Home > Reports > FRC & AASB Annual Report 2003-2004 - Preliminaries

Part 2: Financial Reporting Council
Auditor Independence Report

2004-05

Introduction

The FRC’s functions were significantly expanded from 1 July 2004, following legislative amendments made by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (the CLERP Act), to include monitoring the effectiveness of auditor independence requirements in Australia and giving the Minister reports and advice about those requirements.

Since the enactment of the CLERP legislation, the FRC’s role in respect of the auditor independence function has been primarily concerned with establishing arrangements needed for monitoring the effectiveness of auditor independence requirements in Australia on an ongoing basis.

FRC’s Auditor Independence Functions

The FRC’s auditor independence functions are conferred on it under paragraphs 225(1)(c) and (d), and subsection 225(2B) of the Australian Securities and Investments Commission Act 2001 (ASIC Act).

Under subsection 225(1) of the ASIC Act, the FRC is required to monitor the effectiveness of auditor independence requirements in Australia and to give the Minister reports and advice about those requirements.

In addition, the FRC has the following specific auditor independence functions conferred on it under subsection 225(2B) of the ASIC Act:

• monitoring and assessing the nature and overall adequacy of:
  • the systems and processes used by Australian auditors to ensure compliance with auditor independence requirements;
  • the systems and processes used by professional accounting bodies for planning and performing quality assurance reviews of audit work undertaken by Australian auditors to the extent that those reviews relate to auditor independence requirements;
  • the action that Australian auditors who have been subject to such quality assurance reviews have taken in response to the reports prepared as a result of those reviews;
  • the action taken by professional accounting bodies to ensure that Australian auditors who have been subject to such quality assurance reviews respond appropriately to the reports prepared as a result of those reviews; and
  • the investigation and disciplinary procedures of professional accounting bodies as those procedures apply to Australian auditors;
• monitoring the overall compliance by companies, registered schemes and disclosing entities with the audit-related disclosure requirements of the Corporations Act and the accounting standards;
• giving the Minister reports and advice about the matters referred to in the above paragraphs;
• giving professional accounting bodies reports and advice about matters related to their quality assurance reviews and disciplinary procedures as detailed in the above paragraphs;
• monitoring international developments in auditor independence, assessing the adequacy of the Australian auditor independence requirements provided for in:
  • the Corporations Act; and
  • codes of professional conduct;

in the light of those developments and giving the Minister, and professional accounting bodies, reports and advice on any additional measures needed to enhance the independence of Australian auditors; and

• promoting, and monitoring the adequacy of, the teaching of professional and business ethics by, or on behalf of, professional accounting bodies to the extent to which the teaching of those subjects relates to auditor independence.

To facilitate the performance of the audit independence functions by the FRC, section 225A of the ASIC Act sets out powers that may be used by the FRC for gathering information from Australia’s professional accounting bodies and Australian auditors.

Scope of auditor independence function

During 2004-05, the FRC sought the advice of the Australian Government Solicitor (AGS) on the scope of its auditor independence functions.

The AGS advised that the FRC’s functions should be primarily directed to ensuring that auditors are complying with auditor independence requirements in their Corporations Act 2001 audits. However, the advice also said that it would also be open to the FRC, at least in some of its functions, to look at the issue of auditor independence more broadly, and to examine the non-Corporations Act audits of ‘Australian auditors’.

The implication of this advice is that the FRC should extend the scope of its work beyond Corporations Act audits to cover entities such as self managed superannuation funds.

Performance of functions

To facilitate the performance of the auditor independence functions, the following actions were taken by the FRC during 2004-05:

• the establishment of an Audit Independence Subcommittee;
• signing Memoranda of Understanding (MOU) with the professional accounting bodies, ASIC, ASX and APRA (MOU bodies);
• the appointment of a consultant to provide guidance and advice to the FRC in the performance of the function; and
• meeting with, and gathering information from, the MOU bodies and selected accounting firms.

