Regulatory environment p7

The need for assurance services


Assurance professionals provide reports that give an independent opinion as to whether the subject matter complies with pre-determined criteria. This enables the end user of that information to place more or less reliance on that information when making decisions.


Decision makers within financial markets need to have the confidence to make informed decisions. In order to make these decisions they need information they can trust. The main investment decisions that take place concern the buying and selling of shares. Without credible, reliable information at their disposal investors cannot make those decisions.


It is not just shareholders who rely on this information, there are a range of other stakeholders who also rely on assurance services. For example, it is common for banks to seek audited financial statements and independently examined forecasts before making lending decisions. Many companies request audited financial statements before buying from, or supplying a company.


As well as investments in businesses, other stakeholders must make decisions about how to deploy resources: suppliers, customers, employees and prospective lenders all need information before making significant decisions that could have damaging financial repercussions.


2      Regulation of the profession


As a result of financial scandals, and the public concern that followed, many changes were implemented in the global auditing and accountancy profession.


Examples of developments include:


The IAASB’s International Standards on Auditing (ISAs) have been adopted or are being used as a basis for national standards in over 100 countries worldwide.


The World Federation of Exchanges endorsed the IAASB’s standard setting process and ISAs.


The Code of Ethics for Professional Accountants has been adopted by many member institutions.


The largest accountancy firms have all committed to auditing in accordance with ISAs and to apply relevant sections of the Code of Ethics.


Legislative changes have been established to introduce new corporate governance requirements. The most famous of these, The Sarbanes Oxley Act (SOX) in the US, led to the creation of the Public Company Accounting Oversight Board, who create standards for listed entities and conduct inspections of audit firms’ work.


The Public Interest Oversight Board was set up in 2005 to oversee IFAC’s auditing and assurance, ethics, and education standard setting activities and its membership compliance programme.


Global regulation


The main problem is that harmonisation requires national regimes to adopt ISAs. Many countries have adopted ISAs but they have been adapted to suit local customs/laws and as a result many differences still exist in the quality of audits worldwide.



The need for regulation



Business failures, particularly large, high-profile businesses, cause loss of confidence within global financial markets. Confidence in the reliability of financial information is essential to the functioning of these markets.


Whilst it is not the only factor in helping to achieve confidence, good quality, independent audit and assurance has a key role to play. A series of recent and high profile corporate failures has eroded trust in the assurance market and as a result mechanisms for increased regulation of the auditing profession have been introduced.




The accountancy profession introduced standards to regulate financial reporting and shortly afterwards auditing standards were introduced.


Standards were set by the accounting profession for the accounting profession to follow.


Self-regulation seemed to make sense because:


the accountancy organisations usually had a ‘public interest’ remit written into their constitutions


they understood financial reporting and auditing better than anyone.


However, high profile corporate failures, such as Enron have led to the questioning of self-regulation as a satisfactory mechanism.



Global Regulation


The globalisation of business, professions and investment markets has been rapid.


Once businesses started to cross national borders it soon became clear that the variation of laws and regulations in different countries made life difficult, both for the multinationals and the professions trying to provide services to them.


This realisation led to the foundation of IFAC – the International Federation of Accountants in 1977.


IFAC is structured to operate through a network of boards and committees.

Detailed explanation of IFAC structure




The International Federation of Accountants (IFAC) is the global organisation for the accountancy profession. It was formed in 1977 and is based in New York. As at 1 January 2018, IFAC has more than 175 member bodies of accountants (including the ACCA), representing 3 million accountants from 130 separate countries.


IFAC’s overall mission is to serve the public interest, strengthen the worldwide accountancy profession, and contribute to the development of strong international economies by establishing and promoting adherence to high quality professional standards.


The structure of IFAC is as follows:


The IFAC Council comprises one representative from each member body. It meets once a year and elects the board.


The IFAC Board is responsible for setting policy and overseeing the work of the various committees.


The IFAC Nominating Committee makes recommendations regarding the composition of IFAC boards, committees and task forces.


