Auditor independence in Australia
Professional independence is a fundamental concept for the accounting profession and auditors are held accountable for their actions under an extensive framework of rules established under legislation and by the professional accounting bodies.
Users of audited financial information expect that the auditor has been objective and exercised professional judgment free from all economic, financial and other relationships. Independence is the absence of actual or perceived interests or threats that create an unacceptable risk of material bias with respect to the quality or content of information that is the subject of the audit/assurance engagement.
It has been argued that the greatest threat to auditor independence is the auditor’s relationship with the directors and management of the audited entity. Following recent corporate collapses, both in Australia and overseas, prominence was given to independence issues in the corporate law reforms.
Legislative and professional requirements
Australia has comprehensive legislative and professional requirements concerning the independence of auditors:
- Division 3 of Part 2M.4 of the Corporations Act sets out the requirements that have to be satisfied by the auditors of those entities that are subject to the audit requirements of the Corporations Act.
- Professional Statement F1 Professional Independence1 contains the independence requirements applicable to all members of the ICAA and CPA Australia (CPA). The National Institute of Accountants (NIA) has issued an equivalent statement which is applicable to all members of the NIA (NIA Pronouncements of the Board of Directors 1 Code of Ethics, Section 8).
- Professional Statement APS 5 Quality control for firms2 establishes basic principles and essential procedures and provides guidance regarding a firm’s responsibilities for its system of quality control. APS 5 is only applicable to members of ICAA and CPA. The NIA Statement on Quality Control is an equivalent statement.
- Auditing Standard AUS 206 Quality control for audits of historical financial information.3
Corporations Act requirements
Under the Corporations Act, all disclosing entities (which are primarily listed public companies), other public companies, large proprietary companies and registered managed investment schemes are required to have their financial reports audited. These audits have to be conducted by auditors or audit companies registered by ASIC for the purpose of conducting such audits.
ASIC may, in certain circumstances, relieve a large proprietary company of the obligation to have its financial report audited. On the other hand, the members of a small proprietary company that is not required by the legislation to prepare a financial report can require the company to prepare such a report and have it audited.
The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (the CLERP 9 Act) amended the Corporations Act through the establishment of a comprehensive regime on auditor independence. The amendments implemented recommendations of the Ramsay report (Independence of Australian Company Auditors) and relevant recommendations of the HIH Royal Commission.
As a result of the CLERP 9 Act amendments, the Corporations Act now contains the following measures to promote auditor independence:
- a general requirement of auditor independence;
- a requirement that auditors provide directors with an annual independence declaration;
- a prohibition of a number of specific employment and financial relationships between auditors and their clients which are considered to compromise independence;
- a ‘cooling off’ period of two years for partners of an audit firm or directors of an audit company who are directly involved in the audit of an audit client before they can take up a directorship or senior management position with the audit client;
- consistent with the recommendations of the HIH Royal Commission, a restriction on more than one former audit firm partner becoming an officer of an audit client at any one time;
- a requirement for an auditor of a listed company to attend the company’s annual general meeting, and for shareholders to be able to submit written questions to the auditor concerning the auditor’s report, including the independence of the auditor;
- a requirement for audit partner rotation for auditors of listed companies after five consecutive years. In light of concerns surrounding the impact of this requirement on smaller audit firms and those operating in rural and regional areas, ASIC is able to extend the period after which rotation is required to up to seven consecutive years; and
- a requirement for listed companies to disclose in their annual directors’ report the fees paid to the auditor for each non-audit service, together with a description of the service. In addition, the annual directors’ report of each listed company must include a statement by directors that they are satisfied that the provision of non-audit services does not compromise the auditor’s independence.
Ensuring compliance with requirements
To complement the legislative and professional requirements on independence of auditors, appropriate institutional arrangements have been put in place to monitor compliance with those requirements and, where necessary, take appropriate follow-up action. The principal organisations making up these institutional arrangements, and their respective roles, are outlined below.
Australian Securities and Investments Commission
CLERP 9 strengthened ASIC’s role in the surveillance, investigation, and enforcement of the responsibilities of companies and auditors on financial reporting, audit independence, and compliance with accounting, and auditing standards.
CLERP 9 requires auditors to provide a declaration of their compliance with both the Corporations Act and the professional standards for each audit.
ASIC conducts audit inspections of auditing firms to assess compliance with CLERP 9 audit reforms, including audit independence provisions.
ASIC is the body that registers company auditors in Australia. To become a registered company auditor, an applicant must satisfy ASIC as to their qualifications, experience and competency in auditing.
