Auditing The Auditors – Final Regulation Of Auditing In Australia Report Released.

Overview
 

In mid-November 2020, the Parliamentary Joint Committee on Corporations and Financial Services released their final report on the regulation of auditing in Australia, building upon the ten substantive policy recommendations identified in the interim report released in February 2020.
 

With the COVID pandemic hitting Australia since the interim report release and resultant government economic stimulus measured announced (including the Coronavirus Economic Response Package Omnibus Bill 2020), insolvency featured as a heightened risk for auditors.
 

Relevance to insurers
 

The recommendations in the interim and final reports all point to a more robust and transparent system for audit governance and reporting in Australia. A system based on timely public disclosures of auditor conduct and auditor independence provides a lower probability for extreme misconduct events, as the system is designed to capture early warning signals or high risk areas… a welcome outcome for accountant's professional indemnity insurers.  However the call for increased regulatory scrutiny has the potential to increase the number of auditors seeking indemnity for investigation and defence costs.  
 

Key recommendations
 

• Greater public disclosure of reports: The Committee noted that the inquiry process increased reporting transparency amongst audit firms that had not previously been forthcoming, with Australia's largest audit firms publically disclosing their Australian Securities and Investment Commission (ASIC) audit inspection reports, and a number of the sector's leading companies voluntarily instituting additional transparency oversight committees and reporting structures. Further clarity on organisational structures, remuneration and poor outcomes was also placed on the public record, including:
   

  • auditor evaluation and remuneration, including financial penalties for audit partners who perform poorly in ASIC's audit inspection program;
     

  • information about corporate clients that have collapsed under the watch of the audit firms; and
     

  • the remuneration and tax arrangements of retired audit partners.
     

• The Committee made the following recommendations in relation to the review, reporting and publishing of audit firm inspection reports:
   

  • With the improved transparency achieved by the publishing of ASIC's audit inspection reports, ASIC should continually review its audit inspection methodology, with the aim of producing more robust and transparent reports that take into account the contested nature of some of the professional judgements made by both auditors and ASIC inspectors (Recommendation 1); and 
     

  • ASIC should continue to make public on its website all future individual audit firm inspection reports (Recommendation 2).
     

• Independence and accuracy: A recurrent theme in both the interim and final reports centralises on the 'trust deficit' in the auditing practice, with auditor independence and accurate external auditing being the key determinant in rebuilding trust in capital markets, noting it "is more critical than ever in helping determine efficient and effective capital allocation".

  The Committee's recommendations include:
   

  • ASIC to review its audit inspection program and reporting (Recommendation 1);
     

  • The Financial Reporting Council (FRC) to establish (a) defined categories and associated fee disclosure requirements in relation to audit and non-audit services, and (b) a list of non-audit services that audit firms are explicitly prohibited from providing to an audited entity (Recommendation 3);
     

  • An amendment to the Corporations Act 2001, expanding the auditor's independence declaration to require the auditor to specifically confirm that no prohibited non-audit services have been provided (Recommendation 4); and
     

  • The Accounting Professional and Ethical Standards Board should consider revising the APES 110 Code of Ethics to include a safeguard that no audit partner can be incentivised, through remuneration advancement or any other means or practice, for selling non-audit services to an audited entity (Recommendation 5).

  •  

• Auditor tenure and mandatory tendering requirements: The Committee recommended that the FRC amend the Australian standards to require the disclosure of information of an entity's external auditor tenure, including the length of tenure and the lead audit partner, stating that this is a low-cost and simple regulatory change that will carry considerable benefits for stakeholder perceptions of the audit process. (Recommendation 6)

  In addition, it recommended the establishment of a mandatory tendering regime, through the Corporations Act, so that entities required to have financial reports audited under the Act must (a) undertake a public tender process every ten years; or b) if they elect not to undertake a public tender process, must disclose their reasons for not undertaking a tender process to shareholders.

  The ten year timeframe is purely a recommendation, designed to strike a balance between appropriate stakeholder reporting and independence with commercial aspects of business operation, being that the familiarity auditors establish with an entity over time can lead to efficiencies within the audit process, therefore lower audits costs. Though the Committee noted that "audit arrangements that remain in place for many decades clearly undermine stakeholder confidence in the system as a whole", and that boards should not "set and forget" audit arrangements. (Recommendation 7)

  Given the current economic climate as a result of the COVID pandemic, the Committee reviewed the initial guidance that this regime begin in 2022 and advised that the Government should consider an appropriate timeline for implementation and perhaps look to a staggered implementation to allow boards sufficient time to respond to new processes.
   

• Detection and prevention of fraud: The Committee recommended that the FRC oversee a formal review of the effectiveness of reporting requirements under the Australian standards regarding (a) the prevention and detection of fraud and misconduct, and (b) assessing a company's economic viability as a going concern, noting that contention still exists around what auditors are required to provide under statutory obligations versus what a user of financial reports expects an auditor to provide. (Recommendation 8)
   

• Requirement for an internal controls framework: In February 2020, the Committee recommended that entities that are required to have their financial reports audited under the Corporations Act 2001, must establish and maintain an internal controls framework for financial reporting, and that such framework should include a requirement that the entity's management evaluate and report annually on the effectiveness of their internal control framework. It was also recommended that the external auditor report on the entity's assessment of its internal control framework. (Recommendation 9).

  As with Recommendation 7, given the current economic constrains as a result of the COVID pandemic, the Committee recognised that this implementation may come with a transitional cost to entities, and as such recommended that Government consider an appropriate timeline for implementation, as well as introducing thresholds (such as size and type of entities).
   

• Digital financial reporting:
  The Committee welcomed the AASB and AUASB guidance to auditors, adding that (where it relates to large entities) auditors should apply "sceptical rigor to management's assessment of going concern", and noted that the thrust of the Committee's interim report was directed at the auditing of large complex entities. The Committee stood by its view that even in these unprecedented and often difficult business operating conditions, the AASB should continue to press the International Accounting Standards Board to undertake a thorough review of the standard applying to the impairment of assets, and that while there is risk in implementing potentially substantive changes during a crisis, the process should ultimately move forward with consideration as to appropriate implementation timeframes.

  The Committee recommended that the Government undertake a review to identify and resolve any remaining barriers-to-use of digital financial reports, with view to making digital financial standard practice in Australia in the near future. Machine-readable financial statements allow for timely and accurate analysis by audit firms, regulators, financial market analysts and academics. (Recommendation 10)
   

On Insolvency
 

Since the interim report in February, the Government has introduced the Coronavirus Economic Response Package Omnibus Bill 2020, which included temporary insolvency and bankruptcy protections for financially distressed businesses. Concurrent to this announcement, the Accounting Standards Board (AASB) and the Auditing and Assurance Standards Board (AUASB) issued joint guidance that set out particular cautionary advice that auditors should consider in relation to possible financial reporting misstatements.

The Committee welcomed the AASB and AUASB guidance to auditors, adding that (where it relates to large entities) auditors should apply "sceptical rigor to management's assessment of going concern", and noted that the thrust of the Committee's interim report was directed at the auditing of large complex entities. The Committee stood by its view that even in these unprecedented and often difficult business operating conditions, the AASB should continue to press the International Accounting Standards Board to undertake a thorough review of the standard applying to the impairment of assets, and that while there is risk in implementing potentially substantive changes during a crisis, the process should ultimately move forward with consideration as to appropriate implementation timeframes.
 

 

For further information, please contact:

 

Nicole Wearne, Partner, Clyde & Co 

Nicole.Wearne@clydeco.com