The main bodies to be aware of are:


The International Auditing and Assurance Standards Board (IAASB): develops and promotes ISAs and other assurance standards to improve the uniformity of auditing practices and related services throughout the world.


The International Ethics Standards Board for Accountants: promotes the Code of Ethics. Significantly, the committee continually monitors and stimulates debate on a wide range of ethical issues to ensure that its guidance is responsive to the expectations and challenges of individuals, businesses, financial institutions and others relying on the work of accountants.


The Transnational Auditors Committee (TAC): deals with issues arising from cross-border auditing. It is the executive committee of the Forum of Firms (FoF), open to all firms performing or wishing to perform transnational audits. The TAC is discussed in chapter 8.


Other constituent bodies include:


The Compliance Advisory Panel    CAP  


The Professional Accountancy Organisation Development




The International Accounting Education Standards Board


The Professional Accountants in Business Committee    PAIB    The International Public Sector Accounting Standards Board The Small and Medium Practices Committee.


IFAC has encountered a number of difficulties in carrying out its role:


It was set up by, and continues to be financed by, the accountancy profession worldwide. It therefore represents a self-regulatory body. It is suggested that this is an inappropriate mechanism for regulating the audit profession.


National interests still apply leading to the implementation of international standards being bogged down in arguments between different national approaches.


Its members are the professional accountancy bodies, whose authority has been eclipsed to some extent by the power of the largest accountancy firms.


The need for Global Accounting Networks




Although companies have had their securities listed in both the European and US markets for a number of years, the ability to be based virtually anywhere in the world, and to manufacture, sell and manage businesses on a truly global basis is a more recent phenomenon. Global businesses need global professional firms to support, advise and audit them. The emergence of the ‘Big 4’ global practices has been an accelerating process that has its origins in the    970s. Similar globalisation has happened in the banking and assurance industries and the introduction of external shareholders into the securities markets has led to, e.g. Nasdaq from the US investing in the London Stock Exchange.


3      Corporate governance


Corporate governance is the system of rules, practices and processes by which a company is directed and controlled.


It is about ensuring public companies are managed effectively for the benefit of the company and its shareholders.


Corporate governance pronouncements tend to respond to corporate scandals that arise because unscrupulous management has:


manipulated the share price for personal gain


disguised poor results/mismanagement extracted funds from the company

raised finance fraudulently.


The UK Corporate Governance Code


The UK Corporate Governance Code is seen as best practice and the principles form the basis of corporate governance guidance and regulation around the world.


The Code consists of principles    main and supporting    and provisions. The Listing Rules require companies to apply the Main Principles and report to shareholders on how they have done so. If an alternative to a provision is justified and good governance can be achieved, the reasons should be explained to the shareholders    ‘comply or explain’   .


The main provisions of the UK Corporate Governance Code are:




Every company should be headed by an effective board with collective responsibility.


There should be a clear division of responsibilities between the Chairman and the Chief Executive.


No one individual should have unfettered powers of decision.


The chairman is responsible for leadership of the board and ensuring its effectiveness on all aspects of its role.


Non-executive directors should constructively challenge and help develop proposals on strategy.




The board should have the appropriate balance of skills, experience, independence and knowledge.


There should be a formal, rigorous and transparent procedure for the appointment of new directors.


All directors should be able to allocate sufficient time to the company to discharge their responsibilities effectively.


All directors should receive an induction and should regularly update and refresh their skills and knowledge.


The board should be supplied with quality and timely information to enable it to discharge its duties.


The board and individuals should be subject to a formal and rigorous annual evaluation of performance.


All directors should be submitted for re-election at regular intervals.




The board should present a balanced and understandable assessment of the company’s position and prospects.


The board is responsible for determining the nature and extent of the principal risks it is willing to take in achieving its strategic objectives.


The board should maintain sound risk management and internal control systems.


The board should establish formal and transparent arrangements for corporate reporting, risk management and internal control principles and for maintaining an appropriate relationship with the company’s auditors.




Executive directors’ remuneration should be designed to promote the long-term success of the company.


Performance-related elements should be transparent, stretching and rigorously applied.


There should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors.


No director should be involved in deciding his or her own remuneration.


