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3. Auditor independence in Australia

Australia has comprehensive legislative and professional requirements concerning the independence of auditors. The principal requirements are:

  • Division 3 and 5 of Part 2M.4 of the Corporations Act which sets out the requirements that have to be satisfied by the auditors of those entities that are subject to the audit requirements of the Act;
  • Auditing Standard ASA 220 Quality control for audits of historical financial information, which was issued by the Auditing and Assurance Standards Board in April 2006;
  • Section 290 of the Code of Ethics for Professional Accountants (APES 110), which was issued by the Australian Accounting Professional and Ethical Standards Board (APESB) in June 2006; and
  • APES 320 Quality control for firms, which was issued by the APESB in May 2006.

Under the Corporations Act, all disclosing entities, public companies, large proprietary companies and registered schemes are required to prepare financial reports and have them audited. These audits must be conducted by auditors or audit companies registered by ASIC for that purpose.

In 2004, Australia's audit independence framework was significantly strengthened with a number of measures contained in the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (the CLERP 9 Act). During 2006-07, the Government made further refinements to the auditor independence requirements as part of the package of reforms contained in the Corporations Legislation Amendment (Simpler Regulatory System) Act 2007 (SRS Act). A guide to Australia's auditor independence requirements prepared by the Treasury is at Appendix E.

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 are ASIC, ASX, the professional accounting bodies (the ICAA, CPA Australia and the National Institute of Accountants (NIA)), the APESB, the AQRB, the Companies Auditors and Liquidators Disciplinary Board (CALDB) and the FRC. The respective roles of these organisations are outlined at Appendix F.

3.1 Systems and processes of Australian auditors

The ASIC Act requires the FRC to monitor and assess the nature and overall adequacy of the systems and processes used by audit firms to ensure compliance with auditor independence requirements.

In 2007-08, the FRC performed this function by gathering information from ASIC under the terms of its MOU with that body, by reviewing reports published by the AQRB and the ICAA, requesting information from the professional accounting bodies and through meetings with seven audit firms, including Australia's largest four firms.

As a result of this work, the FRC formed the view that the systems and processes used by audit firms to ensure compliance with independence requirements are working effectively. However, the FRC notes that the inspections by ASIC have revealed that a number of the firms reviewed need to make improvements in their systems to ensure that the systems are robust and comply with all the legislative requirements.

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.

ASIC's 2007-08 report to the FRC summarises ASIC's observations and findings in relation to the independence systems and processes of selected firms where inspections commenced around 1 July 2007 and were substantially completed prior to 30 June 2008. As in past years, the review undertaken by ASIC has constituted a key source of information for the FRC with respect to its responsibilities in this area during 2007-08.

In addition to its report to the FRC for 1 July 2007 to 30 June 2008, ASIC also released a public report summarising the results of its audit regulation activities for the period 1 July 2006 to 31 December 2007. The findings of ASIC's report to the FRC differ to some extent, the public report relates to the period 1 July 2006 to 30 June 2007 and examines 19 firms whereas the report to the FRC relates to the inspections of 12 firms, two of which were not included in the public report and covers the 2007-08 financial year.

The scope of the public report covers audit quality as well as independence, whereas the report to the FRC relates only to the independence systems and processes used by Australian auditors, in accordance with the terms of ASIC's MOU.

ASIC's inspection process for the year ended 30 June 2008 covered 12 selected firms. Of these firms:

  • five were inspected for the first time (Group A);
  • three were inspected for the second time (Group B); and
  • four were inspected for the third time (Group C).

Two of the inspections were conducted jointly with the Public Company Accounting Oversight Board of the Untied States (PCAOB). These were undertaken under an agreement entered into by ASIC to assist the PCAOB ascertain compliance by Australian auditors with the Sarbanes Oxley Act of 2002.

Collectively, the 12 firms inspected by ASIC audit approximately 95 per cent by composition and 99 per cent by market capitalisation of the 300 largest entities listed on the Australian Securities Exchange (S&P/ASX 300).