Australian Stock Exchange
The ASX is required under the Corporations Act to ensure that the listed company markets are fair, orderly and transparent. From 1 July 2006 the key supervisory operations of the ASX have been undertaken by ASX Markets Supervision Pty Ltd (ASXMS), a subsidiary company under a charter to undertake principles-based market supervision. ASXMS is responsible for monitoring the conduct of market users and compliance with ASX Operating Rules, enforcing the Operating Rules, and ensuring that sufficient resources are allocated to it to perform its supervisory functions.
The ASX Corporate Governance Council principles recommend that an audit committee should oversee the appointment of auditors and their independence of listed companies. ASX Principle 4: Safeguard integrity in financial reporting requires the company to have a structure that independently verifies and safeguards the integrity of the company’s financial reporting. This would include, for example, a review and consideration of the accounts by the audit committee, and a process to ensure the independence and competence of the company’s external auditors.
A declaration of compliance with the auditor independence requirements under Section 307C of the Corporations Act or of any applicable code of professional conduct in relation to the audit must be made by the auditor and be included in the directors’ report. The ASX monitors compliance with auditor independence certificate requirements and advises ASIC of any breaches.
Professional accounting bodies
The ICAA, CPA and NIA, being the professional accounting bodies, who are members of IFAC in Australia, undertake regular mandatory quality reviews of members who have a Certificate of Public Practice (CPP) or Public Practice Certificate (PPC). The reviews include ensuring their members are complying with the accounting, auditing and assurance standards and their respective code of ethics. The reviews take place on a rolling three-year programme for auditors of listed entities. Reviews of the Big Four firms are undertaken by the ICAA. The NIA only has a few members who audit public listed entities.
All the professional accounting bodies have updated their quality review programmes and manuals to reflect the new independence requirements under CLERP 9 and IFAC.
Accounting Professional and Ethical Standards Board
During 2006, the Accounting Professional and Ethical Standards Board was established as an initiative of the ICAA and CPA as an independent body to set the code of ethics and the professional standards by which their members are required to abide.
Audit firms (systems and processes)
The Audit Quality Review Board (AQRB) was established in February 2006 by the major audit firms. It is a not-for-profit company limited by guarantee, initiated and funded by the major audit firms to act as an independent review body with a board of members drawn from a broad range of disciplines. The majority of the AQRB’s directors (including the Chairman) are persons who have never been practicing accountants.
The AQRB’s primary purpose is to monitor the processes by which Participating Monitored Audit Firms4 seek to ensure their compliance with applicable professional standards and legal obligations in relation to independence and audit quality with respect to financial statement audits of publicly listed entities. In doing so, AQRB aims to enhance the credibility and integrity of the Australian auditing framework, to improve public confidence in that framework and to contribute to the continual improvement of the audit profession for the benefit of the Australian public.
AQRB has established a Constitution, Code of Conduct and Rules, which provide the framework for its operations. These Rules include a power to specify the monitoring process.
Companies Auditors and Liquidators Disciplinary Board
The CALDB, which is established under the ASIC Act, may take disciplinary action on the application of ASIC or the Australian Prudential Regulation Authority (APRA) against an auditor or liquidator. CALDB has power to admonish or reprimand a person; require a person to give an undertaking to engage in, or to refrain from engaging in, specified conduct; require a person to give an undertaking to refrain from engaging in specified conduct except on specified conditions; suspend or cancel a person’s registration. The CALDB does not have the power to initiate disciplinary actions on its own, even in cases of public interest.
Financial Reporting Council
Since July 2004, the FRC has been responsible for monitoring the effectiveness of auditor independence requirements in Australia and giving the Minister reports and advice about those requirements. The FRC has been given information gathering powers to support its auditor independence monitoring role.
1 From 1 July 2006, Professional Statement F1 was replaced by Section 290 of APES 110 Code of Ethics for Professional Accountants, which was issued by the Australian Accounting Professional and Ethical Standards Board in June 2006. The equivalent NIA statement is Section 290 of NIA Pronouncement 1. Code of Ethics.
2 From 1 July 2006, Professional Statement APS 5 was replaced by APES 320 Quality control for firms, which was issued by the Australian Accounting Professional and Ethical Standards Board in May 2006.
3 For financial reporting periods commencing on or after 1 July 2006, Auditing Standard AUS 206 has been replaced by ASA 220 Quality control for audits of historical financial information, which was issued by the Auditing and Assurance Standards Board in April 2006.
4 The initial participating firms are PricewaterhouseCoopers, Ernst & Young, KPMG, and Deloittes.