Executive Summary
This, the Financial Reporting Council’s (FRC) second auditor independence report, outlines the work undertaken by the FRC in 2005-06 in the performance of its auditor independence functions. The report also sets out the findings of the FRC as a result of that work and, where appropriate, the action taken by the FRC in respect of those findings.
In 2005-06, the FRC addressed each of the core issues that, together, make up its auditor independence functions: systems and processes of Australian auditors, quality review programmes and disciplinary procedures of the professional accounting bodies as related to auditor independence, the teaching of ethics by, or on behalf of, those bodies and compliance by companies with audit-related disclosure requirements. In addition, the FRC gave consideration to international developments in the area of auditor independence.
The overall conclusion that the FRC has reached during 2005-06 is that the auditor independence framework in Australia is operating effectively. No systemic issues were revealed as a result of the significant work undertaken by the various parties. Based upon this finding, stakeholders can have a high degree of comfort that the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (CLERP 9 Act) is operating as envisaged, and investors can have a high level of assurance in the audit process in Australia. While the FRC has concluded that the overall system is working effectively, it has also identified some areas that are worthy of further consideration for potential improvements.
In 2005-06, as in the previous year, the FRC’s work on the systems and processes of Australian auditors relied heavily on the report of the audit inspection programme conducted by the Australian Securities and Investments Commission (ASIC), supplemented by information gathered at meetings between the FRC and the major accounting firms. In this respect, the FRC is mainly interested in ASIC’s observations and findings regarding the independence of auditors. It is only interested in quality review issues to the extent that they impact on its responsibilities under CLERP 9.
ASIC noted in its inspection report that the accounting firms have generally responded positively to the new Australian legislative requirements for auditor independence and audit quality and that its observations and findings vary considerably between the Big Four firms and the other firms.
Although ASIC noted a small number of instances where individuals had failed to comply with the independence requirements of the Corporations Act 2001 (Corporations Act), the firms concerned asserted that these were addressed promptly in accordance with the requirements of the Act. The FRC has concluded that there is no evidence of systemic problems in respect of compliance with those requirements.
The FRC’s 2004-05 independence report foreshadowed that the FRC would examine issues associated with the quality review programmes and disciplinary procedures of the professional accounting bodies and the teaching of ethics by, or on behalf of, those bodies as part of its 2005-06 auditor independence function work programme. This work commenced during the year, with the engagement of a number of short-term consultants to examine each matter, and will be continued in 2006-07 as part of the work programme for that year.
The consultants have made a number of findings and recommendations, summarised at Appendices C to E. The FRC intends to examine these findings and recommendations as part of its 2006-07 work programme, including consultations with the professional accounting bodies and other stakeholders.
The examination of the quality review programmes of the professional accounting bodies concluded that the programmes for reviewing members and firms that undertake audits comply with International Federation of Accountants (IFAC) and Australian professional pronouncements, although the consultants qualified their findings because they did not review files and thus were unable to conclude that the processes and procedures had been followed. The consultants recommend that the files from the quality review programme of the Institute of Chartered Accountants in Australia (ICAA) should be available to the FRC so that it can sight evidence that the professional accounting bodies’ quality review policies and procedures, as they relate to auditor independence, have been followed.
The consultants have also noted the absence of a requirement for auditors in Australia to belong to a professional accounting body as a pre-requisite for registration as a company auditor and for the continuation of that registration. The FRC has monitoring responsibilities over the quality review, teaching of ethics and disciplinary arrangements of the professional accounting bodies as related to auditor independence, but in view of accountants not being required to be members of a professional accounting body to be registered as an auditor, it cannot provide oversight through the professional bodies over a segment of the auditing industry.
The consultants have also highlighted the concentrated structure of the Australian audit industry around the Big Four accounting firms, and recommend further research on the structure of the industry.
The examination of the disciplinary procedures of the professional accounting bodies indicated that the procedures of each body are adequate. However, the consultant has identified a number of threshold issues concerning the purpose and role of the professional bodies in disciplining auditors, their relationship in this area with ASIC and the Companies Auditors and Liquidators Disciplinary Board (CALDB), and the CALDB’s ability to initiate disciplinary actions in the public interest. These issues warrant further examination and consultation with the professional bodies and other stakeholders by the FRC, which the FRC intends to undertake as part of its 2006-07 work programme.
Pleasingly, the examination of the teaching of ethics by, or on behalf of, the professional accounting bodies has found that the depth of understanding of ethical issues by officers of the three bodies and by members of accounting firms, their commitment to deal with these issues and steps being taken to do so, is well beyond anything observed in other disciplines, business or professions, including law. The consultant has also made a number of recommendations on ways to enhance the teaching of ethics in the profession. These recommendations will be subject to further examination and consultation with the professional bodies and other stakeholders by the FRC, which the FRC intends to undertake as part of its 2006-07 work programme.
The FRC’s work on monitoring the overall compliance by companies, registered managed investment schemes and disclosing entities with audit-related disclosure requirements of the Corporations Act and accounting standards was based on information supplied by ASIC from their accounts surveillance programme and the Australian Stock Exchange Ltd (ASX). The results of ASIC’s review (which did not cover the full range of disclosure requirements) showed that the majority of the financial reports examined complied with the requirements examined as part of the review. A similar conclusion was reached by the ASX.
As part of its 2006-07 work programme, the FRC plans to review the level of compliance with audit-related disclosure requirements by considering the information provided by the Memoranda of Understanding (MOU) bodies.
In its last report, the FRC indicated that during 2005-06 it intended researching Australia’s requirements on auditor independence compared with those applicable in other major jurisdictions worldwide. The review, which was undertaken by the Treasury to provide assistance to the FRC, compared five core elements of the Australian auditor independence requirements with the equivalent requirements applying in Canada, the European Union (EU), the United Kingdom (UK) and the United States of America (US). The overall conclusion of the review is that, notwithstanding differences in terminology, institutional arrangements and legal frameworks, there is a substantial underlying equivalence between the Australian auditor independence requirements and ‘best practice’ standards adopted internationally.
The FRC has identified from the review the following areas in which some aspects of the Australian independence requirements differ from the requirements applicable in some or all of the other jurisdictions: employment and financial restrictions, employment restrictions applying to former audit partners and senior audit personnel, multiple former partners of an audit firm/audit company director restrictions and auditor rotation. The FRC will consider these issues as part of its work programme for 2006-07, with a view to submitting appropriate recommendations for consideration by the Government.
The FRC welcomes the Government initiatives aimed at the reduction of red tape affecting businesses. The FRC intends to give further consideration, as part of its 2006-07 work programme, as to whether any scope exists for reducing the overlap of auditor review responsibilities between the firms, professional accounting bodies and regulators. This is particularly important in view of the lesser depth and diversity of auditing resources in Australia compared with the US and Europe.