FRC revises standards in bid to strengthen audit confidence

The Financial Reporting Council (FRC), the UK’s Independent regulator of auditors and accountants, has issued revised ethical and auditing standards in a bid to support the delivery of high-quality audit and strengthen confidence in the practice.

The regulator hopes that the changes will strengthen auditor independence, prevent conflicts of interest and fortify the UK as an attractive business destination due to stronger investor protection that higher-quality audits foster.

The new requirements will come into effect from 15 March 2020.

The FRC’s Chief Executive, Sir Jon Thompson said: “High-quality audit supports the effective functioning of capital markets and gives investors confidence.

“Where audit fails, that confidence is undermined. The steps we have taken in revising our standards include measures which our stakeholders have identified as important to strengthen their confidence in audit, by ensuring greater independence and a focus on delivering high quality and consistent work.”

The previous list, which detailed prohibited non-audit services, has been replaced with a shorter list that simply details permitted services which are ‘closely related’ to an audit, or required by law and regulation. Under the revised standards, no services outside of this list can be rendered by an auditor.

The list of permitted services is:

• Reporting required by law or regulation to be provided by an auditor;
• Reviews of interim financial information;
• Reporting on regulatory returns;
• Reporting to a regulator on client assets:
• Reporting on government grants;
• Reporting on internal financial controls when required by law or regulation;
• Extended audit work that is authorised by those charged with governance performed on financial information47 and/or financial controls where this work is integrated with the audit work and is performed on the same principal terms and conditions.

Auditors will now be prohibited from providing recruitment and remuneration services or playing any part in management decision making, in-line with changes to international ethical requirements.

Addressing the issue of management decision making, the standard states on page 21: “It is not possible to specify all types of decision that are the responsibility of management, but they typically involve leading and directing the entity, including making significant judgments and taking decisions regarding the acquisition, deployment and control of human, financial, physical and intangible resources.”

In addition to meeting these new requirements, firms are expected to have an engagement partner, and failing that an ethics partner, through which breaches of the requirements should be reported.

Public interest entity auditors (PIEs) will now only be permitted to provide non-audit services closely linked to the audit itself or required by law or regulation.

Damage mitigation

The FRC hopes that these revisions will mitigate the risk of damaging conflicts of interests between auditors and clients, where the commercial interests of an auditor are seen to be the most important factor in an audit relationship, as opposed to a focus on the quality of an audit.

The regulator said that the revisions are a result of “a comprehensive post implementation review, supported by two public consultations and extensive outreach.” They added that it would also monitor the outcome of the Brydon review, and consider whether any further changes should be made once his recommendations are implemented.

Commenting on the revisions, Stephen Griggs, deputy CEO and managing partner for audit and assurance and public policy at Deloitte said: “The FRC’s broad package of proposals is a welcome move to address perceptions that may persist around auditors’ independence.

“We have long argued that greater clarity on the work that auditors can, and cannot, do for the entities that they audit is crucial to maintaining trust in the profession. The FRC’s guidance is important in firmly establishing rules around this.

“We are mindful of the perception that auditors are incentivised to cross-sell unrelated advisory work and, in our response to the CMA, we proposed ceasing non-essential non-audit services to the companies we audit.

However, Griggs also highlighted that in some cases, auditors are required to do work that is classed as ‘non-audit’, saying: “In reality, a significant proportion of current ‘non-audit’ work is directly associated with our role as auditors and includes the review of half-year releases, assurance work associated with bond offerings and supporting capital market transactions.

“All of these are technically classed as ‘non-audit’ services but, in practice, the auditor is best placed, and in some cases actually required, to do them.”

Positive changes

There have been positive changes since revisions were last made in 2016, and the FRC will hope that the new set of changes will continue this trend. Since 2016, firm’s fee income from non-audit services provided by entities they audit fell by 8%.

In the last three years, no audit firm asked the FRC to waive the non-audit services fee cap, and the regulator claims that: “audit committees, for the most part, no longer consider their auditor to be the default provider for non-audit services.”

This latest round of revisions has also simplified the Ethical Standard in a hope that it will be clearer to use, while the revised Auditing Standard includes additional application guidance to make it clearer for auditors on how they should respond to requirements.

The FRC also said it received widespread support during its consultation on whether further entities should be subject to more stringent non-audit service requirements for PIEs. A decision on whether the regulator will expand which entities will follow these requirements has been deferred until next year, after the Brydon report has been issued, to ensure consistency.