International Standards on Auditing (UK and Ireland): The FRC’s key proposed changes
James Barbour, Director, Technical Policy highlights the FRC's key proposed changes to International Standards on Auditing (UK and Ireland).
FRC consultation on implementing the European Union (EU) Audit Legislation
This article highlights the Financial Reporting Council's (FRC) key proposals in relation to its proposed revisions to the International Standards on Auditing (ISAs) (UK and Ireland).
The two main sources for the changes are:
The 2014 EU Audit Regulation and Directive
- Articles in both the Regulation and Directive establish requirements that relate to matters that are the subject of the FRC's auditing and quality control standards for auditors.
International Auditing and Assurance Standards Board (IAASB)
- IAASB has issued new and revised standards arising from the following projects:
- In January 2015, IAASB issued a revised suite of auditor reporting standards (ISAs 700, 705 and 706).
- It also introduced a requirement for auditors of listed entities' financial statements to communicate "Key Audit Matters" – those matters that the auditor views as most significant, with an explanation of how they were addressed in the audit – in a new standard ISA 701.
- IAASB has also taken steps to increase the auditor's focus on the going concern basis of accounting by enhancing the auditor's reporting responsibilities, including requiring greater focus on the related disclosures in the financial statements, and adding more transparency in the auditor's report about the auditor's work in this respect.
- ISA 720 has been revised to clarify and enhance the auditor's responsibilities in relation to "other information" – defined in the standard as financial and non-financial information, otherthan the audited financial statements, that is included in (or accompanies) entities' annualreports.
- This revision enhances the auditor's work effort with respect to other information by requiring the auditor to consider whether there is a material inconsistency not only between the otherinformation and the financial statements but also between the other information and the auditor's knowledge obtained in the audit, in the context of audit evidence obtained and conclusions reached in the audit. It also requires the auditor to address the outcome of the auditor's work relating to other information, in the auditor's report.
- The IAASB has revised ISAs covering the audit of financial statement disclosures, in order to enhance the auditor's focus on disclosures, by introducing or enhancing certain requirements and application and other explanatory material in the ISAs addressing risk assessment, evaluating misstatements and forming an opinion on the financial statements relevant for the purposes of auditing quantitative and qualitative disclosures.
Incorporating the requirements of the Regulation and Directive into ISAs (UK and Ireland)
- The requirements of the Directive apply to all statutory audits. The UK needs to implement the requirements of the Directive into either law or regulation.
- The requirements of the Regulation apply to statutory audits of PIEs. The Regulation has the direct effect of law, therefore, the FRC is not required to, (but believes that there is a compelling argument to) include the relevant provisions of the Regulation in the auditing standards.
- FRC proposes to adopt a single implementation date for all proposed changes to the auditing standards, irrespective of their originating source, aligning to the implementation date required by the Regulation and Directive – effective for audits of financial statements commencing on or after 17 June 2016.
- As this effective date is later than the IAASB's (periods ending on or after 15 December 2016), FRC proposes to allow early adoption of the standards in order to facilitate changes to methodologies of international firms.
Adopting ISA 700 (Revised) and ISA 701
- FRC identified two key issues which needed to be addressed with respect to auditor reporting:
- Eliminating unnecessary wording; and
- Making auditor's reports more informative.
- The FRC has actively participated in the IAASB's auditor reporting project and has concluded that the significant concerns that the FRC had with the previous auditor reporting standard have now been addressed. For example, the IAASB's ISA 700 permits the description of the auditor's responsibilities to be cross-referenced to a website or an appendix of the auditor's report. ISA 701 includes the requirement to report on key audit matters, thereby making auditor's reports more informative.
- FRC therefore proposes to adopt the IAASB's ISA 700 (Revised) and ISA 701, subject to including additional UK pluses to retain some requirements already incorporated into the extant ISA (UK and Ireland).
- In revising the reporting standards the FRC has sought to retain those requirements which drove innovation in auditor reporting in the UK and Ireland. Therefore, it has extended the IAASB's definition of key audit matters to include:
- Those extant reporting requirements in the UK and Ireland that the auditor's report should "describe those assessed risks of material misstatement that were identified by the auditor and which had the greatest effect on: the overall audit strategy; the allocation of resources in the audit; and directing the efforts of the engagement team;" and
- The requirement in the Regulation for auditors of PIEs to include in support of the audit opinion "a description of the most significant assessed risks of material misstatement, including assessed risks of material misstatement due to fraud".
- FRC does not expect the two changes referred to above to result in an increase in the number of key audit matters communicated in the auditor's report. However, key audit matters to be communicated in the auditor's report are a matter of professional judgement and will depend on the specific circumstances of the audited entity and engagement.
- The FRC also proposes to extend the requirement in ISA 700 (Revised) for listed entities to apply ISA 701 to:
- Entities that are required, and those that choose voluntarily, to report on how they have applied the UK Corporate Governance Code – in order to maintain the existing similar requirements of extant ISA (UK and Ireland) 700 (Revised September 2014); and
- PIEs – in order to provide auditors with a framework to assess the risks that are required to be reported in accordance with the Regulation. Investors have indicated that the information communicated by the auditor on materiality and the scope of the audit is useful and therefore this requirement has been retained in ISA 701.
Revised requirements of ISA 720
- FRC proposes to adopt the IAASB's revised ISA 720 which applies to other information published alongside the financial statements. This requires the auditor to report whether they have identified any material misstatements in the other information. Auditors will need to consider the work necessary to satisfy this requirement.