The FRC is pleased to note ASIC's overall finding that firms have shown commitment towards meeting their independence obligations.

ASIC observed that, in contrast to its 2006-07 report, more of the firms that were inspected for the first time in 2007-08 had implemented independence policies, systems and processes than the firms visited by ASIC for the first time in 2006-07. However, ASIC also noted that a number of the firms reviewed for a first and second time need to make improvements in their systems to ensure that the systems are robust and comply with all the legislative requirements. The areas where these firms need to make improvements include:

  • Independence policies, systems and processes. ASIC reports that two Group A firms need to take action to ensure their documented policies meet all the legislative requirements of the professional and ethical standards and the Corporations Act.
  • Testing of the annual independence confirmations. The professional and ethical standards require firms to annually confirm, in writing, their compliance with their independence policies. ASIC notes that the majority of firms in Group A and B have not commenced testing of the annual independence confirmations to ensure that processes are operating satisfactorily.
  • Acceptance and continuance policies. While all Group B firms have developed and implemented policies and processes for the acceptance and continuance of client relationships and specific engagements as required by the professional and ethical standards, the acceptance and continuance processes of two Group A firms were not fully developed or appropriately documented.
  • Non-audit services policies and processes. Notwithstanding that all firms have established policies and processes to approve the provision of non-audit services to existing audit clients, ASIC found deficiencies in the quality and existence of documentation to evidence the application of firm policies. In particular, ASIC observed that documentation of the consideration of threats and safeguards by many of the firms before agreeing to provide non- audit services to an audit client could be improved.
  • Human resources and tone at the top. ASIC reports that approximately half of the Group A and Group B firms need to give appropriate recognition to the commitment to independence in the firm's staff evaluation, compensation and promotion processes. Most of the firms in Group A and Group B need to improve their processes so that it is clear that independence has been explicitly considered in partner performance evaluations. While all firms agree independence is a given', few firms assess partners or staff against defined criteria. ASIC also reports a high incidence of staff not being aware of the consequences of non-compliance with independence policies.

ASIC reports that firms inspected for a second and third time have continued to make good progress in addressing the observations and findings raised with them in prior year inspections. All major issues have been addressed and good progress has been noted in most areas.

With respect to Group C firms, which have responsibility for the audit of 90 per cent by composition and 95 per cent by market capitalisation of the S&P/ASX 300, ASIC reports that:

  • All Group C firms are testing the annual independence confirmation processes and the data and systems supporting those confirmation processes. This testing has not revealed any breaches of the Corporations Act although it continues to show levels of non-compliance with the policies of the Group C firms. However, ASIC notes that policies of Group C firms include specific requirements that go further than the requirements of the Act.
  • All but one of the Group C firms has adopted a process that extends beyond the mandatory obligations in relation to requiring staff to confirm in writing that they have no independence conflicts with each specific audit client on which they are working.
  • All Group C firms have developed and implemented policies and processes for the acceptance and continuance of client relationships and specific engagements as required by the professional and ethical standards.
  • All Group C firms have established and are testing their policies and processes for provision of non-audit services to ensure that they are being complied with. The results of testing revealed some non-compliance with the firms' policy requirements to document the approval to provide these services. That said, the testing did not identify any instances of independence impairing services being provided.
  • As was the case for Group A and B firms, there was also a high incidence of staff in Group C firms not being aware of the consequences of non-compliance with independence policies.

In its 2006-07 report to the FRC, ASIC noted that two firms needed to address rotation requirements as a matter of urgency. Both firms took action to avoid breaching the requirements of the Corporations Act by either resigning as auditor where relief could not be provided by ASIC under section 234A of the Act, or appointing external consultants to act as engagement quality control reviewer enabling rotation to be facilitated within the firm.

During 2007-08, ASIC received one application for relief from auditor rotation requirements, which was outside the scope of the Act and subsequently withdrawn by the firm.

