Guidance on audit committees: The FRC's proposed changes
James Barbour, Director, Technical Policy highlights the FRC's proposed changes to the guidance on Audit Committees.
As a result of the need to implement the 2014 EU Audit legislation into the UK and to take account of the Competition and Markets Authority's (CMA) Orders and recommendations, the Financial Reporting Council (FRC) is proposing considerable revisions to its 2012 'Guidance on Audit Committees' (the Guidance).
Changes to reflect the EU Audit Legislation Requirements
- Expanding on changes relevant to the composition of the audit committee covering sectoral competence.
- Removal of the references to audit retendering.
- Changes covering the new rules around the prohibition of non-audit services.
- Consequential changes reflecting amendments to the Ethical and Auditing Standards for Auditors.
Changes to reflect Recommendations of the CMA
Many of the CMA recommendations coincide with amendments made by the 2014 EU Audit legislation, so changes to the guidance have been made with both of these sets of requirements
in mind. The FRC has addressed the CMA's Remedies 1 (and Parts 3 and 4 of the Order); 5 (and Part 5 of the Order); and 6 in the proposed changes to the Guidance.
CMA Remedy 1
This requires FTSE 350 companies to put their audit engagement out to competitive tender at least every ten years. To address this remedy the FRC has removed references to audit retendering in the Guidance as these have been overtaken by the CMA Orders and requirements of the EU Audit legislation. Additionally, the UK Corporate Governance Code and Guidance have been amended to provide that shareholders should be informed about future audit tendering plans. The Guidance expands upon this amendment, further recommending that in instances where the tender is not undertaken in line with the proposed timing this should be explained to shareholders in the audit committee section of the annual report.
The CMA recommended that the UK Corporate Governance Code be aligned with its order relating to an audit committee's oversight of the external auditor and the provision of non-audit services. However, the FRC does not wish to override the 'comply or explain' nature of the Code by requiring certain items, and rather, therefore, has proposed to include the suggested clarifications in the Guidance. Again a number of these align with amendments necessitated by the EU Audit legislation.
This recommended the disclosure of the FRC's Audit Quality Review (AQR) team inspection findings in audit committee reports. In addition, in 2015 the work of the FRC's AQR and the Corporate Reporting Review (CRR) teams was the subject of an externally facilitated review which also recommended greater transparency of their respective findings. The Guidance has therefore been amended to include reporting by audit committees of significant AQR and CRR findings.
In 2014, the FRC published a press notice outlining its suggested approach to disclosure of
AQR findings on individual audits in light of the CMA's recommendations. AQR now routinely reminds audit committees where appropriate, to discuss an AQR report with its auditor together with what actions, if any, they or the committee will take in response to the review, and to consider what information should be included in the audit committee's next report. The FRC has therefore amended the Guidance to provide that: "where a company's audit has been reviewed by the FRC's Audit Quality Review team, the Audit Committee should discuss the findings with their auditors and consider whether any of those findings are significant and, if so, make disclosures about the findings and the actions they and the auditors plan to take. This discussion should not include disclosure of the audit quality category."
CRR seeks to ensure that the provision of financial information by public and large private companies complies with relevant reporting requirements. It writes to companies where there is, or may be, a question whether the Strategic or directors' report or accounts comply with relevant reporting requirements. The FRC's Conduct Committee changed its operating procedures last year to permit the publication of the names of companies who, at its request, had included reference to its intervention when making a substantive change to its accounts.
The revised procedures also encouraged Boards to voluntarily refer to their exchanges with CRR in their reports. FRC's experience of the first year of working under the revised procedures has been that relatively few audit committees have provided clear disclosure of the nature and extent of interaction with CRR, except where the enquiry has resulted in a significant change to their report or accounts. Investors are likely to have an interest in knowing whether the audit committee has engaged in substantive discussions with CRR during the year and in any significant outcomes affecting the preparation of their report and accounts. Disclosure should be factually accurate, fair and balanced in order for the market to understand appropriately and avoid the need for further public clarification. CRR intends to work with audit committee chairs to achieve clear and concise disclosure.
The FRC has amended the Guidance to provide that the audit committee section of the annual report should include disclosure of:
- "The nature; and
- Extent of interaction (if any) with the FRC's Corporate Reporting Review team."
The FRC intends to continue to monitor how audit committees report the outcomes of AQR and CRR reviews in their annual reports.
Ensuring consistency and minimising overlap
The Guidance has been amended to reduce duplication with elements of the UK Corporate Governance Code. The Guidance should be read in conjunction with section C.3 of the UK Corporate Governance Code. The Guidance has also been updated to ensure consistency with other recent FRC documents, for example the Guidance on Risk Management, Internal Control and Related
Financial and Business Reporting released in September 2014 and the Audit Quality: Practice aid for audit committees issued in May 2015.
The section on internal audit has also been updated to reflect recent reviews of best practice in this area. A number of the elements around internal audit were already included in the Guidance, but they have been expanded upon to provide an indication of best practice.
Insights from other work areas
The Guidance also includes insights gathered from the FRC's other work, including changes suggested as a result of the monitoring work undertaken by the FRC's Conduct Division and evidence on the form and type of information preferred by investors as reported by the FRC's Financial Reporting Lab.
Audit Tenders: Notes on Best Practice
The document 'Audit Tenders: Notes on Best Practice', released in 2013 to assist companies in applying the provisions of the Code relating to audit tenders has not been included in the Guidance. The FRC intends to update the note incorporating their views before the end of 2015 and on a regular basis after that.