Relations with shareholders


There should be a dialogue with shareholders based on the mutual understanding of objectives.


The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place.


The board should use the general meetings to communicate with investors and to encourage their participation.


Relevance of corporate governance to external auditors


If a company complies with corporate governance best practice, the control environment of the company is likely to be stronger. There will be a greater focus on financial reporting and internal controls which should reduce control risk and inherent risk which together reduce the risk of material misstatements in the financial statements.


In addition, external auditors may be required to report on whether companies are compliant with the Code. For example, in the UK, external auditors of listed entities are required to report on whether the company is compliant with the UK Corporate Governance Code.


The audit committee of a company must also assess the effectiveness and quality of the external audit and monitor compliance with ethical standards.


4         Audit committees


Audit committees form part of the governance structure of an organisation.


The broad objectives of an audit committee are threefold:


To increase public confidence in the credibility and objectivity of published financial information.


To assist directors in meeting their financial reporting responsibilities.


To strengthen the independent position of a company’s external auditor.


The following requirements are taken from the FRC Guidance on Audit Committees. The guidance is designed to assist company boards when implementing the Corporate Governance Code.


Companies with a premium listing are required to comply with the Code or explain why they have not done so.


Audit committee arrangements should be proportionate to the task and will vary according to size and complexity of the company.


All directors have a duty to act in the interests of the company. However, the audit committee must act independently from the executive to ensure that the interests of the shareholders are properly protected in respect of financial reporting and internal control.


There should be a frank, open working relationship and a high level of mutual respect between audit committee chairman and board chairman, the chief executive and the finance director.


Management is under an obligation to ensure the audit committee is kept properly informed. All directors must cooperate with the audit committee.


The core functions of audit committees are oversight, assessment and review. It is not the duty of the audit committee to carry out functions that belong to others. For example, they should make sure there is a proper system in place for monitoring of internal controls but should not do the monitoring themselves.


The board should review the audit committee’s effectiveness annually.


Membership, appointment and skills


The committee should comprise independent, non-executive directors.


The committee should have at least 3 members        for smaller companies   .


The committee as a whole should have competence relevant to the sector in which the company operates.


At least one member should have recent and relevant financial experience with an appropriate professional accountancy qualification.


Committee members should be independent of operational management.


Appointments to the audit committee should be made by the board on the recommendation of the nomination committee taking into consideration the skills, experience and qualifications to meet corporate governance requirements.


Appointments should be for a period of up to 3 years, extendable by no more than two additional 3 year periods.


New members should receive induction and training should be provided to all members on a continuing basis as required.




The audit committee should hold as many meetings as the roles and responsibilities require and it is recommended that no fewer than three meetings are held.


No one other than the audit committee chairman and members is entitled to be present at a meeting of the audit committee. The audit committee will decide if non-members, such as the finance director, head of internal audit or external audit partner should attend a particular meeting.


The audit committee should meet the external and internal auditors without management at least annually to discuss any issues arising from the audit.


In addition to the formal committee meetings, the audit committee should keep in touch on a continuing basis with the key people involved in the company’s governance.




The audit committee should be provided with sufficient resources to undertake its duties.


The company secretary should ensure information is provided to the audit committee on a timely basis.


Funds should be provided to enable it to take independent legal, accounting or other advice when required.




The remuneration should take into account the level of fees paid to the other members of the board.


The chairman will be paid more than the other members to reflect the additional responsibilities and demands on their time.


Relationship with the board


The audit committee should report to the board on how it has discharged its responsibilities.


Where there is disagreement between the audit committee and the board, adequate time should be allowed to resolve the disagreement and the audit committee should have the right to report the issue to the shareholders.


The audit committee should not just rely on the external auditor to raise issues but should consider matters using their own initiative.


Annual reports


The audit committee should:


Review and report to the board on the significant financial reporting issues and judgments made in connection with the preparation of the financial statements.


Consider the appropriateness of significant accounting policies, significant estimates and judgments.


Review the annual report and accounts and advise the board on whether they are fair, balanced and understandable.