ASIC's inspections did not highlight any significant issues with the rotation processes of firms. However, ASIC reports that their consultations with firms on rotation requirements highlighted two areas of ambiguity within the Act:

  • When the rotation requirements begin to take effect if a company lists on a prescribed financial market in Australia.
  • Whether the interpretation of significant role' as defined in section 9 of the Corporations Act applies to partners who provide assistance on an audit outside of the lead auditor and the review auditor roles.

As part of its 2008-09 work program, the FRC proposes to liaise further with ASIC on the issue of auditor rotation.

Reviews by the AQRB

The AQRB reviewed each of the Big Four accounting firms during 2007 and published a public version of the report summarising the results of its 2007 reviews in May 2008. The report considered issues associated with audit quality as well as auditor independence.

The AQRB concludes that, as a result of its reviews, all of the Big Four firms have established policies and procedures that are designed to enable them to complete effective audits within the framework of current Australian legal and professional requirements.

As a result of its 2007 review, the AQRB found no reason to believe that the firms' Quality Control Reports5 do not reflect, in all material aspects, practice within the firms.

In its report, the AQRB made the following observations about the commitment of the firms to the present auditing environment:

  • All firms had leaders that continued to emphasise, through internal communications to partners and staff, the paramount importance of audit quality.
  • Evidence suggests that leaders of all the firms were prepared to take decisive and strong disciplinary action whenever there is evidence of quality shortcomings.
  • All firms have committed substantial resources and senior staff to dedicated roles in the areas of quality, risk and legal regulation. These functions are also supported by significant staff resources below partner level.
  • In its 2006 report, the AQRB had noted that all firms had invested heavily to establish policies, systems and procedures to ensure compliance with new legislation and audit standards but that at some firms these new tools and systems suffered from a lack of integration resulting in some lack of utility. In 2007, the AQRB reports that the upgrading of existing systems, and functional testing of new online systems, is ongoing, as is the process of obtaining optimum benefit from the information the systems are capable of providing. The AQRB observes that it is likely the firms will continue upgrading existing systems to meet the evolution of new standards and legislation.
  • In its 2006 report, the AQRB observed that the processes for ensuring that auditors remain duly independent of their audit clients in compliance with the law and auditing standards were perhaps the most focussed upon areas in both the firms' internal monitoring programs and regulators' reviews. In 2007, the AQRB remain satisfied with the firms' proactive approach towards independence and threats to independence.
  • Although some firms had a disappointingly high number of breaches in 2007, the AQRB notes that these were generally minor in nature, and only entailed a breach of the firm's own (more stringent) internal policies rather than legislative requirements. The AQRB also observed that firms were responding appropriately to these breaches.
  • All firms take into account compliance with independence rules in performance assessments for senior levels. Serious breaches can attract financial penalties.
  • Three of the four firms require all staff on a particular audit engagement to make a comprehensive independence declaration in respect of that client, normally at the commencement of the engagement. The fourth firm relies on its systems, continual staff independence reporting requirements and annual independence declarations to provide it with assurance on the required independence of staff on each engagement.
  • All firms maintain comprehensive, normally global, client databases so as to enable monitoring processes both in respect of permissible investments and non-audit services.
  • All firms have extensive human resource and professional development policies and procedures. Firms dedicate substantial investment in the area of training and developing staff.
  • All firms have effective policies dealing with the procedures which must be followed prior to acceptance or continuance of client relationships and specific audit engagements and the documentation of conclusions reached in this regard. Each firm has a process to categorise its engagements across the spectrum of perceived risk and its policies determine what additional resources and processes shall be applied to higher' risk engagements. The AQRB believes that the firms' policies are comprehensive and provide an excellent basis for risk evaluation and employment of resources and, where needed, additional resources and processes. However, the AQRB noted that at some firms the policies are not always well applied and the reasoning behind the policies may not always be well understood. Documentation of acceptance and continuance processes, particularly on the audit files of clients classified as higher risk, is not in some cases, in the AQRB's view, adequate. That said, enquiry by the AQRB of the audit team members normally showed that they fully appreciated the heightened risk and had reacted appropriately.
  • Each firm has its own program to test compliance with its quality control systems and processes. The AQRB observed that the firms make a large time and financial investment in their annual monitoring programs.

