Accounting & Auditing Developments in the EU
Author:
Karel Van Hulle
[Excerpt] The Rome Treaty, which is the basis for action at EU level, does not contain a specific mandate for the EU institutions to harmonise the rules on accounting and auditing. Harmonisation in this area is part of company law harmonisation. It has led to the adoption of a number of Directives of which the most important ones are no doubt the Fourth Directive (1978), the Seventh Directive (1983) and the Eighth Directive (1984).
Because of the growing importance of capital markets in the beginning of the 90s, the Commission published in 1995 a Communication on a New Accounting Strategy. This Communication suggested to Member States that they should examine the possibility for their global players to present their consolidated financial statements in accordance with (preferably) IAS.
In 1998, the Commission published a Communication on Statutory Audit in the EU. This document sets out the policy which the Commission intends to pursue in the area of statutory audit. It also contains the basic mandate for the new EU Committee on Auditing, which met for the first time in May 1998.
While the 1995 Communication primarily concerned those companies which were looking for capital on international capital markets, the June 2000 Communication on the future of financial reporting in Europe looks at the situation of companies within the EU. It aims at improving the efficiency of capital markets in the EU by imposing uniform accounting standards for all listed EU companies and by insisting on effective enforcement in the area of financial reporting. The ultimate aim is to create a capital market that is as liquid as that in the US, thereby contributing to a lowering of the cost of capital for EU companies.
On 13 February 2001, the Commission published a Proposal for a Regulation on the application of IAS. All EU companies listed on a regulated market in the EU as well as all EU companies which have made a public issue of their securities will be required to prepare their consolidated financial statements over the financial year starting on or after 1 January 2005 in accordance with the international accounting standards adopted by an EU endorsement mechanism, the Accounting Regulatory Committee, composed of Member States representatives and chaired by the Commission.
The endorsement mechanism will not rewrite the standards developed by the IASB. It will provide for democratic legitimacy and enable a pro-active European input into the international harmonisation debate.
The work of the Accounting Regulatory Committee will be prepared by a technical committee, which is in the process of being established. It will emanate from a private sector initiative, called EFRAG (European Financial Reporting Advisory Group), which will be set up by a number of European organisations that represent the main parties interested in financial reporting, comprising among others the accounting profession, standard-setters and industry.
The Commission's proposal is the result of difficult negotiations. For the first time, in the area of financial reporting, a Regulation is being proposed. This will ensure that by 2005 all listed EU companies will be required to apply IAS without any need for further intervention from Member States. The challenge is now to find an appropriate institutional arrangement which will be acceptable to the private sector, upon which will fall the most important burden, and to the political authorities (Commission, Council and European Parliament) which are by virtue of the Rome Treaty responsible for legislation in the EU.
Introducing a set of uniform accounting standards for listed EU companies is one thing, making sure that the standards are effectively complied with is quite another matter. The Commission is examining with Member States and with the Securities Regulators organised in the Forum of European Securities Commissions (FESCO) ways and means to improve the present situation.
The June 2000 Communication also announces a modernisation of the Accounting Directives. The Commission should come forward with suitable proposals before the end of 2001. In this context, it has been proposed to exclude EU companies which apply IAS from the scope of the Accounting Directives or to exempt those companies from having to comply with most provisions in the Directives. Although attractive at first sight, such a solution would make it difficult to keep a co-ordinated approach between listed and unlisted companies and to move from one category to the other. This solution might also run into political difficulties with the clear wish of the European Parliament to keep a coherence between IAS (developed by the private sector) and the Accounting Directives (for which the Parliament has co-responsibility).
It may therefore be preferable to increase the number of alternative accounting treatments in the Directives so as to allow Member States (if they so wish) to adopt legislation in the area of accounting which is both in line with the Accounting Directives and with IAS. This would show the general direction in which accounting legislation should preferably develop without imposing IAS compatibility for all companies and for both individual and consolidated accounts.
External quality assurance - independence - auditing standards
There is a direct linkage between the reform proposed in the area of financial reporting and the activities of the EU Committee on Auditing. An equivalent high quality level of statutory audit is an essential feature of an efficient European capital market. However, account must also be taken of the particular situation in the EU where all large and medium-sized limited liability companies are required to have their financial statements audited by a qualified professional. In order to avoid creating different quality levels of statutory audit, it is important that the same rules apply to all statutory audits, whether they concern listed or unlisted companies.
On the basis of extensive discussions within the EU Committee on Auditing, the Commission issued on 15 November 2000 its first Recommendation in the area of statutory audit on Quality Assurance for the Statutory Audit in the EU: Minimum Requirements. This document is by definition not legally binding. However, the discussions within the Committee have had as an important consequence that all Member States have now agreed to introduce a system of monitoring or peer review aiming at assuring the public and regulators that auditors and audit firms are performing at a level that meets the established auditing standards and ethical rules.
The Recommendation sets a number of minimum requirements. Quality assurance systems must have adequate public oversight consisting of a majority of non-practitioners on the overview board of the quality assurance system. The results of quality assurance should be adequately published and - where necessary- disciplinary sanctions should be taken. These elements are important because they can help to convince the public that the profession is taking positive steps to improve the quality of its work.
In December last year, the Commission also published a consultative paper on Auditor Independence, elaborated within the EU Committee on Auditing, with a comment deadline of 2 March 2001. This document tries to fill an important gap in the present regulatory environment of statutory audit. Although the Eighth Directive insists that the auditor should be independent, the definition of independence is left to Member States. There is at present no level playing field in this area and this is certainly not adding to the credibility of the audit function and to the realisation of an internal market in audit services.
1 The views expressed in this article are only attributable to the author.
Accountancy Ireland Vol 33 No 2 April 2001