Internal control and risk management


The board has ultimate responsibility for risk management and internal control but may delegate some functions to the audit committee such as:


Reviewing the systems established by management to identify, assess, manage and monitor financial risks.


Receiving reports from management on the effectiveness of systems and the conclusions of any testing carried out by internal and external auditors.


Reviewing and recommending disclosures to be included in the annual report in relation to internal control and risk management.


Internal audit process


The audit committee should regularly review the need for establishing an internal audit function.


Where there is an internal audit function the audit committee should review and approve the internal audit plan. The plan should be aligned with the key risks of the business.


The audit committee should ensure the function has unrestricted scope, the necessary resources and access to information to be able to perform its work in accordance with professional standards for internal auditors.


The audit committee will approve the appointment or termination of the head of internal audit.


The internal audit function should have a reporting line independent of the executive so it can exercise independent judgment.


The audit committee should monitor and review the effectiveness of the internal audit function’s work. This includes:


– Confirming that the quality, experience and expertise of the function is appropriate for the business.


– Meeting with the head of internal audit without the presence of management to discuss effectiveness.


–    Receive a report on the results of the internal auditors’ work.


The audit committee may consider an independent, third party review of the internal audit function’s effectiveness.


External audit process


FTSE 350 companies should put the audit out to tender at least once every ten years to enable the audit committee to compare the quality and effectiveness of the services provided by the incumbent auditor with those of other firms.


The audit committee has primary responsibility for the appointment of the auditor including the tendering process and selection procedures.


An annual assessment should be made of the qualifications, expertise, resources and independence of the external auditor.


If the external auditor resigns the audit committee should investigate the issues giving rise to the resignation.


The audit committee should approve the remuneration and terms of engagement.


The audit committee should monitor compliance with the Ethical Standards including the level of fees, former employees of the audit firm who now work for the company, partner rotation and non-audit services.


The audit committee should set and apply a formal policy specifying the types of non-audit services which are approved.


At the start of the audit, the audit committee should ensure that appropriate plans are in place for the audit including whether the planned materiality level and the resources are consistent with the scope of the work to be performed.


The audit committee should discuss with the external auditor any matters which could affect audit quality.


The audit committee should review and monitor management’s responsiveness to the external auditor’s findings and recommendations and should also review the written representation letter before it is signed.


The audit committee should assess the effectiveness of the external audit process including:


–    asking the auditor to explain the risks to audit quality


–    whether the auditor has met the agreed audit plan


– obtaining feedback from key people involved such as the finance director about the conduct of the audit


– reviewing the content of the management letter and whether recommendations have been acted upon.


Communication with shareholders


The chairman of the audit committee should be present at the AGM to answer questions.


A separate section of the annual report should describe the work of the committee. Specifically:


A summary of the role of the audit committee.


The names and qualifications of all members of the audit committee during the period.


The number of audit committee meetings.


The significant issues that the committee considered in relation to the financial statements and how these issues were addressed.


An explanation of how it has assessed the effectiveness of the external audit process and the approach taken to the appointment or reappointment of the external auditor.


Benefits and drawbacks of audit committees




Improved credibility of the financial statements, through an impartial review of the financial statements, monitoring of the independence of the external auditors, and discussion of significant issues with the external auditors.


The quality of management accounting will be improved as the audit committee is better placed to criticise internal functions.


The control environment may be strengthened as the internal audit function will report to the audit committee increasing their independence and adding weight to their recommendations.


Communication between the directors, external auditors and management may be improved.


Conflicts between management and auditors may be reduced/avoided.


The skills, knowledge and experience, and independence of the audit committee members can be an invaluable resource for a business.


It may be easier and cheaper to arrange finance as the presence of an audit committee can give a perception of good corporate governance.


It would be less burdensome to meet listing requirements if an audit committee    which is usually a listing requirement    is already established.




Difficulties recruiting the right non-executive directors who have relevant skills, experience and sufficient time to become effective members of the committee.


A fear that their purpose is to police executive management.


Non-executive directors may be overburdened with detail.


Non-executive directors are normally remunerated, and their fees can be quite expensive thereby increasing costs for the company.