Overall, the AQRB's findings reflect positively on the auditor independence systems and processes used by the Big Four accounting firms. The findings support those of ASIC and the professional accounting bodies (referred to in section 3.2).

Meetings with audit firms

During 2007-08 the FRC met with the Big Four accounting firms and three other firms with auditing practices. During the course of these meetings, the FRC did not become aware of any systemic issues in respect of the adequacy of Australia's auditor independence framework. However, a number of issues were raised that will continue to be monitored by the FRC. The issues discussed at these meetings included:

  • Auditor rotation. A number of stakeholders voiced their concern about the inconvenience and costliness of auditor rotation and its potential to put audit quality at risk. The FRC Chairman invited stakeholders to make submissions in support of their claims that auditor rotation was having a negative impact. Most stakeholders responded positively to this suggestion and agreed to provide the FRC with supporting evidence.
  • Material financial fraud. Undetected material financial fraud is one of the greatest risks to an organisation's viability and corporate reputation. Material financial fraud is one of the key factors evident in corporate collapse and preventing such fraud is a key challenge. The Chairman discussed with stakeholders whether there is a need for an optional standard on material financial fraud which might include features adopted in the United States regarding internal controls. The FRC notes that whilst this is an issue relevant to audit quality, it will nevertheless continue to monitor this matter.
  • Graduated auditor designations and registrations. There was general consensus among stakeholders that the audit market consists of different tiers, and with this, comes different levels of audit skills and audit performance across the profession. In light of these different skill levels, a number of stakeholders raised the option of introducing graduated designations and registrations for auditors. This would require differential qualification of audit engagements.
  • Ethical behaviour and perception. Stakeholders were keen to engage the FRC on the issue of ethical behaviour in the profession and market perception of this. It was suggested that part of the evaluation of an audit might include an analysis of ethical behaviour.
  • Professional ethics. With a view to increase professional awareness of ethics and training opportunities, the proposal of a joint effort to develop an ethics education campaign' was raised at the meetings. All stakeholders responded positively to the suggestion and expressed willingness to participate in any such project.
  • Outsourcing and off-shoring of financial services and the impact on audit independence. Some stakeholders expressed concern about the impact of the outsourcing of financial services on auditor independence. It was suggested that the audit value chain would unavoidably become longer with the off-shoring of financial services work, and the obvious complexities arising from this growing practice requires attention. The FRC will explore whether this is an issue that requires further consideration.

3.2 Quality review programs and disciplinary procedures of the professional accounting bodies

Under 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; the responsive action taken by auditors who have been subject to such reviews; and the action taken by the professional accounting bodies to ensure that auditors are responding appropriately. In addition, the FRC is required to monitor and assess the nature and overall adequacy of the investigation and disciplinary procedures of the professional accounting bodies as those procedures apply to Australian auditors.

During 2007-08 the FRC met these requirements by requesting relevant information from the professional accounting bodies, obtaining information at periodic meetings with the professional accounting bodies and reviewing publicly available material issued by those bodies.

CPA Australia advised that during 2008, approximately 1,200 public practice certificate holders will be subject to its quality review process. In the year to 30 June 2008, these reviews did not reveal any breaches of the audit independence requirements.

The NIA noted that, in the vast majority of cases, their quality reviews did not identify any issues of concern. During 2008, quality reviews identified only two cases where members had prepared and audited the financial reports of a self managed superannuation fund (SMSF). In one case, the NIA has obtained an assurance that this type of conflict has ceased. The other instance has yet to be concluded.

The ICAA's annual report on its quality review program for the year ended 30 June 2008 summarises the results of 480 reviews, of these 29 per cent were practices that conduct audits which are subject to the Corporations Act. The practices reviewed by the ICAA ranged in size from national partnerships with multiple offices to sole individual offices with a sole practitioner. As at 30 June 2008, a further 510 practices were under review. Independence compliance formed only a part of the ICAA reviews.

