Readers will be aware that the work of the UK Financial Reporting Council (FRC) is relevant in Ireland not least because:
(i) the accounting standards developed by one of its operating bodies, the Accounting Standards Board (ASB), are promulgated for use in Ireland by the Institute of Chartered Accountants in Ireland;
and
(ii) another of the FRC’s operating bodies, the Auditing Practices Board (APB), is responsible for the auditing standards applicable to audits carried out in Ireland.
Towards the end of last year, in November 2006, the FRC published a discussion paper, Promoting Audit Quality, for comment by 31 March 2007. More recently, on 12 October 2007, the FRC published its report on the responses it received. The report sets out the actions the FRC intends to take in relation to the promotion of audit quality and includes the FRC’s framework for the assessment of audit quality.
Drivers of Audit Quality: A Framework
The FRC notes that certain audit firms will be required to produce ‘Transparency Reports’ from 2008 (courtesy of the implementation of the 8th Directive) and hopes that audit firms will use the framework (panel omitted from online version of this article) to structure their communications regarding audit quality.
While one could argue with the emphasis given to various matters in the framework, in general I would agree that it identifies attributes that if present yield a reasonable expectation of a quality audit.
Interestingly, the framework makes no mention of the quality of auditing standards as being a prime driver of the quality of an audit that complies with those standards.
Proponents of the IAASB’s clarity project (which will lead to 34 new standards for auditors in 2008/9) as well as auditors who have to apply the standards in practice are very conscious of the influence of high quality audit standards on audit quality generally.
While the rate of change in laws, regulations, accounting and auditing standards is not dealt with in the framework, it is reasonable to conclude that the pace of increasing change and the adoption of a much more rules-based mentality has not necessarily always been conductive towards quality audits. Auditors do not operate in a stable environment of standards and change fatigue from constantly fluctuating requirements is not conducive to audit quality.
People Skills
Audit is a process. Much of it involves interaction between human beings with all the fallibility that entails. The FRC’s framework fails to acknowledge sufficiently the behavioural aspects of audit quality. An auditor with a good gut feel for when the numbers are correct, while perhaps not very technically adept with standards, may play a much more important role on a particular audit than an expert in obscure accounting standards.
Likewise the auditor who has personal skills to show empathy for the client yet is sufficiently persuasive to bring the client along and have them willingly accept a treatment that complies with standards is much more valuable in terms of audit quality than the technically proficient auditor unable to persuade the client to follow an appropriate course of action.
To my mind, insufficient emphasis on the importance of teamwork and building a team with the appropriate mix and match of skills is a short coming in the framework which, no doubt, will be addressed over time.
Recruitment Difficulties
One factor outside the control of the auditor not mentioned in the framework is the ongoing ability to attract people of the requisite talent into the profession. The more laborious the rules imposed and the more risky the profession is made by regulators the less attractive it becomes to graduates. If the firms cannot recruit sufficient numbers of appropriately talented personnel the quality of audit will invariably suffer. While this has not emerged yet as a problem for Ireland or the UK, there are a number of international locations where recruitment difficulties are recognised as a significant constraint on quality. That said, I welcome the framework. The FRC have acknowledged that it is a work in progress and that they expect it to develop over time. As such, it has potential to be a useful tool helping bolster support for the quality audit.
Responses received
The FRC have published on their website (www.frc.co.uk) the 37 non-confidential responses they received to the November 2006 discussion paper. Of the 37, two are Irish – one from the Revenue Commissioners and one from the Office of the Director of Corporate Enforcement.
Revenue Commissioners
In their response to the FRC, the Private Secretary to the Chairman of the Revenue Commissioners wrote to say that they had ‘little to add’ but commented that: ‘consideration could be given to the question of auditors having a role in reporting on anything that they come across in the course of an audit that would indicate non-compliance with tax laws’. The Revenue also noted that, notwithstanding the role of the audit committee, a conflict remains in the process of appointing auditors as the auditors’ role is to examine some aspects of management’s performance. ISA (UK and Ireland) 250 already deals with compliance with laws and regulations.
The FRC’s report is silent in relation to the comment on tax law received. The website does not record any comment from the Inland Revenue.