FRC Audit Quality – Practice aid for audit committees




The Corporate Governance Code requires audit committees to assess the quality and effectiveness of the external auditor. To help fulfil this requirement, the FRC has issued guidance to audit committees. Assessment of the external auditor should cover three main areas:


  • Inputs


The audit committee should obtain evidence from a variety of sources including:


–    Management


–    Internal auditors


–    Other company personnel


–    External auditors


–    Regulators


  • Evaluation


4 key elements of audit quality should be evaluated:


– Mindset and culture – adherence to high professional and ethical principles.


– Skills, character and knowledge – strong auditing skills developed through effective training and relevant experience.


– Quality control – identifying the risks to audit quality and establishing adequate controls to address these.


– Judgment – professional judgment is applied at all stages of the audit.



  • Concluding and reporting


The audit committee should consider if they have sufficient evidence before concluding and reporting on the quality of the audit and the effectiveness of external audit. This includes whether:


– The auditor has communicated key accounting and audit judgments to the audit committee.


– The management letter demonstrates a good understanding of the business.


– Any changes made to materiality have been reported to the audit committee.



Board structures



There are two models of board structure adopted around the world:


Unitary board structure – as used in the UK and Ireland and jurisdictions whose company law systems have a similar basis.


Two tier/supervisory board structure – as used in the US and similar jurisdictions.


Unitary board characteristics


Collective board responsibility


No distinction in law between the responsibilities of executive and non-executive directors


The need to distinguish between the function of executive and non-executive directors


The need to establish board committees to monitor and act on different functions – nomination committee, remuneration committee, audit committee, etc.


Two tier system characteristics


Lower level management    operating    board


– Comprises executive management – CEO, CFO, Vice president, etc.


–    Operational responsibility for running the business


–    Coordinated by the CEO.


Upper level supervisory board


– Comprises non-executives, employee representatives, environmental groups and other stakeholders


–    Appoints, supervises and advises the management board


–    Strategic oversight of the organisation


–    Members elected by shareholders at the AGM


–    Receives information and reports from the management board


–    Coordinated by the chairman.



Sarbanes Oxley




In the US, corporate governance is enshrined in law namely the Sarbanes Oxley Act. As well as dealing with the oversight of auditors, the act enforces certain governance responsibilities, such as:


Implementation of sound systems of controls.


Clear documentation of financial processes, procedures, risks, and controls.


Evidence that management has evaluated the adequacy of the design and the effectiveness of operation of procedures and controls.


Evidence that the auditor has adequately evaluated the design and operation of financial controls.


Evidence that the audit committee has taken a keen interest in the effectiveness of controls.


Explicit sign off procedures by the chief executive and chief financial officer.


Overview of the Act


‘The primary benefit is to provide the company, its management, its board and audit committee, and its owners and other stakeholders with a reasonable basis to rely on the company’s financial reporting. The integrity of financial reporting represents the foundation upon which this country’s public markets are built.’


The key characteristics of Section 30  


CEO and CFO need to certify that:


The SEC report being filed has been reviewed


The report does not contain any untrue statements or omit any material facts


The financial statements fairly present the financial position, results of operations and cash flows of the registrant


They are responsible for, and have designed, established, and maintained disclosure controls and procedures as well as evaluated and reported on the effectiveness of those controls and procedures within 90 days of the report filing date



Deficiencies and material weaknesses in disclosure controls and procedures have been disclosed to the registrant’s audit committee and external auditors


Significant changes in internal control affecting transactions in the period have been reported.


The key characteristics of Section 404


With the filing of their accounts, companies are required to include an annual internal control report of management over financial reporting which includes:


Responsibilities for establishing and maintaining adequate internal controls and procedures.


Conclusions about the effectiveness of the company’s internal controls and procedures.


An attestation by the company’s registered public accounting firm on management’s evaluation.




The Sarbanes Oxley Act came into force as a result of the Enron corporate failure.


The fraudulent financial reporting at the heart of the Enron collapse has had major repercussions for the accountancy profession worldwide. It was one of the largest and most complex bankruptcy cases the world has ever witnessed. Consequent investigations identified numerous creative accounting techniques designed to improve reported profits and hide significant debts from investors.


