Rules and regulation

The need for regulation


The role of the auditor has come under increased scrutiny over the last thirty years due to an increase in high profile audit failures. The most high profile case, and the catalyst for regulatory change, was the collapse of Enron and its auditor Arthur Andersen.


In order to try and regain trust in the auditing profession, national and international standard setters and regulators have tried to introduce three initiatives:


  • Harmonisation of auditing procedures, so that users of audit services are confident in the nature of audits being conducted around the world.


  • Focus on audit quality, so that the expectations of users are met.


  • Adherence to a strict ethical code of conduct, to try and improve the perception of auditors as independent, unbiased service providers.


In order to achieve this, practitioners have to follow regulatory guidance:


  • National corporate law (e.g. The Companies Act 2006 in the UK and The Sarbanes Oxley Act in the US).


  • Auditing Standards (the basis of this text is International Standards on Auditing).


  • Code of Ethics. Covered in the chapter ‘Ethics and acceptance’.


2      Legal requirements for audits and auditors


In this section, the law referred to in most cases is UK law and the Companies Act 2006. Different countries may have different requirements but generally the same principles will apply across the world.


National law includes:


  • Which companies are required to have an audit


  • Who can and cannot carry out an audit


  • Auditor appointment, resignation and removal


  • The rights and duties of an auditor.


Who needs an audit and why?


In most countries, companies are required by law to have an audit.


Small or owner-managed companies are often exempt. This is because there is less value in an audit for these companies.


Note that these exemptions often do not apply to companies in certain regulated sectors, e.g. financial services companies or companies listed on a stock exchange.


Reasons for exempting small companies from audit


  • The owners and managers of the company are often the same people.


  • The advice and value which accountants can add to a small company is more likely to concern other services, such as accounting and tax.


  • The impact of misstatements in the financial statements of small companies is unlikely to be material to the wider economy.


  • The audit fee and disruption of an audit are seen as too great a cost for any benefits the audit might bring.


Who may act as auditor?


To be eligible to act as auditor, a person must be:


  • A member of a Recognised Supervisory Body (RSB), e.g. ACCA, and allowed by the rules of that body to be an auditor or


  • Someone directly authorised by the state.



Conducting audit work


Individuals who are authorised to To be eligible to offer audit
conduct audit work may be: services, a firm must be:
• Sole practitioners • Controlled by members of a
• Partners in a partnership suitably authorised
supervisory body or
• Members of a limited liability
• A firm directly authorised by
the state.
• Directors of an audit


Note: In some countries only individuals can be authorised to act as auditor and need to be directly authorised by the state.


Who may not act as auditor?


Excluded by law: The law in most countries excludes those who manage or work for the company, and those who have business or personal connections with them from auditing that company.


Excluded by the Code of Ethics: Auditors must also comply with a Code of Ethics. The Code of Ethics requires the auditor to consider any factors that would prevent them acting as auditor, such as independence, competence or issues regarding confidentiality. This is considered in more detail in the next chapter.


Who appoints the auditor?


Members (shareholders) – of the company appoint the auditor by voting them in.


Directors – can appoint the first auditor or to fill a ‘casual vacancy’. This requires the members’ approval at a members’ meeting. In some countries the auditors may be appointed by the directors as a matter of course.


Secretary of State – if no auditors are appointed by the members or directors.


Auditors of public companies are appointed from one AGM to the next one.


Auditors of private companies are appointed until they are removed.


Removing the auditor


Arrangements for removing the auditor have to be structured in such a way that:


  • the auditor has sufficiently secure tenure of office, to maintain independence of management.


  • auditors can be removed if there are doubts about their continuing abilities to carry out their duties effectively.


Removal of the auditor can usually be achieved by a simple majority at a general meeting of the company. There are some safeguards, such as a specified notice period, to prevent the resolution to remove the auditors being ‘sprung’ on the meeting.


The auditor can circulate representations stating why they should not be removed if applicable.


A statement of circumstances must be sent to the company and the regulatory authority to set out issues surrounding the cessation of office.


Resigning as auditor


In practice, if the auditor and management find it difficult to work together, the auditor will usually resign.


The auditor issues written notice of the resignation and a statement of circumstances to the members and regulatory authority.


Notifying ACCA


If an auditor resigns or is removed from office before the end of their term of office, they must notify the ACCA.