Audit Independence Subcommittee

The Audit Independence Subcommittee, which was established by the FRC on 18 June 2004, held eight meetings during 2004-05.

Members of the Committee during the year were Ms Elizabeth Alexander AM (Chairman), Ms Karen Hamilton (to December 2004), Mr David Jackson (from February 2005), Mr Charles Macek, Mr Greg Pound (to March 2005), Mr Brian Scullin (from February 2005), and Ms Catherine Walter AM.

The Subcommittee’s Charter, which was approved by the FRC on 20 September 2004, provides that it will assist the FRC by:

• making recommendations to the FRC concerning the engagement of a person, or persons, to assist the FRC in the performance of the functions conferred on it under subsection 225(2B) of the ASIC Act (the consultant);
• performing, either alone or in conjunction with the consultant, the work and other activities needed to ensure the FRC meets the obligations imposed on it by subsection 225(2B) of the ASIC Act;
• making recommendations to the FRC Chairman concerning the notices that should be given by the Chairman pursuant to section 225A of the ASIC Act; and
• preparing, for the consideration of the FRC, a draft of the report the FRC is required to prepare under section 235BA of the ASIC Act.

Memoranda of Understanding

MOUs were signed with the three professional accounting bodies (CPA Australia, The Institute of Chartered Accountants in Australia and the National Institute of Accountants), the Australian Stock Exchange, the Australian Prudential Regulation Authority, and the Australian Securities and Investments Commission in order to facilitate the efficient exchange of information between the MOU bodies and the FRC.

In addition, a letter of understanding was also entered into between the Companies Auditors and Liquidators Disciplinary Board and the FRC.

Appointment of Consultant

On 23 December 2004, the FRC Chairman announced that Mr William Bartlett had been engaged to undertake the FRC’s auditor independence consultancy. The purpose of the consultancy is to assist the FRC in the performance of the auditor independence functions conferred on the FRC by the CLERP Act. Before retiring as a partner of accounting firm Ernst & Young in June 2003, Mr Bartlett spent 35 years working in the accountancy field, including as auditor of firms in the financial services industry. He is presently a director of a number of Australian public companies and also a company which is listed on the New York Stock Exchange.

Meetings with MOU bodies and accounting firms

Meetings were held with all the MOU bodies and the CALDB and information requests were sent to all bodies. Replies were received from and the relevant information produced by all bodies.

1. Meetings were also held with the four major accounting firms and one mid-tier firm. The four major accounting firms (Deloitte Touche Tohmatsu, Ernst and Young, KPMG and PricewaterhouseCoopers) audit listed entities comprising 91 per cent of the market capitalisation of the 300 largest ASX listed entities and 54 per cent of all ASX listed entities.

A meeting was held in March 2005, with staff from the US Public Company Accounting Oversight Board (PCAOB) and ASIC to determine their approach to companies and auditors registered with the PCAOB. The PCAOB staff advised that they were discussing the possibility of a cooperative arrangement with ASIC under which ASIC would work jointly with them in respect of the Australian audit firms that are registered with them.

FRC’s findings and conclusions

Section 235BA of the ASIC Act requires the FRC to report annually to the Minister on the performance of its auditor independence functions, including the findings and conclusions that the FRC reached in performing those functions, and the actions (if any) that were taken by the FRC in respect of those findings and conclusions. This chapter focuses on reporting the FRC’s findings and conclusions for 2004-05 and any actions that the FRC took in respect to those findings and conclusions.

Systems and processes used by Australian auditors

Subparagraph 225(2B)(a)(i) of the ASIC Act requires the FRC to monitor and assess the nature and overall adequacy of the systems and processes used by Australian auditors to ensure compliance with auditor independence requirements. In 2004-05, the FRC performed this function by gathering information from ASIC under the terms of its MOU with that body and through meetings with the four largest accounting firms and one mid-tier firm.