The ICAA found that the vast majority of reviewed practices are meeting independence requirements. The ICAA report identifies three areas where a small proportion of firms need to take action. Specifically:

  • fourteen per cent of those reviewed either had no documentation or inadequate documentation when considering possible threats to independence;
  • thirteen per cent of reviewed firms had not adequately applied appropriate safeguards when carrying out audit and accounting functions for a client; and
  • five per cent of firms reviewed were auditing the SMSF of a partner in their practice.

In each of these instances, the ICAA requires non-compliant practices to confirm in writing that these issues have been addressed.

In response to the non-compliance issues identified in their report, the ICAA introduced a range of measures in 2007-08, and are developing a number of others, to assist members in complying with regulatory and legal requirements as well as professional standards. Initiatives of the ICAA have included:

  • amending their retention policy to allow the ICAA to retain the results letter that is issued to practices so that it can be considered when the practice is next reviewed. Where required the FRC will have access to review files. The aim of this is to increase the transparency of the ICAA's review program;
  • publishing, in conjunction with the NIA and CPA Australia, a competency framework for the audit of SMSFs. The framework provides a structured and formal set of criteria that auditors of SMSFs should meet; and
  • continuing to promote guidance and run a range of training and development events in respect of business and professional ethics and auditor independence for members.

The professional accounting bodies also plan to launch a revised and updated Co-regulatory Guide to Independence in 2008-09. This will be via an on-line resource aimed at providing consistency and support in the practical application of independence requirements outlined under the Corporations Act and independence principles under section 290 of APES 110 Code of Ethics for Professional Accountants.

In its 2006-07 report, the FRC encouraged the ICAA to assess and, if appropriate, place reliance on reviews by other bodies, such as the AQRB, to avoid duplication and minimise disruptions and costs to practices. The FRC is pleased to note that during 2007-08 the ICAA introduced changes to their procedures to help avoid duplicating the work of other bodies. Quality reviews now assess and, if appropriate, place reliance on reviews by other bodies.

The FRC has also considered information supplied by the professional accounting bodies in relation to their disciplinary procedures. Each of the professional bodies has confirmed that there were no disciplinary actions taken against their members in respect of auditor independence.

Based on the information provided by the professional accounting bodies, the FRC did not become aware of any deficiencies in either the systems and processes used by the bodies for planning and performing quality reviews of audit work, or in the overall adequacy of the professional accounting bodies investigation and disciplinary procedures.

Consideration of consultants' reports

During 2005-2006, the Treasury, in consultation with the FRC, engaged consultants to review the quality review programs and disciplinary procedures of the professional accounting bodies. Messrs Graeme MacMillan and Michael Cain of CiptaNet International Pty Ltd examined the bodies' quality review programs while Mr William J Bartlett examined their disciplinary procedures. A summary of the findings and recommendations made by each of the consultants was published in the FRC's Report on Auditor Independence 2005-06.

In its 2006-07 report, the FRC indicated that prior to considering the findings and recommendations of the consultants, it had decided that the recommendations should be reviewed to ensure they:

  • clearly identify the need for a change to current policies, procedures or regulations by the professional accounting bodies, the Government or other stakeholders in order to better meet stated policy objectives in an efficient and effective manner;
  • establish, when government intervention is recommended, a policy rationale for the proposed intervention which is consistent with the Government's legislative and policy frameworks; and
  • include consideration and assessment of alternative means to meet the stated policy objectives.

To undertake this project for the FRC, the Treasury engaged The Allen Consulting Group Pty Ltd who presented their report to the FRC in May 2007. The recommendations made by Allen Consulting were considered by the FRC during 2007-08.

The Allen review recommended that the FRC further examine the nature and extent of the risks to compliance with current regulatory approaches to audit independence presented by the increasing concentration of firms in audit services, including alternative approaches to regulating auditor independence which mitigate identified risks and provide for market confidence in a robust way into the future.

The FRC notes recent reforms to the auditor regulation framework which have enhanced the robustness of the regulatory requirements. For example, ASIC's audit inspection powers were significantly enhanced by the ASIC Amendment (Audit Inspection) Act 2007. The robust legislative framework in the Corporations Act is also supplemented by the professional conduct rules applying to members of the professional accounting bodies. In addition, the bodies have established an independent ethical standards board, APESB, which is responsible for the professional conduct rules applicable to their members.

