It is more than a decade since the Auditing Practices Board (APB) of the Financial Reporting Council (FRC) issued APB Ethical Standards (ESs) 1-5 relating to auditing, ES – Provisions Available for Small Entities (ES – PASE), and the Ethical Standard for Reporting Accountants (ESRA). Now, all seven standards are being consolidated into a single ES Final Draft: Revised Ethical Standard 2016.
The FRC has spent the past 18 months consulting on proposed revisions to the ES as part of a larger exercise, which includes a thorough review of ethical matters and reflects changes to UK and European Union legislation. And the FRC has revised auditing standards to reflect changes to International Standards on Auditing issued by the International Auditing and Assurance Standards Board and also made corresponding changes to the UK Corporate Governance Code and Guidance on Audit Committees.
“The FRC ethical review was designed to emphasise the importance of auditors considering ethical principles, rather than considering them as a set of rules, and in so doing develop a more outcome-based approach,” says Mark Babington, FRC deputy director, audit policy. The focus of the legislative changes strengthens auditor independence and seeks to remove the risks posed by conflicts of interest, particularly for public interest entities (PIEs), through rotation of audit firms and partners, prohibitions, a fee cap on provision of non-audit services – and more.
Some of the provisions in the new FRC ES apply to audits; some to public interest assurance engagements such as investment circular reporting engagements. Some provisions apply to all audits; some apply only to audits of listed and non-listed PIEs (as defined by the Audit Regulation and Directive); some apply to listed non-PIEs; some provisions apply to smaller entity audits. “Audit committees and firms will need to be very clear on which aspects of the new regime apply to them,” says Henry Irving, head of the ICAEW Audit & Assurance Faculty.
Some aspects of the transition from the individual APB ESs to one individual FRC ES are relatively straightforward. “All the references have changed, so people may need to spend a while finding things. But for most audits and auditors life can carry on broadly as before,” says Tony Bromell, ICAEW head of integrity and markets.
The FRC has long been concerned that people can become so focused on ticking off rules they forget about principles. The revised ES tackles this in a new section, Part A. This sets out the principles of integrity, objectivity and independence, with supporting ethical provisions, and establishes a framework on which to base decisions that will, hopefully, lead to ethical outcomes – which are to be evaluated from the perspective of an “objective, reasonable and informed third party”.
This reasonable and informed third party test is now central to the revised ES, which is more explicit about who auditors are trying to demonstrate their integrity, objectivity and independence to. However, auditors have always needed to be, and be seen to be, independent in order to undertake an audit engagement, so as Bromell notes, in this area the revised ES provides clarification, but “it does not move the goal posts”.
Broader personal independence requirements introduced by the revised ES may, however. The chain of command definition in the APB ESs is replaced with a greater range of covered persons “in a position to influence the conduct or outcome of an engagement”. This makes clear, for example, that the management board of the audit firm is covered, but it also raises questions around exactly who is covered.
Some changes in the revised ES do provide much needed clarity. For example, APB ES 5 prohibits an auditor from acting as an advocate “before an appeals tribunal or court”. These words have been removed because they could be interpreted to mean that advocacy problems arise only when appearing before a court or tribunal. Bromell says: “The revised ES makes it clearer that auditors cannot do something that would cause an advocacy threat if the matter would be material to the accounts and subjective, but auditors can, for example, still sit in a tax tribunal if they are there to provide facts.”
Some of these provisions apply only to the audits of listed and non-listed PIEs (as defined by the ARD), but these classes of entity are subject to some of the biggest changes – and may raise some of the biggest questions. Implementation of the ARD takes place partly at EU level and partly by being transposed into national law. Where the FRC has directly transposed wording from the EU Regulation into the revised ES, the results are not always clear.
For example, the Regulation states that firms auditing PIEs cannot provide services from the prohibited list of non-audit services either directly or indirectly. But what does “indirectly” mean? Does it mean you can’t do it through an agent that purports to be a third party, or is it to be interpreted in a much wider sense? There are broad prohibitions on PIE audits in the revised ES.
Bromell says: “The PIE non-audit service list is more prohibitive than what is in the outgoing ES 5, particularly in tax services, where there are some comprehensive prohibitions – although there is an immateriality clause.” The corporate finance prohibitions are also pretty broad, though not entirely clear. So there is uncertainty around some of the direct transpositions from the Regulation and the precise meanings of some words and phrases.
ICAEW is developing guidance and the FRC has established a technical advisory group to identify areas where additional guidance may be necessary. The way the revised ES was written it looked as if it would need to be applied to all audits immediately from 17 June. However, the FRC has added an errata on its website, stating that the revised ES will apply for audits of periods commencing on or after 17 June.
This may well be good news for all auditors (the revised ES is vast and complex). There are some scenarios where it may be particularly welcome, such as international audits. The FRC has made changes around territorial reach, which will make life more complicated for group auditors who need to think ahead. “The revised ES seems to say that if there is a PIE somewhere in a group, every network firm that is doing the audit around the world has to follow the FRC’s ES, or the UK firm cannot consider them to be independent,” explains Bromell.
The APB standards allow UK audit firms to follow these ESs, while non-UK firms on the group audit follow the international Code of Ethics for Professional Accountants of the International Ethics Standards Board for Accountants. That FRC erratum to the revised ES enables firms to stick with this on engagements for periods starting before 17 June 2016. Subsequent periods may be complicated by interactions with national law plus the different interpretations of the ARD which will materialise in countries across the EU.
Despite the change, challenges and unanswered questions, some of the revised ES provisions will make life easier for some audit firms and audit entities. “The retention of the exemptions and the alternative provisions in what is now Section 6 will be welcome. Not just because of the clarifications and changes made elsewhere in the ES, but because its implementation dates broadly align with those for many smaller audit entities moving onto FRS 102,” says David Smith, a lecturer and consultant with Mercia Group, who specialises in audit.
A lighter touch has been retained for smaller (non-PIE) listed and smaller quoted entities, as defined by the €200m threshold and three-year rolling framework of the Markets in Financial Instruments Directive (MIFID). “Some AIM companies will find auditors can do more for them, subject to overall threats and safeguards assessment, than now,” says Bromell. So audit firms and audit entities may find the revised ES so appealing that they want to adopt it early. Though, perhaps unsurprisingly, questions remain about whether this is permitted.
For the consolidated Ethical Standard, see frc.org.uk/Our-Work/Audit/Audit-and-assurance/Standards-and-guidance/Standards-and-guidance-for-auditors/Revised-Ethical-Standard-2016.aspx