FRC strengthens auditor independence requirements
The Financial Reporting Council (FRC) has published revisions to its Ethical Standard. Some of the key changes are summarised below.
The revised FRC Ethical Standard has been simplified and made more use friendly.
Scope of more stringent non-audit services requirements
In 2019, the FRC consulted on whether further entities should be subject to the more stringent non-audit services requirements for public interest entities. This proposal received widespread support. A decision on expanding which entities will follow these requirements had been deferred until post the publication of Sir Donald Brydon’s report to ensure a consistent approach. Given that this report was published on 18 December 2019, it is now likely that this matter will be considered in the new year.
Recruitment and remuneration services
The FRC has followed the lead of the International Ethics Standards Board for Accountants (IESBA) by incorporating requirements which now prohibit auditors from providing recruitment and remuneration services or playing any part in management decision making.
The auditor of a public interest entity will now only be able to provide non-audit services which are closely linked to the audit itself or required by law or regulation. To facilitate this the revised Ethical Standard contains a new section 5B “Approach to Non-audit / Additional Services Provided to Public Interest Entities”.
Rather than containing a list of prohibited services this new section details the types of non-audit services that an auditor of a public interest entity and a member of its network (where applicable) can provide to that PIE, its UK parent undertaking or its worldwide controlled undertakings. The provision of any such service is also subject to the approval of the audit committee after it has properly assessed threats to independence and the safeguards applied in accordance with the FRCs Ethical Standard.
SME listed entity
The concessions that were offered in the 2016 FRC Ethical Standard to entities of this nature have been removed.
New provisions incorporated into Section 1 highlight the increased importance placed on the Ethics Partner:
Paragraph 1.15 of the FRC Ethical Standard
1.15 If differences of opinion arise between the Ethics Partner and persons consulting them, the firm’s policies and procedures for dealing with and resolving differences of opinion shall be followed. If in following those procedures, the firm concludes that the opinion of the Ethics Partner is not to be followed where it relates to an engagement on a public interest entity, the matter shall be reported to the firm’s independent nonexecutives and to the Competent Authority. The engagement partner shall also report this matter to those charged with governance.
This new requirement to report to the Competent Authority and Those Charged with Governance (PIE auditors ONLY) where there has been a disagreement will require consideration as to how best to operationalise.
Paragraph 1.21 of the FRC Ethical Standard
1.21 Whenever a possible or actual breach of this Ethical Standard, or of policies and procedures established pursuant to the overarching principles and supporting ethical provisions and requirements
established in it, is identified, the engagement partner, in the first instance, and the Ethics Partner, where appropriate, shall assess the implications of the breach, determine whether there are safeguards that
can be put in place or other actions that can be taken to address any potential adverse consequences and considers whether there is a need to resign or withdraw from the engagement. The firm shall report all breaches to the Competent Authority on a biannual basis and to those charged with governance of an entity relevant to an engagement, where a breach relates to a specific engagement or engagements in a timely manner.
Likewise, this new requirement to report to the Competent Authority and TCWG where there has been a breach (all audit firms not just PIEs) will require consideration as to how best to operationalise.
The FRC has made a subtle but significant change to requirements in relation to long association for non-PIE audit entities. What was previously an “or” in paragraph 3.6 (in 2016 and 2019 versions) has been replaced by an “and”. Therefore, where an audit engagement partner has held that role for a continuous period of ten years, appropriate safeguards (refer to paragraph 3.5 of FRS ES 2019), have to be applied; along with documenting the reasoning as to why the individual continues to participate in the engagement is documented, and the facts are communicated to those charged with governance of the entity.
The insertion of a new paragraph 4.2 (see below) represents another significant change. This will require firms to be able to justify, including with the application of appropriate safeguards, where a lower than expected audit fee is charged.
4.2 Paragraph 4.1 is intended to emphasise that there are no circumstances where the amount of the engagement fee can justify any lack of appropriate resource or time taken to perform a proper engagement in accordance with applicable Engagement and Ethical Standards. However, where an engagement partner agrees a fee for an engagement that an objective, reasonable and informed third party would conclude that it is probable that the independence of the auditor would be compromised as a result, the engagement partner shall report the safeguards applied to ensure the delivery of a fully compliant audit to those charged with governance in accordance with paragraph 1.62 of this Ethical Standard.
In addition, paragraph 4.5 introduces a prohibition on contingent fees for the provision of non-audit and audit-related services to an entity relevant to an audit engagement, its UK parent undertaking and any worldwide controlled undertaking
The revised Ethical Standard becomes effective on 15 March 2020, except for paragraph 5.42 which applies to periods commencing on or after 15 December 2020. Firms may complete engagements relating to periods commencing before 15 March 2020 in accordance with existing ethical standards, putting in place any necessary changes in the subsequent engagement period. Engagements to provide previously permitted non-audit or additional services entered into before 15 March 2020, and for which the firm has already commenced work, may continue until completed in accordance with the original engagement terms, subject to the application of appropriate safeguards.