Nevertheless, this recommendation raises other issues to consider, including those in the areas of competition policy and international developments. However, as these are policy matters which fall outside the FRC's area of responsibility they have been referred to Treasury. As part of the FRC's audit independence work program, the FRC will continue to consider the level of non-audit service fees and rotation of audit partners. The FRC will consult with relevant stakeholders on these matters.

The Allen review also recommended that the FRC provide an information program to improve the understanding of the current regulatory framework with a focus on improving the understanding within the profession of the roles of ASIC and CALDB and their statutory requirements in fulfilling those roles. The FRC has included this recommendation as part of its future work program. In a meeting between CALDB and the Chairman of the FRC, an invitation was extended to CALDB to participate in an education campaign through which the demarcation and clarification of respective roles could be emphasised. CALDB advised of its willingness to engage in such a program. CALDB also advised that a recent information program on their role and function had received a positive response from the profession.

In an effort to further enhance overall market understanding of the regulatory framework, the FRC has included the Short Guide to the Auditor Independence Requirements in the Corporations Act' (prepared by the Treasury) at Appendix E and, as part of its 2008-09 work program, will continue to consult relevant stakeholders to canvass ideas on how to improve market understanding.

3.3 Teaching of ethics by the professional accounting bodies

The ASIC Act requires the FRC 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 subjects relates to auditor independence.

In 2007-08, the FRC continued to monitor the adequacy of the teaching of ethics by requesting relevant information from the professional accounting bodies and through its periodic meetings with these bodies. Having examined the information supplied by the three professional bodies, the FRC is satisfied that the teaching of ethics by each of the bodies is adequate.

Consideration of consultants' reports

During 2007-08 the FRC considered the recommendations of two consultants engaged in previous years to examine the teaching of professional and business ethics.

In April 2006, the Treasury, in consultation with the FRC, engaged Ms Jane Walton of Henderson Walton Consulting Pty Ltd to examine the teaching of professional and business ethics. In its 2006-07 report, the FRC indicated that prior to considering the findings made by Henderson Walton (Walton report) it had decided that a more detailed evaluation should be undertaken of how professional and business ethics are applied in practice by accounting firms.

To undertake this project for the FRC, the Treasury engaged Mr Richard Boele of The Banarra Trust. Banarra provided its final report (Banarra report) to the FRC in September 2007.

Walton report

Walton's examination of the teaching of professional and business ethics found that the depth of understanding of ethical issues by officers of the three professional accounting bodies and members of accounting firms, their commitment to deal with these issues and steps being taken to do so, are well beyond anything observed in other disciplines, businesses or professions, including law. A summary of the findings and recommendations made in the Walton report was published in the FRC's Report on Auditor Independence 2005-06.

The FRC has noted that most of the recommendations made in the Walton report are matters outside of the FRC's mandate. The majority of recommendations relate to the teaching of ethics as part of university and professional association programs. The FRC considers this to be an area for the professional accounting bodies which already have a direct role in setting university teaching curricula and professional association programs. The FRC will however further engage with the professional accounting bodies and relevant stakeholders on certain elements of the recommendations made by the Walton report. As part of its work program, the FRC will also encourage the professional accounting bodies to further engage with academia and those parties that assist in the development of university teaching curricula.

The Walton report recommended that the FRC ensure that professional associations include ethics as a stand alone course and integrate it throughout the technical curriculum with issues, case studies and problems that students will encounter at every level of practice. The FRC notes comments from the professional accounting bodies suggesting that their programs already incorporate ethics as a substantial stand alone component, and that there is integration of ethical considerations throughout the technical materials. The FRC's future work program will consider this issue through consultations with the professional accounting bodies and other key stakeholders.

