FRC and the audit committee

By Ian Welch, head of policy, ACCA

Just when it seemed that the debate on the future of audit was taking a well-earned rest for a few weeks until the EC's post-Green paper draft legislation (expected in November) the UK's accountancy regulator decides to stir the pot. 

In two wide-ranging reports out today, the Financial Reporting Council outlines the responses, and proposed follow-up to, its major consultation paper issued in January, Effective Company Stewardship - Enhancing Corporate Reporting and Audit. ACCA will be responding on all the various issues covered, including narrative reporting, risk reporting, and governance in due course, but here I will look at the auditing issues it has raised.

The first point to note is that on one of the EC's favourite issues - the length of time that auditors typically remain in post - the FRC has nipped in ahead of Commissioner Barnier and has floated the idea of mandatory tendering of audit firms after 10 years, or at least for companies to have to explain why tendering has not happened. The EC (and the US regulator, the PCAOB) seem to be favouring mandatory rotation after a similar length of time - so tendering might be seen as an attempt to coax Brussels into this softer, more palatable option. ACCA is opposed to forced rotation, which could add to costs and force companies to lose the most appropriate auditor, but it is hard to argue against having to put the audit out to tender once a decade. Given that some sort of reform is inevitable, that proposal would be one the profession should not go to the barricades to prevent.

But on the more fundamental issues of audit reform, the FRC comes out from its consultation process with a clear view - it is the audit committee, not the auditor, which should be responsible for providing the key information in annual reports; the paucity of which has led companies to come under strong criticism from users. The FRC also notes the Lords and Treasury Select Committees’ conclusions that 'audit is not meeting user and/or public expectations, and that there is a need for greater transparency about the judgements made by management and auditors in the course of preparing and auditing financial statements'. The EC and PCAOB meanwhile have both focused on the possible provision of such information by the auditors.

The audit committee should take the lead role, says the FRC, because the company is responsible for the report and statements and it is their views 'that are wanted by and should be reported to investors and other users.' The FRC argues that it is the board and management that have direct access to these users, so auditors should not be 'making judgements that are properly those of management'. Just to reinforce the point, the FRC says that auditors might be tempted to use boilerplate standardised language whereas the audit committee is 'more likely to be specific to the business.'

Given that the FRC has based its conclusions on 100+ responses from market participants and its accompanying document spells out the summary findings from those discussions with companies, investors and analysts, it makes disagreement difficult. After all, policy should be evidence-based. But while ACCA supports an enhanced role for the audit committee we should be wary of raising expectations too much and assuming this is a panacea to all problems. Also as some of the FRC's respondents point out, there is a concern at the 'circularity in the system that would arise from the [proposed] requirement for the auditor to review the report of the audit committee, which is supposed to be overseeing their work.'

There is not much to warm auditors generally in the report. The current audit report is 'opaque and wholly uninformative'. And there was, it seems, ‘little enthusiasm for external auditors to be given mandatory responsibilities for validating risk reporting'. Why so? The reasons given include that it was not appropriate for the company's willingness to take on risk to be assured as it was a commercial decision. This seems curious, given the strength of feeling among investors that the FRC has identified for more information on risk. And, except in relation to financial controls, 'it was felt that audit firms did not have the expertise to assess risk management and internal controls'. Yet in the US, there is a requirement for audit firms to report on internal controls. The FRC's main suggestion for improving auditing is to revise the auditing standards relating to reports by auditors to audit committees and so make auditors give greater detail on the factors they relied on in their judgements on areas such as controls, materiality and accounting policies.

While ACCA would agree that auditors should not seek to replace management's responsibilities, we have consistently argued for an extension of the role of audit to take on additional reporting in areas like internal controls, risk and governance. While we disagreed with much of the EC's Green Paper proposals on structural reform, we nonetheless applauded its willingness to look at an enhanced reporting role for audit. Ditto the PCAOB's proposed 'Auditor's Discussion and Analysis' free-flow report. The FRC has rejected these ideas and put the onus for communicating with shareholders and other users wholly on management and boards' shoulders.