Report from ASIC

The MOU that the FRC has entered into with ASIC provides for periodic consultations and information sharing between the two bodies to assist in undertaking their respective responsibilities under the law. In this context, ASIC advised the FRC of their intention to conduct in 2004-05, a review of the big four accounting firms, with particular emphasis on the systems and processes used by these firms to ensure compliance with auditor independence requirements, and to report to the FRC on any systemic issues that might be identified as a result of this activity. The review undertaken by ASIC has thus constituted a key source of information for the FRC with respect to its responsibilities in this area during 2004-05.

ASIC informed the FRC that during the second half of 2004-05, it conducted on site inspections at each of the big four accounting firms. ASIC reviews were focussed on whether the firms had documented and implemented a quality control system that provides reasonable assurance that the firms comply with the independence requirements of the Corporations Act. The firms have not previously had a regulator’s inspection of their policies, systems and processes. Not surprisingly, in each case, ASIC suggested improvements to the firms’ systems and processes. Generally, ASIC’s report focuses on suggested areas of improvement in the systems, policies, procedures, practices or conduct of certain audit firms, rather than setting out all of the positive aspects. ASIC noted in its report that the suggested areas of improvement do not detract from the conclusions listed in the next paragraph.

In their report to the FRC, ASIC noted that:

• All firms had documented policies in place and these were assessed as being generally adequate;
• While ASIC conducted a limited review of engagement files to see whether these policies were being implemented in practice, they did not seek to comprehensively test for breaches of the audit independence requirements; and
• No breaches of the Act were identified in the course of their inspections.

ASIC also noted that:

• Overall, the firms have responded positively to the new legislative requirements for auditor independence; and
• The firms have committed resources and where needed have developed policies, systems and processes to assist them in complying with Australian legislative requirements, being assisted in this by being part of global firms.
• addition to the above general observations, ASIC has identified and conveyed to the firms areas where there is scope for improvements in their systems and processes. Particular observations made by ASIC are noted below:
• Each firm’s executive leadership has sent a strong message within their firm about the importance of independence, but in some firms there is scope to improve oversight of independence policies and practices, and to improve formal reporting on independence to the firms’ Boards;
• The firms have systems to monitor compliance with internal policies and processes, and with the firms’ legislative obligations (including CLERP 9). The firms’ own internal testing of compliance with their policies and procedures has revealed some unsatisfactory results, although in every case the firms asserted this did not result in a breach of Australian legal independence requirements;
  • ASIC has noted that a high level of non-compliance with internal policies potentially increases the risk that breaches of legal requirements may occur in the future (although, as noted above, ASIC did not identify specific breaches of legal requirements);
• All the firms’ documentation of engagement level independence confirmations was inadequate, partly as a result of some firms not having a documented process for obtaining independence confirmations from individual team members on each engagement or, when this process was in place, due to an unsatisfactory level of compliance with it;
  • ASIC has noted that there is a potential for independence policies to be breached without this engagement level sign-off;
• The extent of documentation for approving non-audit services varied amongst the firms. Each firm has a policy requiring that non-audit engagements for existing audit clients be pre-approved by the lead client service partner, but most policies do not specify whether or how the approval should be documented;
• Varying commitments have been made to CLERP 9 training by the firms. Despite each firm’s leadership reiterating the importance of independence requirements of the Corporations Act, at several firms this support has not translated into attendance and completion of mandatory training by all professional staff;
• In some of the firms the link between breaching policies and processes and the impact on performance and / or remuneration was not clear to staff;
  • ASIC has noted the need to better communicate the consequences of non-compliance for staff; and
• Most firms do not have formal collection of data on independence queries and issues and some firms did not have a register of all independence breaches;
  • ASIC has noted that formalising how knowledge is retained and shared will reduce reliance on key independence personnel.

In addition to the above procedural observations, ASIC has also made some comments on a number of principles and timing-related issues. These are indicated below with the FRC’s comments.