Before its bankruptcy, Enron employed approximately       ,000 people and was one of the world’s leading electricity, natural gas, and communications companies. In    00    its revenue peaked at nearly $   0    billion. Much of the reported profit and position was sustained by institutionalised and systematic accounting fraud.


Ultimately the scandal that followed in the wake Enron’s bankruptcy led to the collapse of one of the ‘Big 5’ accountancy firms, Arthur Andersen. The role of Arthur Andersen in the financial fraud came under close public scrutiny and much of the trust in the auditing profession was lost. The firm was found guilty of obstruction of justice for destroying documents related to the Enron audit and was forced to stop auditing public companies    although the conviction was later thrown out by the US Supreme Court   .


The story can be briefly summarised as follows:


A significant portion of Enron’s profits were the result of deals with special purpose entities    SPEs   , which it controlled.


Many of the entities were offshore, which allowed Enron to avoid taxes, move currency and hide overall company losses.


Enron used an accounting technique known as marking to market    MTM   , which effectively meant that Enron could recognise revenue and earnings on deals a long time before the actual revenue was realised.


The huge profits Enron reported drove up its share price. This allowed executives    who knew about the offshore accounts and hidden losses!    to trade millions of dollars’ worth of Enron stock to their own benefit.


Share prices began to fall and Enron’s massive liabilities started to exert pressure on its liquidity. This eventual led to problems with its debt agreements and credit downgrades.


The lower credit rating increased the cost of Enron’s borrowing to unsustainable limits.


Wall Street analysts exposed a number of inconsistencies and problems with Enron’s accounts and the extent of earnings management was exposed.



UK syllabus: Audit and assurance regulations




Scope and authority of Audit and Assurance Pronouncements


March    0   3


Audit and Assurance regulations include:


Quality control standards The Auditor’s Code

Ethical and engagement standards


Guidance for auditors, reporting accountants and auditors involved with other assurance engagements.


Practice notes and bulletins are further forms of guidance but are less prescriptive than ISAs.


These regulations are applicable to:


Statutory audits of companies in accordance with the Companies Acts


Audits of entities in accordance with other legislation e.g. banks, charities, pension funds


Public sector audits


Other audits that are required to comply with UK standards.


Failure to apply the FRC regulations will result in regulatory action which may include the withdrawal of registration and therefore eligibility to perform company audits.


Audit exemption


In accordance with the Companies Act    006 those companies falling below the small company threshold are not required, in law, to have an annual audit. Companies may still choose to have one voluntarily.


The main criteria for audit exemption which apply from     January    0   6 are:


Turnover not exceeding £   0.    million


Gross assets not exceeding £5.    million


The number of employees must not exceed 50.


In order to qualify, the company must meet two out of the three criteria.



UK syllabus: Financial Reporting Council



The FRC is the UK Competent Authority for audit regulation.




The FRC board is supported by two committees:


Conduct Committee


Responsible for overseeing the FRC’s work in promoting high quality corporate reporting. This encompasses monitoring of Recognised Supervisory and Recognised Qualifying Bodies    RSBs, RQBs   , audit quality reviews    AQRs   , corporate reporting reviews, professional discipline and oversight of the regulation of accountants and actuaries.


Codes and Standards Committee


Responsible for maintaining an effective framework of UK codes and standards for Corporate Governance, Stewardship, Accounting, Auditing and Assurance, and Actuarial technical standards.



The Codes and Standards Committee has three councils:


Audit and Assurance Council Corporate Reporting Council


Actuarial Council.


Role of the FRC


Promote high quality corporate governance and reporting and high standards of corporate governance through the UK Corporate Governance Code.


Encourage engagement between investors and Boards through the Stewardship Code.


Set standards for corporate reporting, audit and actuarial practice, including ethical guidance for auditors and reporting accountants in the UK. The FRC issues International Standards on Auditing for use within the United Kingdom. The standards are supplemented and revised before issuing them, mainly in order to ensure they remain compliant with national laws, such as the Companies Act    006.