- However, ISA 720 clearly states that this reporting requirement should not be interpreted as a form of assurance, unless it relates to a specific requirement of the Directive.
- The Directive requires the auditor to give an opinion on certain of the other information (interpreted in UK [and Irish] legislation as the director's report and where one is required, or voluntarily prepared, the strategic report and the separate corporate governance statement and defined in the proposed standard as 'statutory other information').
- Under existing legislation, the auditor is required to give an opinion on whether the statutory other information is consistent with the financial statements. The Directive goes further, and requires auditors, based on the work undertaken as part of the audit, to:
- Express an opinion on the compliance of the statutory other information with the applicable legal requirements; and
- State whether any material misstatement in the statutory other information has been identified by the auditor in light of the knowledge and understanding of the audited entity, which they have gained during the course of the audit.
- FRC proposes to address this by incorporating requirements in ISA (UK and Ireland) 720 (Revised) to require the auditor to: obtain an understanding of the applicable reporting framework used to prepare the statutory other information; consider whether there are material misstatements between the other statutory information and that framework; and report on the statutory other information in accordance with the legislation.
- In addition, the following have been incorporated into ISA (UK and Ireland) 720 (Revised):
- Certain paragraphs currently included in extant ISA (UK and Ireland) 700 (Revised) relating to reporting on other information;
- Requirements formalising the reporting on the Listing Rules currently undertaken by premium listed entities; and
- Relevant requirements and guidance (updated where necessary) from ISA (UK and Ireland) 720 Section B.
- FRC proposes to withdraw ISA (UK and Ireland) 720 Section B and "Section A" will be dropped from the title going forward.
Reporting on the going concern basis of accounting
- FRC proposes, in addition to the enhancements made by the IAASB, to include additional UK pluses in ISA (UK and Ireland) 570 (Revised) for entities where the use of the going concern basis of accounting is appropriate and no material uncertainty has been identified to:
- Where the auditor is required to or voluntarily applies ISA (UK and Ireland) 701, require the auditor to consider whether to communicate a key audit matter about going concern; and
- Require the auditor to report by exception on management's use of the going concern basis of accounting and whether material uncertainties have been identified but not disclosed.
Reporting to regulators of PIEs
- The Regulation requires auditors of PIEs to report the following to the competent authorities responsible for oversight of those PIEs:
- Certain material breaches in laws, regulations of administrative provisions;
- A material threat or doubt over the continuous functioning of the PIE; and
- A refusal to issue or a modification of the audit opinion.
- These requirements have been incorporated into ISA (UK and Ireland) 250 Section B 'The Auditor's Right and Duty to Report to Regulators in the Financial Sector' and as such thescope of this section of the ISA (UK and Ireland) has been widened to include all PIEs,although in practice the matters that will require reporting will relate to the financial sector.
Retention of records
- FRC proposes to include a requirement in ISQC (UK and Ireland) requiring audit working papers which will include those documents and information required to be retained by the Regulation to be retained for a minimum period of 6 years for all entities from the date of the auditor's report.
Changes arising from the Accounting Directive
- The Companies, Partnerships and Groups (Accounts and Reports) Regulations 2015 implement the requirements of the Accounting Directive in respect of 'abridged' accounts (which will come into effect for years commencing on or after 1 January 2016) such that:
- Small companies will be permitted to prepare and file an abridged rather than full profit and loss account or an abridged rather than full balance sheet, or both, where all members agree;
- The previous option for small and medium-sized companies to file abbreviated accounts will be removed; and
- A special auditor's report on the abbreviated accounts is therefore no longer required and no similar provision has been introduced for abridged accounts.
- Where either i) a balance sheet only; or ii) an abridged statement as part of a set of accounts; is filed, the directors are required to include a statement on the balance sheet about certain aspects of the audit (name of audit firm and senior statutory auditor, whether the opinion was modified or included an emphasis of matter) and a statement that a resolution has been passed to the effect that all members agreed to the preparation of abridged accounts (if applicable). The Accounting Directive precludes the filing of an audit report alongside these accounts.
- No responsibilities are imposed by law on the auditor with respect to the filing of these accounts. FRC therefore takes the view that it therefore does not appear appropriate or proportionate to mandate or recommend procedures that the auditor should follow (e.g. assessing whether the requirements of Companies Act with respect to the required statements have been complied with).
- The FRC therefore proposes to withdraw Bulletin 2008/48 with effect for periods commencing1 January 2016.
True and fair view
- Where the company has chosen to prepare an abridged profit and loss or balance sheet, or both, as its statutory accounts subject to audit, the auditor needs to be satisfied that the resulting financial statements give a true and fair view and that any additional disclosures that the auditor believes should be included have been provided.
- Additional application material has been added at paragraph A15-1 of ISA (UK and Ireland) 210 (Revised) to provide guidance.
- The micro-entities regime was introduced in UK company law in 2013 with significantly reduced financial statements presentation and disclosure requirements.
Deemed true and fair view
- FRS 105 is not a fair presentation framework as defined by ISA (UK and Ireland) 200 (Revised) as it does not acknowledge explicitly or implicitly that to achieve fair presentation of the financial statements it may be necessary for management to either provide disclosure beyond that required by the framework or to depart form a requirement in the framework to achieve fair presentation. However, the financial statements of an entity prepared in accordance with the micro-entities regime are presumed in law to show a true and fair view. Entities that prepare their financial statements in accordance with the micro-entities regime are not required to have an audit. Where one is requested the auditor will need to address the "deemed" true and fair view in the auditor's report.