• In some instances firms have remained more focussed on the requirements of the Sarbanes-Oxley than CLERP 9. Some firms did not update their global policies, systems and processes for Australian legislative requirements until after 1 July 2004.
  • The FRC acknowledges that the CLERP 9 legislation was not passed until late June 2004 and it is understandable that firms would have required some time for implementation.
• All the firms have policies in respect of holding of a financial interest in audit clients. While all the policies comply with the requirements of the Corporations Act, some firms have implemented higher standards than others. The different policies range from where one firm prohibits all professional staff from holding a financial interest in any audit client worldwide, to where only members of the engagement team are prohibited from having a financial interest in the audit client when they work on that engagement. All firms require their partners to be financially independent of all audit clients.
  • The FRC acknowledges ASIC’s comments and believes that it is appropriate for the firms to further consider this issue.
• ASIC has also noted that some firms appeared to take a somewhat narrow and legalistic view of their obligations. They may provide services to Australian clients that they do not provide to their SEC-registered clients on the basis that those services are prohibited in the US and not in Australia.
  • The FRC considers it is appropriate for firms to take into account public perceptions in relation to auditor independence when deciding to offer these services.

Issues raised by accounting firms

In addition to the report from ASIC, the FRC obtained additional information from a separate round of meetings it conducted around the end of 2004-05 with each of the big four accounting firms and with a mid-tier sized firm.

The overall message that emerged from these meetings was that it is early days in respect of the implementation of the new audit independence requirements. The firms noted and the FRC acknowledged that there could be some anomalies reflecting unintended consequences from the CLERP 9 legislation. The FRC understands that most of the anomalies are being dealt with by ASIC and Treasury.

Particular observations raised by the firms that may warrant further examination by the FRC during the upcoming 2005-06 year are:

• Takeovers are creating practical issues for firms being free of independence conflicts with partners and personnel having to rearrange their affairs in a short time frame;
• Firms wishing to take part in an audit tender need to cleanse themselves from an audit independence perspective where the proposed audit independence change takes place retrospectively. This requirement could lead to companies having a reduced appetite for audit change. Some firms are experiencing problems in hiring new lateral partners, and are finding some resistance from graduates to consider the auditing profession as a career path.
  • The FRC is of the view that it would be unfortunate if the audit independence framework, including the practical issues referred to above, made it more difficult to hire appropriate personnel. This is an area the FRC will be focusing on in 2005-06 with a view to considering whether recommendations for any legislative changes might be considered appropriate.
• Difficulties are being encountered by the mid-tier firms and the small offices of major firms with the requirement to rotate review partners; and
• Firms are spending a great deal of time dealing with minor procedural issues as opposed to the important issues. Their perception is that interpretation by the regulators is more rules based (black letter law) than principles based.
  • As noted above, the FRC welcomes the work that is being undertaken to address these anomalies.

Following the introduction of CLERP 9, the four major firms, subsequently joined by most of the mid tier firms and with support from the accounting profession, have been proposing to set up an independent body known as the Audit Quality Enhancement Monitor (AQEM) to monitor the processes by which participating firms seek to ensure compliance with independence and quality related professional standards and law. As at 30 June 2005, the establishment of this body had not been finalised. The FRC considers that the establishment of a common audit oversight board (instead of firm-specific audit review boards) could be seen as a strengthening of self-regulation. To the extent that AQEM replaces the independent review boards of two of the big four firms, it should achieve greater consistency across the industry.

Systems and processes used by professional accounting bodies

Under subparagraphs 225(2B)(a)(ii), (iii) and (iv) of the ASIC Act, the FRC is required to monitor and assess the nature and overall adequacy of the systems and processes used by the professional accounting bodies for planning and performing quality assurance reviews of audit work undertaken by Australian auditors to the extent that those reviews relate to auditor independence requirements and subsequent follow-up actions by both auditors subject to such reviews and the professional bodies. In addition, under subparagraph 225(2B)(a)(v) the FRC is required to monitor and assess the nature and overall adequacy of the investigation and disciplinary procedures of professional accounting bodies as those procedures apply to Australian auditors.