Office of the Director of Corporate Enforcement (ODCE)
The FRC (which by design is independent of the profession) states at paragraph 2.1 of its October 2007 report ‘..audit is fundamentally sound’. In contrast, the ODCE states in its response ‘..we would have serious concerns as to the quality of some audits ...The ODCE believes that there are particular issues with smaller audit firms, ... The ODCE has come across numerous examples of very poor quality audits ...’ What research the ODCE undertook to ensure that the assertion they make is factually accurate and sufficiently representative of the state of auditing in Ireland is not stated in their response to the FRC Discussion Paper. It would be most unfortunate if these comments, no matter how well-intended, damage Ireland’s standing internationally by calling into question the general quality of audit here. One could validly and robustly argue that there is plenty of evidence in the public domain to support the quality of audits undertaken in Ireland, including the annual reports from the Chartered Accountants Regulatory Board’s monitoring units to the Department of Enterprise Trade and Employment. By necessity the ODCE can only expect to see cases of alleged failure of one sort or another and therefore needs to be particularly careful that its comments are not misunderstood or used as a basis for inaccurate generalisations regarding corporate Ireland. Para 1.6 of the FRC’s October report notes the increasingly international context for standard setting in relation to financial statements. The ODCE is more local in approach and its response refers to audit firms ‘doing the legal minimum in their dealings with the ODCE’.
The FRC is pursuing quality in relation to the true and fair opinion rather than in relation to any localised reporting requirement. Nonetheless this strongly indicates that there is an expectation gap in the ODCE in this regard. The ODCE response highlights a number of other perceived flaws including audit reports indicating a qualification that implies a problem with the maintenance of accounting records but containing an unqualified opinion in relation to the keeping of proper books of account. The ODCE response encloses a copy of the text of the proposed law in relation to compliance statements as a measure to reduce the risk that external factors may adversely affect the audit process.
Response of The Institute of Chartered Accountants in Ireland
In addition to the Revenue's and ODCE's responses, the ICAI also responded to the FRC. The ICAI response is on its
website and is dated 7 March 2007. The ICAI’s cogent and well-written response ranges over all the issues raised by the FRC and in addition highlights that the quality of the independent oversight function on auditors is also a key component of audit quality. The ICAI notes that those regulators engaged in the oversight of auditors need to keep themselves up to date and be expert in the practical application of standards. Critically, regulators should say what went well on the audits they review in addition to dealing with areas for improvement if they are to contribute positively to audit quality. Among other matters, the ICAI response also acknowledges that in times of rapid economic growth the competition for resources can pose concerns for audit firms.
Action points
The FRC’s October report outlines a number of actions it proposes to take as a result of the responses received. These include:-
- Establishing a task force to look at training in the profession.
- A number of commentators expressed a view that 5 year mandatory rotation of audit partners is too short. EU legislation and IFAC ethical standards refer to 7 years. The APB is currently reviewing its Ethical Standards and is explicitly seeking views on this matter as part of that process.
- APB to establish a working party to consider the content and wording of the audit report.
- A variety of other actions including a review of the communication of reasons for auditor resignation.
Ireland: Potential Actions
Like the FRC, the Institute of Chartered Accountants in England & Wales (ICAEW), has had the quality of the audit on its agenda for some time. This has influenced a number of interesting developments in UK company law. Given the importance of Ireland being able to hold itself out as a location of excellence in corporate governance it is arguably not in our interest to have a lesser regime than that of our nearest neighbour and competitor. Accordingly, consideration is needed as to whether it would be appropriate to introduce into Irish law a number of measures already in force in the UK aimed at bolstering audit quality:-
- Amend the audit report wording in section 193 Companies Act 1990 to remove the potential for interpreting the true and fair opinion as being qualified for the accounting framework used. Instead, the audit report wording should specify that the accounts have been prepared in accordance with the framework adopted.
- Amend section 158 Companies Act, 1963 to introduce to the Directors’ report similar disclosures to those contained in 234ZA of the Companies Act, 1985, namely a statement to the effect that: (a) so far as the directors are aware, there is no relevant audit information that the company's auditors are unaware of, and (b) each director has taken all the steps that he or she ought to have taken as a director in order to make themselves aware of any relevant audit information and to establish that the company's auditors are aware of that information.
- Include a new duty in law on the company to notify the appropriate authorities where an auditor ceases to hold office before the end of their term in office. The notice should be accompanied by a statement from the company setting out the reasons for the auditor ceasing to hold office and include a copy of the auditor’s statement of circumstances in connection with his /her ceasing to hold office that need to be brought to the attention of members or creditors of the company.
- Continue to monitor the progress the UK makes at both ICAEW and FRC levels in pursuing the audit quality agenda and related UK company law changes.
More important, perhaps, than all the above actions is the action that audit firms should now be considering: namely how best to apply the FRC’s drivers of audit quality in their every day work. In addition, both audit committees and regulators need to absorb the messages from the FRC’s framework and consider how best they might apply it intelligently to support quality audits.
Note:
(1) Article 40 of the Directive 8th Company Law Directive (2006/43/EC) when taken with Article 39, requires that auditors of companies traded on a regulated market (as defined in the directive) publish annually on their web-site a transparency report including information on their structure, governance and systems for ensuring audit quality. Member States have until June 2008 to implement the Directive.
Oliver Holt is a director in Deloitte. The views expressed above are the author’s alone. Accountancy Ireland December 2007 Vol.39 No.6