Regulation, An Auditor's View
The Institute of Chartered Accountants in Ireland (ICAI) hosted a Regulators Conference at Druids Glen, Co. Wicklow in November 2007 where delegates heard perspectives on regulation from an impressive group of senior regulators. Arising out of that conference, Accountancy Ireland invited Ronan Nolan to give readers a perspective on regulation from the standpoint of a practising auditor. The article that follows is based on Ronan’s presentation at the conference.
My main occupation is as an audit partner in Deloitte, but I am also involved in the activities of the ICAI and am the Irish member of the Auditing Practices Board (APB). These different involvements give me perspectives on regulation and also bring me into contact on a frequent basis with many of our regulators.
A basic point is that regulation is an absolutely fundamental factor in underpinning business confidence. As such, it is key to Ireland’s success. The flip side of this, of course, is that overregulation could become a real disincentive and create a problem for us in maintaining our competitiveness as a business location. There is plenty of evidence that the majority of our regulators are conscious of the need for balance in both the development and implementation of regulation.
Principles vs Rules
Another key theme is the tension between a rules-based approach – which is often seen as a result of US influence – and a principles-based approach, which by definition is less prescriptive and recognises the importance of the spirit of regulations and the significance of professional judgement. While most Irish regulators genuinely support a principles-based approach, international audit and financial reporting standard-setters are under real pressure in attempting to contain and resist the development of an increasingly rules-based environment.
An encouraging trend is the push for simplification of regulations, particularly as they impact on smaller entities. We have already seen the introduction and subsequent increase of scope of audit exemption for small companies. This is very welcome, and the EU has recently issued further proposals with the intention of reducing the burden of compliance on smaller entities. This is also on the agenda of the Irish Government.
I think it is fair to say that the challenge of being aware of, and complying with, the plethora of regulation is very significant for a practising auditor.
Auditing Practices Board (APB)
A key part of the work of the APB is the issuing of auditing standards. This has become an international process with the International Standards on Auditing (ISA) issued by the IAASB being adopted in the UK and Ireland with very little or no amendment. The intention is to phase out what have been referred to as ISA Plus* completely in the short term, leaving the direct adoption of ISA as the normal process. This will depend on the position taken by the European Commission and it is certainly to be hoped that they will not see it as appropriate to adopt any editing role in relation to the ISA.
New standards emanating from the IAASB fall into two broad categories, the first being those issuing under the clarity project, where standards are not changed in substance but the drafting is tightened up so as to make the requirements more uniform and understandable. The second category, which is of more significance in terms of its impact on auditors, is the standards which are new or changed in a major way. This includes standards in relation to the audits of group financial statements, related parties and management representations, for example. Each of these new standards has the potential to have significant impacts on auditors and the expectation is that they will become effective in 2009 and 2010.
Practice Notes for auditors are guidance issued by APB to assist auditors in dealing with specialized areas such as regulated entities like banks, insurance companies and investment businesses. A lot of work has been done in the recent past updating Irish versions of a number of these practice notes. The insurance practice note has issued in draft and the banking practice note is at an advanced stage.
I should also mention an exercise I was directly involved in myself, which is the production of a practice note in respect of Irish credit unions. The draft practice note is the first Irish practice note not to be based on a UK template. This reflects the much greater significance of credit unions in the Irish economy and the demand for guidance given the expectations of the Financial Regulator and the wide spread of credit union audits across the accounting profession. We worked very closely with the Regulator in producing the draft practice note and encountered some interesting issues, notably those arising from the requirements in credit union law in relation to the preparation of financial statements.
There is a major question as to whether fair value accounting under FRS 26 is permitted by Irish law for credit unions and this is a very pertinent issue given the increasing complexity and sophistication of investments acquired by credit unions. The hope is that we will have clarity on this matter by the time the practice note has completed its consultation period in the first half of 2008.
Another interesting topical debate arises from the exemption of many corporate entities from the statutory audit requirement. There has been quite a debate as to what indication professional accountants should give in relation to their involvement in the preparation and issue of such nonaudited financial statements.
The APB is very clear that an audit is an audit and no watered down form of audit report is appropriate for accounts that have not been subjected to a full audit, carried out in compliance with ISA.
The Institute of Chartered Accountants in England & Wales (ICAEW) did issue a discussion paper in relation to a possible form of assurance report, but it was not well received and the matter remains unresolved. This is rather unsatisfactory because users of such financial statements understandably want some clarity around the level of confidence they can place on such financial statements.
ICAI Technical Agenda
I would like to emphasise the value of early dialogue between regulators and the accounting profession when regulators are considering additional or changed requirements in relation to assurance reports they may require from accountants. We have a very useful basis for such reports in M39 Reporting to Third Parties, and good examples of productive outcomes of dialogue include:
-Reporting to the Financial Regulator, and
-Reporting on Client Money Requirements.
The point I want to make is that we can invariably come to an agreed basis of reporting as a result of dialogue. Where reporting requirements are issued unilaterally real difficulties can arise.
Ireland is almost unique in the developed world at present in persisting with a legal regime that requires auditors to accept unlimited liability on a joint and several basis. ICAI has been active in promoting a discussion as to how the position canbe made more equitable, and we have genuine hopes of achieving some form of cap on auditor liability, possibly together with limited liability partnerships, as in the UK, and perhaps some form of proportional liability to limit the risks currently inherent in the joint and several regime.
Finally, ICAI has been encouraged by support evident for the proposal to protect the use of the term ‘Accountant’. Subject to appropriate sunset provisions for those currently using the title on an unregulated basis, we believe there is a good prospect of this protection being included in law in the near future.
Readers will be aware that there is a plethora of regulation coming from the EU, principally in the form of Directives that have to be incorporated into national law. I commented earlier that I hoped the EU would not become involved in editing ISA. This is pertinent because in the case of International Financial Reporting Standards (IFRS) the EU adopted a ‘carve out’ approach, disapplying certain provisions of IFRS applicable to financial instruments.
The move, which was the result of political pressure from certain large member states, set a very alarming precedent. With the recent announcement by the SEC that it will henceforth accept IFRS financial statements without requiring a reconciliation to US GAAP, unless the European Commission abandons the carve out approach, the EU could end up as a backwater in a world dominated by IFRS.
The 8th or Statutory Audit directive will be very significant in setting rules for statutory annual and consolidated accounts, and work is ongoing on its transposition into Irish law. It deals with recognition of registered auditors, and with standards, training and related manners.
There is a particular focus on the audits of public interest entities, one interesting impact of which will be to require transparency reports to be published by audit firms which serve public interest entities. These reports will give details of legal structure and ownership of the audit firms and also financial information, including information about the basis for partner remuneration. This will provide interesting insights into the currently very private world of the large accounting partnerships!
Regulation is a key facet of the environment in which the auditor operates, and the challenge of being aware of, and complying with, the wide range of relevant regulations is formidable. The ICAI Regulators Conference offered an excellent opportunity for practitioners to listen to, and interact with, the most senior regulators in Ireland, and was a most successful event.
* International Standards on Auditing (UK and Ireland) (ISA+) apply to audits with years ending
on or after 15 December 2005.
Ronan J. Nolan, FCA is a Partner with Deloitte in Dublin. His main focus is on audit, principally in the Financial Services sector. A member of the Council of the Institute of Chartered Accountants in Ireland, Ronan chairs the Representation and Technical main policy committee. He is also the Irish member of the Auditing Practices Board (APB), the auditing standard setter for UK & Ireland.