide just how much of a ‘financial burden’ the audit requirement actually is on these companies. Ours being a competitive environment there is a strong downward pressure on the price of the audit. My personal view is that on average we are possibly talking of an annual audit fee which amounts to a few hundred Euros. The financial saving would be even less if the audit is replaced by a review or some other form of assurance. Careful consideration should be had to see if these potential savings are such as to outweigh other negative effects that may come about with the removal of the audit.
There is the risk of course that the quality of unaudited financial statements and reporting as proposed for the micro and small groups will deteriorate over time. This should be of concern not only to accountants but to capital and credit providers including banks and suppliers.
The European business environment is not homogenous. Mediterranean cultures are very different in some respects to Northern European cultures and this is amply manifest when it comes to fiscal morality and related considerations. There could be a problem with a ‘one size fits all’ approach and we as a country would do well to assess this risk.
As an Institute besides participating in the transposition exercise we are also organising meetings to obtain clarity from Government and related state bodies on the policies that will underpin Malta’s adoption of the Directive. It is our intention to put forward our members’ views and reservations on these matters.
There is no denying the fact that the removal of the audit to potentially more than 90% of local companies will in my view have a negative effect on a number of different fronts, not least our profession – in our case the effect i am talking about is not so much from a financial perspective (as I am sure we will be able to provide other related services) but more from a competencies perspective in that the audit competence which today is widespread in the profession, as it is found in large and small audit service providers, will in future be less so. As a country we will run the risk that smaller accounting firms will be scaling back their investment in audit service as this will no longer be tenable.
I also think however that matters have come to a point where we as a profession should have the courage to question ourselves, especially at times such as this where there are new developments in accounting and audit policies. As FEE (European Federation of Accountants) so aptly puts it we can ignore these developments, resist calls for change and run the risk of becoming less relevant to the different stakeholders or alternatively we can embrace change and place ourselves at the forefront in proposing new ideas.
Indeed, in its paper ‘The Future of Audit and Assurance’, FEE puts forward a number of discussion points for consideration and as an Institute we will be making our own submissions to FEE on these points. I strongly urge our members to read this paper and put forward their views which we will take into consideration when preparing our submission.
There are some in the business community who maintain that we have a vested interest to keep the status quo with regard to accounting and auditing. May I remind one and all however that a distinguishing feature of our profession, indeed its hallmark, has always been recognition of our responsibility to act in the public interest. We have never upheld our positions at the expense of the public good and we will not do so now.
As a country we should think long term and make a holistic consideration of the effects potential changes in accounting and audit will have on various different sectors including: on the local company cost make up, on Government revenue collection, on the accounting profession, on the different users of the financial statements, on the financial services sector, on the fiscal regime and thus related foreign investment. We should carry out the necessary empirical studies to be able to make informed rather than ‘gut feeling’ decisions as the ramifications are considerable.
We need to do our homework well so that 10 years down the line Malta will not regret any changes made as it would be very difficult, indeed neigh impossible, to turn the clock back and reverse the overall negative consequences that could result.