In 2004-05, the FRC performed this function by gathering information from the three professional accounting bodies (ICAA, CPA Australia and NIA) with which it has entered into MOUs. As stated in the respective MOUs, each of the professional accounting bodies has undertaken to provide the FRC with information about their respective:

• quality assurance reviews in relation to auditor independence, including general outcomes from the reviews undertaken; and
• disciplinary processes regarding auditors, including general information about Australian auditors who have been subject to disciplinary action.

Quality reviews

The three accounting bodies have periodical quality review programmes for their members. Reviews undertaken by ICAA are now scheduled to take place on a rolling three years programme for auditors of listed entities. Up to mid-2003, the ICAA reviewed all members in public practice on the basis of a five year rolling programme. CPA Australia is contemplating introducing a three year cycle as part of its current review. Members who have a joint public practice certificate can choose either ICAA or CPA Australia to undertake a review. Reviews of the big four firms are undertaken by the ICAA, as there are no registered company auditors in the big four firms that have a public certificate with CPA Australia. The NIA has only a small number of members who audit listed entities.

All the professional accounting bodies have amended, or are in the process of amending, their quality review programmes and manuals, to reflect the new independence requirements instituted by CLERP 9. CPA Australia is reviewing its policy by which the auditor can select the reviewer.

• The FRC has advised the bodies to continue to allocate priority to these efforts.
• The FRC will be monitoring in 2005-06 the amount of resources allocated to the quality review programmes to ensure a comprehensive review is conducted at the audit firms.

The professional accounting bodies have revised and updated their codes of conduct dealing with professional independence (F1 in the case of ICAA and CPA Australia) with the aim of making them compatible with the independence requirements of the Corporations Act.

• The FRC has encouraged the professional bodies to maintain an active dialogue with ASIC to ensure this objective is met.

The ICAA and CPA Australia are also considering the establishment of a joint ethical standards board to advise on professional ethical standards, with all three professional accounting bodies currently reviewing their own code of ethics.

The professional accounting bodies have also undertaken a number of initiatives to provide guidance to their members in meeting their audit independence requirements.

As a result of the initiative by the major firms to form AQEM, the ICAA decided to suspend its review programme for the four major accounting firms. As it turned out, discussions with ASIC and other parties with an interest in the possible establishment of AQEM took longer than anticipated by ICAA and this resulted in none of the big four firms being reviewed since the introduction of CLERP 9. In fact, due to the earlier frequency of reviews, none of the existing big four firms were actually reviewed by the ICAA since 2002.

• The FRC advised ICAA on the desirability of a prompt resumption of these reviews.
• On 26 April 2005, the ICAA advised the FRC of its decision to resume the review programme for the big four accounting firms. The FRC welcomes this decision and will be reviewing the extent and quality of these reviews as part of its 2005-06 work programme.

Disciplinary processes

The FRC reviewed at a high level the whole framework of disciplinary systems which deal with CLERP 9 and auditor independence. There are many entities potentially involved, including the accounting bodies, ASIC and the CALDB, but because they have all acted independently there are situations of potential overlap and underlap. The FRC is uncomfortable with the present framework and it is the FRC’s opinion that there is significant room for improvement and strengthening of disciplinary procedures. The FRC believe it could be premature to make comments or recommendations at this stage and will be reviewing this area in detail in 2005-06. The FRC would appreciate dialogue and cooperation from all parties so that present uncoordinated efforts can be optimised

All of the various bodies are in the process of strengthening their disciplinary systems. The ICAA and CPA Australia advised the FRC of a number of initiatives that are being considered to strengthen their disciplinary procedures, with this approach being welcomed by the FRC:

• CPA Australia has changed its policy to allow the suspension of a member that is being subject to an investigation process;
• ICAA is considering a change to their disciplinary processes by which it could notify the public when a member’s professional conduct is being investigated.

