By John Davies, head of technical, ACCA
The House of Lords Economic Affairs Committee has published BIS’ response to their March audit market inquiry. There’s nothing particularly unexpected in BIS’ response as many of the positions have been outlined before. Overall, it’s a curate’s egg: we agree with BIS where we expected to (for example, on IFRS) and disagree in other expected areas (for example, on small business audit requirements). A couple of things jump out that are worth going through:
The Audit Commission (Para 178)
EAC: Recommended the Government encourage the development of a rival to the Big 4; Baroness Hogg from the FRC suggested that this could possibly be created out of the ashes of the Audit Commission
BIS say they are looking at a ‘range of options’ for the future of the Audit Commission’s in-house practice. ACCA is supportive of Baroness Hogg’s suggestion for the future of the Audit Commission’s audit practice. We believe that the Government should work to ensure that the Audit Commission’s audit practice is successful as it provides an opportunity to enhance competition and choice.
Restrictive bank covenants (Para 180)
EAC: Recommended the Office of Fair Trading should conduct a market study of restrictive bank covenants
BIS point out in their response that they’ve already asked the OFT to look into this, and we welcome the government’s acknowledgement that bank covenants can be anti-competitive and need looking into.
Audit liability (Para 181)
EAC: Recommended OFT investigate whether audit liability arrangements deter non-Big 4 auditors from taking on large listed clients
We’re looking forward to the OFT investigation, but it is disappointing that BIS seem to be pre-empting the outcome of that investigation by saying they have ‘no current plans’ to further limit liability. BIS note the 2006 Companies Act in their defence, but this hasn’t exactly been a roaring success. Audit liability needs to be reformed alongside the broader reform of audit, which is something we’ve looked into in more detail here (we’ll have a post about this report up soon).
Audit for small businesses (Para 185)
EAC: There is a case for some reduction in the audit requirement on smaller companies to reduce regulation, but this is unlikely to reduce audit market concentration
BIS unsurprisingly agree with this given their previous announcements on small business audit. We think BIS are wrong on this one, but it’s interesting to see they’ve not responded to the committee’s caveat that a change would not impact audit market concentration.
Non-audit services (Paras 187)
EAC: Recommended that a firm’s external auditors should be banned from providing internal audit, tax advisory, risk committee advice. OFT should investigate whether other services should be banned.
BIS take the position that there should be no fixed ban on the provision by auditors of non-audit services, which is to be welcomed. The ethical standards issued by APB (Auditing Practices Board) already contain extensive guidance on how auditors should react to threats to their independence and objectivity posed by such matters. We would however point to the points made by the AIU (Audit Inspection Unit) in its 2010 annual report about the need for the big firms to show more commitment to complying with the ethical standards in respect of independence issues.
IFRS (Paras 192-4)
EAC: International Financial Reporting Standards have resulted in a loss of prudence in accounting; IFRS is weak in relation to bank audits
We welcome BIS’ clear recognition that IFRS does not encourage or result in a loss of prudence in accounting. Professional scepticism also remains an integral element of the approach of the independent auditor and we support any efforts to ensure this element is present in the work that auditors do. There are widespread regulatory concerns though that auditors need to do more in this areas. Recent steps by the FRC, FSA, and other standard setters to ensure auditors focus on this issue are positive moves.
Mandatory dialogue (Paras 200-3)
EAC: Dialogue between bank auditors and supervisors is poor and a statutory obligation is required.
BIS say they aren’t persuaded by the need for additional legislation. We welcome the moves to institutionalise more frequent dialogue between auditors via the FSA's new code of practice and trust that this will result in an enhanced quality of communication between the two sides. But the conclusions of the committee report were especially damning on this matter and the Government must reserve the right to legislate further unless significant improvements are forthcoming. It seems very possible in any case that the current review of audit being undertaken by the EU will conclude that exchange of information needs to be put on a statutory footing.