FRC hedges bets over audit governance

A RAFT OF consultation documents issued by the Financial Reporting Council have set greater oversight and reporting standards for company boards, audit committees and auditors.

The regulator is planning to update the UK’s 20-year old corporate governance code with a host of changes that will encourage more informative reporting by audit committees, including on the process of appointing an external auditor and commenting on their effectiveness.

There will also be a greater onus on auditors to ramp up their communication with audit committees and increase their reporting levels as part of proposed revisions to International Standards on Auditing.

By forcing auditors and audit committees to be more explicit about their activities in preparing company reports it is hoped the greater levels of transparency will restore faith in the reporting process while making the whole thing more rigorous than it has been.

Proposed changes include heightening the scrutiny of how annual reports are prepared with boards required to explain why they consider the report to be “fair, balanced and understandable”; audit committee expected to add additional oversight; and auditors to report by exception in circumstances where they believe the content of reports does not meet the “fair, balanced and understandable” criteria.

This brought stinging criticism from James Barbour, ICAS’ director of technical policy, who said reporting by exception is “outdated” and a “dilution of what is required”.

“Reporting by exception…does not place sufficient emphasis on an increasingly important part of corporate reporting,” he says.

In addition to reporting to the board on the front-end, or narrative’ section of the report, audit committee’s section of the annual report will be expanded to include an explanation of its approach to appointing or reappointing auditors.

Timothy Copnell, associate partner and member of the audit committee institute at KMPG, says these are areas already considered by audit committees, but by making the process transparent “it will better communicate the role of audit committee and restore integrity in business reporting”.

“The FRC’s unstated objective is that a little bit of external disclosure will drive rigour and robustness in the process.”

It is no surprise audit committees are going to be forced to explain why the company did or did not go out to tender; and if it did not, when a tender was last conducted. The length of audit tenures has become a prickly issue.

FTSE 350 companies are tardy at best when it comes to switching auditors. According to analysis from the Office of Fair Trading, average switching rates for FTSE 100 companies is every 43 years and for FTSE 250 companies is every 24 years.

The European Commission is due to release planned reforms that will enforce mandatory rotation of auditors on companies every six years, while the Dutch parliament is considering forcing companies to rotate their auditor every eight years.

“Whether rightly or wrongly auditors have been open to criticism over the length of audit contracts disclosure by audit committees will provide confidence in instances where there isn’t a change that due process has been gone through,” says Copnell.

However, the FRC appears to be moving even further away from the stance taken by the EC. Its latest proposals, which were already far less aggressive than the EC’s, will require FTSE 100 and FTSE 250 companies – rather than the entire listed market as previously stated – to put their audit out to tender at least once every ten years.

The FRC said it watered down the proposals because rolling out the change to the whole listed market would have resulted in s stampede of companies rushing out to change their auditor in the same year. In some instances the change could be deferred by up to five years, the regulator added.

The move was welcomed by Barbour, who agreed there should be “a period to see how it works before extending its scope.”

By forcing FTSE 350 companies to put their audits out to tender every ten years, while not requiring them to rotate, the FRC has created a halfway house that will appease auditors that believe the frequency of rotation should be placed in the hands of audit committees rather than regulators.

The FRC also appears to be hedging its bets. The EC may be in favour of mandatory rotation, but this is yet to be ratified by the European Parliament.

As one market source put it; “As with all things Europe, you can’t be sure where this will end up.”