Monitor and enforce accounting and auditing standards. The Audit Quality Review team monitors the quality of the audits of listed and other major public interest entities. Part of this role involves performing audit inspections of all FTSE 350 companies on average once every 5 years and monitoring smaller audit firms performing public interest entity audits.


Oversee the regulatory activities of the actuarial profession and the professional accountancy bodies and operate independent enforcement arrangements for public interest cases involving accountants and actuaries.


Promote the principles, professional behaviour and culture which are collectively fundamental to quality audit outcomes, and which serve the public interest. The Conduct Committee ensures that appropriate standards are maintained by members and member firms, by operating an independent professional disciplinary scheme for accountants.


FRC’s 7 key objectives for audit


Auditors are trustworthy, act with integrity and professional scepticism, serve the public interest and consistently demonstrate that the objectives of audit and auditing standards are met.


Audit is subject to appropriate oversight within a clear regulatory regime.


Roles and responsibilities of auditors and Audit Committees are clear, and aligned with the interests and needs of investors.


Audit is a sustainable business with adequate capacity, and


sufficient levels of investment, competition and choice.


Audit innovates to meet changing business and economic circumstances to improve audit quality.


Global audits are effectively managed and overseen, and quality is consistent across international work.


There is a mechanism for standard setting to be more responsive to the needs of users, and to respond to emerging issues on a more timely basis.



UK syllabus: FRC: Developments in audit    0   6/   7 Audit monitoring



The standard of audit work for FTSE 350 companies improved during    0   6-   7, with evidence of continuous improvement.


The number of audits assessed as good or requiring limited improvements increased from 77% last year to       % this year. The FRC aims to have at least 90% of audits requiring no more than limited improvement by    0      –   9.


Areas of good practice


Greater involvement of senior team members in key audit areas such as planning and review.


Greater focus on root cause analysis when things go right as well as wrong.


High standard of direction over the work of component auditors.


Greater scepticism applied when evaluating management assumptions and estimates.


Evaluation of IT control weaknesses and additional testing required.


Effective use of data analytic techniques in the audit of revenue and journals.



High quality reporting to the Audit Committee in relation to property valuations.


Effective audit of key management judgments in relation to uncertain tax provisions.


Areas requiring improvement


Fair value and value in use measurement – insufficient scepticism.


Revenue recognition – lack of precision in setting expectations for substantive analytical procedures and insufficient testing of accrued income.


Audit committee communication – inadequate communication of internal control deficiencies, key areas of judgment in relation to impairment and insufficient discussion of the adequacy of disclosures.


Auditor’s report – inaccurate description of audit procedures performed.


Independence and ethics – failure to consult with ethics partners on non-audit fee levels and investment breaches where partners and staff held investments in audit clients.


Reasons for improvement in audit quality


Tendering and rotation of audit firms has brought new perspective into audits.


Reforms to Corporate Governance regulations improving financial reporting and audit transparency.


The number of quality inspections carried out by the FRC has increased.


The FRC is communicating directly with audit committees about the results of their inspections.


Revision to the Audit Firm Governance Code


The Code applies to firms that audit    0 or more listed companies, but may also be adopted on a voluntary basis by firms auditing fewer than that.


Key objectives of the Code have been to promote audit quality and ensure that risks to the firms are managed in the public interest.


Review of the Code had indicated that it was generally working well, but that there was scope for increasing the focus on audit quality.


As a result, the Code has been revised to:


Clarify the Code’s purpose to ensure that audit quality is at its core.


Introduce a minimum number of INEs for firms and a provision that at least one should have experience in audit or another relevant sector.


Maximise transparency in reporting by the firms and their independent non-executives.


FRC future activity


The FRC plans to continue its work on continuous improvement by:


Responding to audit failures more promptly, concluding on cases quicker and ensuring that sanctions applied are effective at deterring poor quality.


Promoting professional scepticism including revision to ISA 540 Auditing Accounting Estimates Including Fair Value Accounting Estimates and Related Disclosures and ISA 3   5 Assessing the Risks of Material Misstatement Through Understanding of the Entity and Its Environment. Changes to ISA 540 will require more detailed risk assessment and greater emphasis on disclosures. Changes to ISA 3   5 will require greater focus on risk assessment and reflect evolving environmental influences such as increased use of technology.


