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ABAF Meeting 24 September 2005

This overview provides information on the EU 8th Directive, which covers issues such as independence, liability, network definition, and transparency in statutory auditing. It also discusses the implementation of IFRS in Europe and the impact of the directive on the audit profession.

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ABAF Meeting 24 September 2005

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  1. ABAF Meeting24 September 2005 EU 8th Directive – EU update Martin Manuzi ICAEW, Director, EU Office

  2. Overview of EU issues • EU 8th Directive on Statutory Auditing Independence/Auditor Liability/Network definition/Transparency • Professional Qualifications/Services Directives • 4th and 7th Company Law Directives • IFRS implementation in Europe

  3. 8th Directive: introduction • Most comprehensive single EU legislative initiative to impact on audit profession • 8th Directive no longer a sufficient title • High degree of harmonisation – but not full harmonisation: Member State options • Context is perceived need for greater confidence in audit function • EU regards this legislation as critical to the success of its regulatory dialogue with US

  4. 8th Directive: Co-decision timetable • Council general approach Dec 2004 • EP plenary session was due in September but now October • If approved on ‘first reading’, final implementation date middle of 2008 • No further changes to text now proposed, i.e. we are almost there • BUT institutional issue on comitology (not unique to 8th Directive) has caused delays

  5. 8th Directive: Comitology • Essential for implementation of 8th Directive: endorsement of standards, liaison with third country auditors, independence • EP wants“call back” clause giving Parliament 3 months to review implementing measures • Problem exacerbated by European Constitution vote • UK Presidency high priority • Solution appears to have been found for CAD

  6. 8th Directive: specific issues (1) • Ownership and management control • Qualification, continuous education, mutual recognition • Auditing standards/reporting: ISAs (endorsed by EU technical committee) • Quality assurance – independent of reviewed auditor, funding of system free of undue auditor influence, subject to public oversight

  7. 8th Directive: Specific issues (2) • Public oversight bodies- profession must be in minority. • EU coordination of oversight bodies: key feature • International aspects (i.e. recognition of third country auditors) • Special provisions for public interest entities (PIES) and audit thereof. • Definition of PIEs left ultimately to Member States: • “… for instance entities that are of significant public relevance because of the nature of their business, their size or the number of their employees.” • Audit committees (or comparable bodies) for PIEs

  8. 8th Directive: Issues of particular interest • Independence overall and Independence for PIEs - most discussed articles • Liability - not included in original EC proposal but now very much on agenda • Network definition • Transparency report

  9. 8th Directive: Independence (1) • Article 22. Includes: “Member States shall ensure that a statutory auditor (…) shall not carry out a statutory audit if there is any direct or indirect financial, business, employment or other relationship between the statutory auditor, audit firm OR THE NETWORK – including the provision of additional non-audit services – and the audited entity from which an objective, reasonable and informed third party would conclude that the statutory auditor’s (..) independence is compromised”

  10. 8th Directive: Independence (2) • Significant threats to be documented, safeguards to be applied. If safeguards insufficient: audit must not be carried out. • Huge debate over Article 22 whether to include additional paragraph: “Member States may set additional conditions to this Article, such as on the scope of the activities that auditors and audit firms may carry out.” • Debate “resolved” through two means

  11. 8th Directive: Independence (3) • First solution = Additional requirements for auditors of PIEs. • Auditor rotation (internal but external also permitted) • Annual written confirmation to audit committee of independence from audited entity • Annual disclosure to audit committee of any additional services to audited entity • Obligation to discuss with audit committee existing threats and use of safeguards to mitigate them • Prohibition of auditor/key partner taking up management role in audited entity for two years

  12. 8th Directive: Independence (4) • Second solution= opens way for more radical approach on prohibitions Article 52a: “The Member State requiring the statutory audit can impose more stringent requirements, unless otherwise indicated in the text of the Directive.” ….Independence debate certain to continue. Forum likely to be comitology as this will deal with implementation measures

  13. 8th Directive: auditor liability • Specific Article in the Directive requiring an economic study including an objective analysis of limitation of financial liability and a report to EP with, if appropriate, recommendations to member states • EC study and Forum: Challenge for profession to contribute as much as possible to the study. (UK commitment to proportionality)

  14. 8th Directive: Network Definition (1) • Article 2: "Network" means the larger structure : - which is aimed at cooperation to which a statutory auditor or an audit firm belongs, and; - which is clearly aimed at profit or cost sharing or shares common ownership, control or management, common quality control policies and procedures, common business strategy, the use of a common brand-name, or a significant part of professional resources;

  15. 8th Directive: Network definition (2) • Importance in relation to independence requirements: In addition to Article 22, Recital 10: “In order to determine the independence of auditors, the concept of “network” in which auditors operate needs to be clear. In this regard, various circumstances have to be taken into account such as instances where a structure could be defined as a network because it is aimed at profit or cost sharing, which may also be demonstrated if statutory auditors and/or audit firms have common usual [audit] clients. The criteria for demonstrating that there is a network should be judged and weighed on the basis of all factual circumstances known to exist.”

  16. 8th Directive: Transparency (1) • In relation to auditors of PIEs: Obligatory requirement of annual transparency report: • Among the items to disclose: ownership/legal structure, internal control, financial information, fees by services, independence practices… • Member States may add other items…

  17. 8th Directive: Transparency (2) • Specific requirement in relation to networks: “where the audit firm belongs to a network, a description of the network and the legal and structural arrangements in the network”. • One audit firm auditing one PIE in one Member State would trigger this requirement.

  18. 8th Directive: More on networks • The inclusion of the definition would appear to have wider relevance than independence • Network definition is also a global issue: IFAC consultation (closes 30 September) • FEE study on networks – on reality of networks, not definitions. • Trans-national aspects of accounting/auditing firms likely to be re-visited (Single Market policy) • Perceptions and disclaimers: can they co-exist?

  19. Professional Qualifications/Services Directive • New Recognition of Professional Qualifications Directive adopted -introduces form of cross-border service provisions (modified country of origin concept) • Services Directive: 1000+ proposed amendments. Small impact on accountants. • EC Competition work on professions

  20. 4th and 7th Company Law Directives • Another “confidence in reporting” initiative • Proposal undergoing co-decision procedure. EP position unclear: divergent views • Off-balance transactions: all companies to disclose material arrangements • Collective responsibility of boards • Corporate governance statement – as part of annual reports • Internal control (start of major EU activity?) • Rise in thresholds? – to ensure only appropriate companies fall within remit. Audit/assurance debate

  21. IFRS • IAS Regulation of 2002 now being implemented • Growing interest in IFRS consistency – US influence (SEC/EU Roadmap) • Possibility of new Forum (implications for IFRIC?) • Re-structuring of DG Internal Market • What future for EFRAG?

  22. Conclusion • Major implications arising from EU activity for the profession! • Further information available from: european.office@icaew.co.uk Tel 0032 2 2303272

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