The auditors responsibilities on removal/resignation


The following is taken from UK law, but provides an example of the typical responsibilities of the auditor.


  • Deposit at the company’s registered office:


– A statement of the circumstances connected with the removal/resignation or


–    A statement that there are no such circumstances.


  • Deal promptly with requests for clearance from new auditors.


The auditor’s rights


During appointment as auditor


  • Access to the company’s books and records at any reasonable time.


  • To receive information and explanations necessary for the audit.


  • To receive notice of and attend any general meeting of members of the company.


  • To be heard at such meetings on matters of concern to the auditor.


  • To receive copies of any written resolutions of the company.


On resignation


  • To request a General Meeting of the company to explain the circumstances of the resignation.


  • To require the company to circulate the notice of circumstances relating to the resignation.


The auditor’s duties


The external auditor’s primary duty is to audit the financial statements and provide an opinion on whether the financial statements give a true and fair view (or are fairly presented in all material respects).


They may have additional reporting responsibilities required by local national law, such as confirming that the financial statements are properly prepared in accordance with those laws.



3      International regulation

The International Federation of Accountants (IFAC)


The International Federation of Accountants (IFAC) is the global organisation for the accountancy profession.


IFAC promotes international regulation of the accountancy profession. By ensuring minimum requirements for accountancy qualifications, post qualification experience and guidance on accounting and assurance for accountants around the world, there will be greater public confidence in the profession as a whole.


International Standards on Auditing (ISAs)


One of the subsidiary boards of IFAC is the International Audit and Assurance Standards Board (IAASB). It is their responsibility to develop and promote International Standards on Auditing (ISAs).


There are currently 37 ISAs and one International Standard of Quality Control, although not all are examinable for this syllabus. A list of examinable documents is available on the ACCA website. You do not need to learn the names or numbers of the ISAs but you do need to know and be able to apply the key principles and requirements of the standards.


Main features of ISAs


  • ISAs are professional guidance that the auditor must follow to ensure each audit is performed consistently and to a required standard of quality.


  • ISAs are not legal requirements. If a country has a law in place which is inconsistent with the requirements of the ISAs, local law should be followed.


  • ISAs are written in the context of an audit of the financial statements but can be applied to the audit of other historical financial information.


  • ISAs must be applied in all but exceptional cases. Where the auditor deems it necessary to depart from an ISA to achieve the overall aim of the audit, this departure must be justified.


  • The ISAs contain basic principles and requirements followed by application and other explanatory material to aid the auditor on how to follow the requirements.


Development of ISAs


For an ISA to be issued, a lengthy process of discussion and debate occurs to ensure the members affected by the guidance have had an input.


An exposure draft (ED) is issued for public comment and these comments may result in revisions to the ED.


Approval of two thirds of IAASB members is required for the ISA to come into force.


The relationship between international and national standards and regulation


IFAC is simply a grouping of accountancy bodies, therefore it has no legal standing in individual countries. Countries therefore need to have their own arrangements in place for:


  • Regulating the audit profession


  • Implementing auditing standards. National standard setters


  • May develop their own auditing standards and ethical standards


  • May adopt and implement ISAs, possibly after modifying them to suit national needs.


In the event of a conflict between the two sets of guidance, local regulations will apply.


UK as an example


In the UK, the Financial Reporting Council (FRC) is the national regulator responsible for overseeing the accountancy profession.


The Audit and Actuarial Regulation Division within the FRC is responsible for the development of auditing standards and guidance in the UK, monitoring of auditors of public interest entities, and oversight and regulation of Recognised Supervisory Bodies (such as ACCA).


The Audit and Assurance team within the Audit Division take the ISAs as issued by the IAASB and modify them for UK use.


The Audit and Assurance team has also developed its own ethical standard which must be followed. The safeguards within the ethical standard are either the same as those required by IFAC’s Code of Ethics or more comprehensive. For example, partner rotation rules in the UK are more stringent than those required by IFAC.


The Audit Quality Review (AQR) team monitors the quality of work performed by audit firms that perform audits of public interest entities in the UK. The AQR performs inspections of audit files to ensure firms are following the requirements of the ethical standard, auditing standards and quality control standard. Inspection reports are available to view on the FRC website.