More widespread use of data analytics and artificial intelligence software in audit to improve audit quality.


Continuing to ensure auditors apply the principles of the Ethical Standard rather than a rules based mentality.


Looking to develop opportunities for the use of technology and monitoring risks of cyber threats and risks to client data.


Continuing to monitor audit fees and provision of non-audit services.


   0   7-       Thematic reviews


Audit firm culture and governance – how audit firms are promoting measuring and assessing their own culture, following the recent report on Corporate Culture.


Auditors’ responsibilities for areas of the annual report beyond the financial statements, including the audit of directors’ remuneration, and auditors’ reporting by exception on other matters such as risk management and viability statements.


Materiality – to provide an update and explain developments in the last four years since the FRC’s previous thematic review in this area.


Test your understanding    



Becher is an independent construction company, dealing with large scale contracts throughout the UK and with some international interest in Europe, particularly in Spain. Becher has recently established an audit committee, the members of which are very concerned about complying with corporate governance best practice, particularly since they are currently looking at the possibility of obtaining a stock exchange listing.


You are an internal auditor with the company and have been asked to conduct a review of how well the company is meeting relevant corporate governance requirements.


You are required to prepare a report that addresses the following.


  • Explain the term ‘corporate governance’ and why it is important for

companies to comply with relevant corporate governance requirements.


  • Explain the key issues Becher needs to address to achieve effective

corporate governance.                                                                                 5 marks  


  • Explain the role of the audit committee in relation to corporate

governance.                                                                                                        5 marks  


   Total:    5 marks  

Test your understanding answers


Test your understanding    



  • Corporate governance


Corporate governance concerns the way that a company is directed and controlled. It encompasses the following key aspects:


–    The role of the board and audit committee.


–    Overall control and risk management framework.


Corporate governance has become increasingly important in the wake of high profile accounting frauds. These frauds have had a damaging impact on the effective operation of world stock markets due to reductions in investor    and public    confidence in the roles of directors and company auditors.


Management and control is often more difficult to achieve in larger, more complex organisations. In addition, shareholders tend to be more remote from the directors who manage the company on their behalf. Having an agreed set of corporate governance standards therefore facilitates the adoption of good corporate governance practices and improves accountability to investor groups.


Failure to comply with these agreed standards of corporate governance could lead to significant penalties, namely:


–    Fines and penalties, where corporate governance is enforced

through law, the US for example. This could, in the most extreme cases, lead to imprisonment of directors.


– Penalties imposed by stock market regulators, such as removal from the listing.


–    Replacement of board members.


  • Requirements of corporate governance


The nature of issues to be addressed depends on the legal or listing requirements in place in the country of operation. However the following basic principles may be universally applied:


– The board should be responsible for the assessment of and response to risk.


–    The board should be responsible for monitoring the

effectiveness of the system of internal control.


– An independent system    including the use of committees    should be established to enable the effective recruitment and retention of directors.


– Communication with, and independence of auditors, should be overseen by the audit committee.


– There should be explicit and transparent reporting of compliance with corporate governance requirements/ principles.


UK Syllabus Focus: In the UK, listed companies must report on how, and whether, they have complied with the UK Corporate Governance Code.


  • Role of the audit committee


The role and importance of the audit committee has increased as corporate governance requirements have been strengthened. The audit committee should have at least three non-executive directors who should be independent of the company, i.e. have no direct involvement in the day to day running of its affairs.


The objectives of the audit committee are:


– To increase public confidence in the credibility and objectivity of published financial information.


– To assist directors in meeting their financial reporting responsibilities.


– To strengthen the independent position of a company’s external auditor.


The audit committee should:


–    Oversee the internal audit function.


– Assess the effectiveness of the external audit process and monitor audit quality.


– Ensure appropriate financial reporting processes are in place and ensure the annual report is fair, balanced and understandable.


– Ensure there is appropriate communication with shareholders on audit matters.


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