The FRC also discussed with professional accounting bodies whether in some instances the reasons for resignation from a professional body should be made public. The bodies would like in some instances to make the reasons public but are concerned about the legal ramifications¹. It was noted that in Canada there is protection via a tribunal.

• The FRC has concluded that there is merit in investigating further this option in 2005-06.

A related area that needs to be considered further is the case of registered company auditors who are not a member of any of the three professional bodies and are therefore not subject to any of the professional development requirements, ethical requirements, or disciplinary procedures. The non-membership of a professional body by an auditor could present a potential for abuse.

• In the year to 30 June 2006 the FRC will attempt to establish in broad terms the quantum of auditors who are not members of an accounting body. ASIC also has noted a concern that the requirements of CLERP 9 do not apply to foreign auditors performing audits of overseas subsidiaries of Australian entities, a matter that needs to be addressed in the upcoming financial year.

The professional accounting bodies currently choose not to take action against auditors if there are legal proceedings outstanding against the auditor until the conclusion of those proceedings. There may also be circumstances, such as the existence of criminal proceedings, which could cause the CALDB to defer action against the auditor. In some cases the proceedings go back many years, and there is a danger that a person can continue to practice as an auditor even though they may have been party to an audit with serious deficiencies.

Compliance with audit-related disclosure requirements

The FRC is required by paragraph 225(2B)(b) of the ASIC Act to monitor the overall compliance by companies, registered managed investment schemes and disclosing entities with the audit-related disclosure requirements of the Corporations Act 2001 and the accounting standards. The principal audit-related disclosure requirements in the Corporations Act and accounting standards are:

• paragraph 298(1)(c) of the Corporations Act, which requires a company, registered managed investment scheme or disclosing entity to include in its directors report for each financial year a copy of the auditor’s independence declaration under section 307C in relation to the audit for the financial year;
• subsection 306(2) of the Corporations Act, which provides that the directors’ report of a disclosing entity must include a copy of the auditor’s independence declaration under section 307C in relation to the audit or review for the half-year;
• paragraphs 5.3(a) and (b) of accounting standard AASB 1034 Financial Report Presentation and Disclosures, which require an entity or economic entity to disclose in its financial report the remuneration of the auditor, showing separately amounts for audit and other services; and
• paragraphs Aus 126.1 and Aus 126.2 of accounting standard AASB 101 Presentation of Financial Statements, which contain disclosure requirements equivalent to those in paragraphs 5.3(a) and (b) of AASB 1034 but greater detail in respect of non-audit services.

The requirements of section 307C of the Corporations Act apply to financial reports for financial years that start on or after 1 July 2004. The disclosure requirements in the current version of AASB 1034 apply to financial years ending on or after 30 June 2001, while the requirements in AASB 101 (which, in respect of audit-related disclosures, replaces AASB 1034) apply to financial years commencing on or after 1 January 2005.

The MOU that the FRC has entered into with ASIC provides for ASIC to give the FRC regular reports identifying matters arising from its financial reporting or auditor surveillance activities in relation to compliance by auditors and companies with the independence disclosure requirements in Part 2M.3 of the Corporations Act. MOUs with APRA and ASX also provide for those bodies and the FRC to exchange information.

During discussions with the MOU bodies, the FRC was advised by ASX that there are inconsistencies in the manner in which a significant number of companies have complied with the requirements of the Corporations Act in respect of the inclusion in the Directors’ Report of a copy of the auditor independence declaration. However, the FRC is not aware of any material instances of auditors advising of non-compliance with the independence requirements.

The FRC will be undertaking a detailed examination of the audit-related disclosure requirements as part of its 2005-06 work programme.

