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New auditing rules took effect from 17 June 2016

04 July 2016

Although the full impact has yet to be felt, from an auditor’s point of view one of the major features of the past year has been the implementation of the EU Audit Directive and Regulation, and the efforts of the various interested parties to ensure that the requirements are applied in the UK in a sensible and proportionate manner. The Directive amends the EU’s 2006 Statutory Audit Directive which governs statutory audits throughout the EU and on which our current auditing regime is partially based. The Regulation only applies to the audits of public interest entities (PIEs), ie entities with securities listed on a regulated market, banks, building societies and insurers. AIM companies are not regarded as PIEs.

Both the Directive and the Regulation are the outcome of a long process to reform and regulate the audit market with a view to improving quality, competition and consistency across the single market of the EU. Much of the focus of the new legislation is on the issue of auditor independence, the role of the audit committee in monitoring audit quality and in strengthening audit regulation. The result is a significant package of changes that came into effect on 17 June 2016.

Changes arising from the implementation of the Directive and Regulation are widespread and include:

  • Revised and restructured ethical standards issued by the Financial Reporting Council (FRC) – primarily affecting audits of PIEs. These impose more onerous restrictions and rules regarding independence and the provision of non-audit services, but also widen the scope of the revised ethical standard to cover other assurance services as well as audit.
  • Significant restrictions on non-audit services include bans on provision of certain services and a cap on the value of other services provided worldwide by the audit firm and members of its network.
  • New rules for auditor rotation with mandatory re-tendering after ten years and a maximum tenure of 20 years (subject to transitional rules). This may cause issues where significant parts of the audit are carried out in other jurisdictions where different rotation and tenure rules may apply.
  • Revised auditing standards incorporating detailed requirements of the Directive and Regulation.
  • Further minor changes to the UK Corporate Governance Code.
  • Changes to Financial Conduct Authority and Prudential Regulation Authority rules for regulated entities, mainly regarding audit committees.
  • Changes in the role of the FRC which is now the ‘competent authority’ for oversight and regulation of the audit profession. As part of this, the FRC will now directly carry out regulatory reviews in respect of the audit of PIEs, bringing a number of smaller listed and unlisted PIE entities and their auditors within the scope of its inspection regime for the first time.
  • The FRC ceases to be the competent authority for audit regulation in Ireland and this role will be taken over by a new Irish body.

At the same time, the FRC has taken the opportunity to update and revise applicable Auditing Standards, now called ISA (UK), to reflect a number of changes made recently to ISAs by the International Auditing and Assurance Standards Board (IAASB), including adoption of the IAASB’s revised auditor reporting standards. This latter change will have a big impact on the format and wording of auditor’s reports – although in most cases the new standards will first apply for June 2018 year ends.

One key change in the audit report is the introduction of a new ISA (UK) 701 dealing with reporting of ‘Key Audit Matters’ (KAMs). This follows the same sort of approach to enhanced reporting as has been used recently in the UK for listed companies, and others, who follow the UK Corporate Governance Code, but now extends the requirements to all companies traded on AIM and ISDX and further envisages the possibility of voluntary reporting of KAMs by auditors of other entities.