The accountancy profession in the UK is therefore primarily self-regulated by the FRC. There is little government involvement in the regulation of accountancy firms.


Whilst self-regulation is working effectively it is likely to continue. However, if a major audit failure occurs which damages the reputation of the profession as a whole, then it is likely that the government will get involved. In European countries, there is considerably more government involvement.


4      The role of professional bodies


Professional bodies (such as the ACCA and ICAEW) promote quality within the profession through provision of:


  • Rigorous qualifications to acquire the knowledge and skills needed to provide a competent service


  • Support to members to demonstrate high professional and ethical values


  • Technical expertise to governments on accounting and business matters. This input may help shape the introduction of new laws and regulations affecting the profession.


To obtain membership to a professional body, a person must:


  • Successfully complete the exams provided by that body


  • Be able to demonstrate appropriate practical experience (usually a minimum of three years)


  • Complete an ethical assessment.


To maintain membership a member must demonstrate continuing professional development (CPD) to ensure knowledge and skills are kept up to date. In addition, members must comply with a code of ethics and conduct to ensure they act in a professional manner at all times.


If a member is found not to have complied with the rules of the professional body, disciplinary action will be taken which may involve fines, reprimands, suspension from membership for a limited time or withdrawal of membership. Most disciplinary matters will be dealt with internally by the relevant professional body. However, if the behaviour of the person or the firm is considered very serious, the matter can be referred to the national regulator (e.g. the FRC in the UK) and action can be taken at a higher level. This will generally be the case for significant public interest issues.


By having such rigorous membership requirements and disciplinary proceedings the public can be assured that professional accountants are performing work of a high standard which increases trust in the profession as a whole.



Test your understanding 1


Explain THREE rights that enable auditors to carry out their duties. (3 marks)


Test your understanding 2


You have been asked to conduct a training workshop for your firm’s new trainees which will cover the  s surrounding the auditing profession. You have prepared a short test for the trainees to take at the end of the workshop to assess whether they have understood the content covered.


  • Which of the following statements is false?


A Auditing standards are laws which must be followed during all audits


B Auditing standards should be followed during all audits unless there are exceptional circumstances which would mean the audit objective would not be met


C   Auditing standards are professional regulations


D Auditing standards may be different in different countries, even those using ISAs



  • Which of the following are reasons for the audit profession issuing auditing standards?


  • To ensure consistency of audits across different firms.


  • To provide bureaucracy for auditors.


  • To ensure quality in the standard of audits performed.


  • All of them


  • (i) and (ii) only


  • (i) and (iii) only


  • (ii) and (iii) only


  • Which of the following people may act as auditor for a company?


  • The company’s previous finance director who left the company five years ago to join the audit firm


  • A director of the company being audited who holds a valid audit certificate


  • An employee of the company being audited who holds a valid audit certificate


  • The wife of the finance director who works for a reputable audit firm


  • In most jurisdictions, the auditors of a company will be appointed by which party?


  • Directors


  • Audit committee


  • Government


  • Shareholders


  • Which of the following statements is true?


  • The shareholders of most companies will also be the directors


  • The directors are the stewards of the company responsible for looking after the company on behalf of the owners


  • Directors will always have a vested interest in the company doing well because they own shares in the company they work for


  • Auditors are allowed to be business partners of the company directors


5          summary

Test your understanding 1


Auditor’s rights


  • Right of access to the company’s books and records at any reasonable time to collect the evidence necessary to support the audit opinion.


  • Right to require from the company’s officers the information and explanations the auditor considers necessary to perform their duties as auditors.


  • Right to receive notices of and attend meetings of the company in the same way as any member of the company.


  • Right to speak at general meetings on any matter affecting the auditor or previous auditor.


  • Where the company uses written resolutions, a right to receive a copy of those resolutions.



Test your understanding 2


  • AAuditing standards are professional guidance, not law.


  • CBy issuing standards, audits should be performed more consistently which should improve quality.


  • AAn auditor cannot be an employee or director of the company or someone with a close personal relationship with someone that could influence the audit. An ex-employee or director can be involved with the audit once a cooling-off period has passed.


  • D


BWhilst directors may be shareholders of the company they work for, large public companies will have a significant number of shareholders who are not involved in the operations of the company. The auditors are not allowed to be business partners of the directors of a company they audit.

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