Teaching of professional and business ethics

Under paragraph 225(2B)(f) of the ASIC Act, the FRC is required to promote, and monitor the adequacy of, the teaching of professional and business ethics by, or on behalf of, the professional accounting bodies to the extent to which the teaching of those subject relates to auditor independence.

The three professional bodies have provided the FRC with detailed information about their courses on business and professional ethics. The FRC plans to undertake an in-depth examination of this information during 2005-06.

During the course of its meetings with accounting firms, the FRC was informed that the in-house courses conducted by the firms (for example, induction, promotion to manager and appointment as partner) all contain material about business and professional ethics. The FRC welcomes efforts by the firms to promote a high ethical culture among their partners and staff.

International developments in auditor independence

Paragraph 225(2B)(e) of the ASIC Act provides that the FRC is to monitor international developments in auditor independence, assess the adequacy of the Australian auditor independence requirements provided for in the Corporations Act and the codes of professional conduct in light of those developments and give the Minister, and professional accounting bodies, reports and advice on any additional measures needed to enhance the independence of Australian auditors.

In 2004-05, the FRC monitored international developments through consideration of publicly-available inspection reports issued by overseas oversight bodies (for example, the US Public Company Accounting Oversight Board, the Canadian Public Accountability Board and the UK Professional Oversight Board for Accountancy), other material placed on the internet websites of these oversight bodies and associated regulatory agencies and general media reports about audit independence issues.

In addition, the FRC Chairman attended in September 2004 a meeting in Washington of heads of oversight bodies convened by the Financial Stability Forum and met with representatives of overseas oversight bodies during overseas visits in November 2004 and June 2005.

During the year, the FRC did not become aware of any international developments in the area of audit independence that suggest Australia’s new requirements are in need of revision or further enhancement.

In 2005-06 the FRC intends to research Australia’s requirements on auditor independence compared with those applicable in other major jurisdictions worldwide.

Other issues

In the course of the performance of its auditor independence functions the FRC has become aware of a number of related topics that merit inclusion in this report as they have a potential impact on the effectiveness of auditor independence requirements in Australia. These other issues are covered in this section.

CLERP 9 implementation

Reference was made earlier in this report to observations made by the major accounting firms about the implementation of the CLERP 9 requirements. ASIC, in its letter to the FRC dated 24 June 2005, also commented on this matter when it noted that, although the overall auditor independence framework under the Corporations Act appears to be working, a number of anomalies and issues have been identified in respect of the amendments made by CLERP 9.

• The FRC understands that ASIC and the Treasury are exploring options for the prompt resolution of this matter, a course of action that it supports.
• The FRC is also of the view that these issues highlight the risks of having a too prescriptive approach to regulation.

The FRC is aware that some of the accounting firms are concerned about the extent of ASIC’s powers to review the firms and undertake inspection work. ASIC clearly has the power to inspect an audit of any reporting entity to test its compliance with the Corporations Act, but queries have been raised about its powers to inspect the firms’ systems and processes. The FRC is of the opinion that ASIC’s powers of inspection in relation to audit firms needs to be clarified, and in this regard, the FRC notes the recent release by the Commonwealth Treasury of a consultative paper containing proposals for law reform in relation to ASIC’s powers for gathering information about how audit firms carry out the audit function. A key policy objective of the Treasury paper has been to avoid unnecessary duplication between Australian and overseas audit regulation systems, such as that administered by the US PCAOB, thus minimising the need for the overseas bodies to undertake their own inspections in Australia. The Treasury paper also includes proposals for changes to ASIC’s inspection powers with the aim of reducing the regulatory burden for firms subject to inspections in purely domestic situations.

• In the 2005-06 Commonwealth Budget, the Government announced its decision to support the expansion and upgrade of ASIC’s audit regulation programme in the context of facilitating cooperation between Australia’s system of audit regulation and those of other jurisdictions.

Corporations Act disciplinary matters

ASIC and APRA are the only parties who have the power to refer registered company auditors for breaches of CLERP 9 to the CALDB. Our inquiries revealed that no referral to the CALDB had ever been made by APRA.

• The FRC noted that in the event that APRA refuses to accept an auditor continuing as auditor to one of their registered bodies, it is important that the person be referred to ASIC or the CALDB. Otherwise, an auditor that is not considered to be fit and proper in an industry may continue to practise in other industries.

With the introduction of CLERP 9 the CALDB may face increased requirements in respect of auditor independence.

• The FRC recommends that sufficient funding be allocated to CALDB to enable it to perform its functions.

Action against the accounting firm as opposed to the individual

In Australia, any action for a breach of auditor independence is taken against the individual as opposed to the firm. In the United States, action is taken against both. In Australia, the legal system does not allow action against the firm. The FRC has not come to a conclusion as to whether any action could be extended against a firm and will investigate this area in more detail in 2005-06.

Self managed superannuation funds

Whilst self managed superannuation funds are not within the prime ambit of the FRC’s responsibility, we understand that there are instances of accountants providing both audit and book-keeping services and in extreme cases the same person acting as a director and auditor of a self managed fund. The accounting bodies, especially the NIA, have provided advice to their members but it is our impression that the level of knowledge regarding this issue in the accounting community is low.

• The FRC will be looking at this area in more detail in 2005-06 and will be seeking input from all relevant stakeholders.

Overall conclusion

During the first year of operation of CLERP 9, the FRC focused on gaining an understanding of all of the various stakeholders’ attitudes and monitoring systems in relation to independence and quality control as it relates to CLERP 9. It is recognised that with the quick introduction of CLERP 9, most parties took several months to put arrangements in place. A number of issues have been identified that warrant attention in the upcoming year, but no systemic deficiencies have been identified. The FRC has seen evidence this year that:

• There is an open approach to the significant changes required by CLERP 9 by all of the MOU bodies and the major accounting firms. The ‘tone at the top’ regarding independence at all these bodies is positive.
• The major accounting firms have significantly upgraded their systems, quality control, training and disciplinary processes. These firms have different approaches to some of these issues but all comply with the level required by CLERP 9.
• The regulators have updated their processes to monitor compliance with CLERP 9 and in the case of ASIC have completed their first round of visits to the major accounting firms.
• The ICAA has reviewed its monitoring of the major accounting firms and whilst not performing any reviews of the major continuing accounting firms since 2002, will now ensure the reviews are done in 2005-06. The professional bodies are upgrading their quality control, independence monitoring, and disciplinary procedures and the FRC will be paying special attention to the upgrades in 2006.

The FRC would also like to register a few general observations with respect to the auditor independence framework in Australia:

• As noted earlier in this report, we consider that there are risks of having a too prescriptive approach to regulation and welcome the actions that are being taken to address some unintended consequences of the legislation.
• The need for the auditing profession to have a clear public interest focus in their activities should be reinforced. Public trust in the profession is heavily influenced by perception of its actions, which needs to be taken into account by the profession in its conduct. This is a key component of the strategic direction that the FRC has given to the AUASB with respect to its auditing standard setting activities and is an area that we will continue to monitor closely.
• Finally, audit firms need to ensure that the appropriate ‘tone at the top’ is reflected in a strong message conveyed to staff on the importance of adherence to their own systems and processes, including attendance at training on audit independence requirements.

The work conducted by the FRC in 2004-05 was focussed on its core functions dealing with the monitoring of the systems and processes used by Australian auditors and by the professional accounting bodies to ensure compliance with the auditor independence requirements in Australia. In 2005-06, while continuing to address these functions, an increased emphasis will be placed on the monitoring of the teaching of ethics, the compliance by companies with the audit-related disclosure requirements and the research into best practice worldwide with respect to auditor independence requirements.

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¹ The ICAA has informed the FRC that it does have the power to make public, in certain circumstances, the reasons for a member’s resignation, particularly if it has followed the initiation by the Institute of disciplinary proceedings.