The FRC will encourage and support the professional accounting bodies in promoting the development and reinforcement of the profession's appreciation of the importance of culture in ethical standards within their respective firms and organisations. The FRC notes comments from the professional accounting bodies confirming that they have already undertaken various activities in this regard. Examples of such activity include: the ICAA's seminar and subsequent white paper on values, codes of ethics and the law; CPA Australia's regular ethical dilemma columns; and the NIA's regular ethical issues section appearing in their journals. The professional accounting bodies also direct their members to newsletters that provide regular updates on ethical and professional standards and changes therein.

The Walton report also recommended that the FRC utilise public practice programs to develop and reinforce ethical leadership skills. This is a matter for the professional accounting bodies and firms. The FRC notes, however, comments from the professional accounting bodies confirming that their public practice programs already address this. With respect to this recommendation, the FRC identifies its role as providing encouragement to the professional accounting bodies and firms to utilise public practice programs to develop and reinforce ethical leadership skills. The FRC will continue to do this as part of its future work programs.

Overall, the FRC has already included elements of the Walton recommendations in its work program, and is consulting with relevant stakeholders to encourage development in these matters. The FRC has also raised the possibility of combining efforts with various stakeholders — including the professional accounting bodies, the APESB, CALDB, and the Big Four firms — to develop and implement an education campaign on ethics and fraud. All stakeholders have responded positively to the proposal. The FRC will continue to gauge interest and seek input from relevant stakeholders, with a view to developing a more substantive plan in its future work program.

Banarra report

In its report, Banarra found that ethical practices are highly valued within the profession and that the profession has leading ethical practices. Banarra also found that while it could not arrive at any clear conclusions in terms of ethics practice between the Big Four and the significant other firms, there were clear differences in practice between individual firms.

The FRC considers that the scope of its responsibilities with respect to ethics is limited by the operation of the ASIC Act to ethics as it relates to auditor independence. Accordingly, the FRC considers that much of the Banarra report's recommendations are not directly relevant to the FRC. The FRC does, however, recognise the usefulness of the observations made and encourages the professional accounting bodies and APESB to consider the recommendations and encouragements made in the report.

The Banarra report recommended the professional accounting bodies and the APESB be encouraged to establish a mechanism that facilitates the sharing, reviewing and critiquing of leading ethical practices. The FRC has received advice from the APESB noting that the APESB has commenced dialogue with the professional accounting bodies (in particular, the education and continuing professional development departments of those bodies), to explore opportunities to achieve an outcome that will contribute to the highest ethical behaviour across the whole profession. The FRC encourages any initiatives that promote the commitment of the profession to ensuring it is driving the highest ethical standards. The FRC, therefore, will continue to encourage both the APESB and the professional accounting bodies to maintain their engagement with each other in order to develop ways to facilitate this.

The Banarra report suggests that widespread belief exists amongst firms to the effect that the FRC has a supervisory role' in relation to independence compliance. In order to overcome market misinterpretation of the FRC's role in ethics as it relates to auditor independence, the FRC will endeavour to further clarify its role in this area, as well as to make it clear that it is not considering an expansion of its role in ethics beyond auditor independence. As an initial step, the FRC recently refreshed its MOU with ASIC in order to highlight ASIC's responsibility for compliance and audit quality.

The Banarra report recommends that the FRC show greater leadership in both facilitating and participating in the debate on the dynamic and evolving tensions between the principles-based and rules-based approaches to encouraging ethical behaviour within the profession. As part of its work program going forward, the FRC will continue to encourage relevant stakeholders to participate in the debate on ethical behaviour within the profession, particularly through its engagement with stakeholders on the issue of ethics as it relates to audit independence.

3.4 Compliance with audit-related disclosure requirements

The FRC is required by the ASIC Act to monitor the overall compliance by companies, registered managed investment schemes and disclosing entities with audit-related disclosure requirements of the Corporations Act and the accounting standards. A summary of these requirements is provided at Appendix G.

Level of compliance

The FRC assesses the level of compliance with audit-related disclosure requirements by reviewing and analysing the information provided by the MOU bodies.

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. The MOU with ASX also provides for that body and the FRC to exchange information.

ASIC has informed the FRC that its 2007-08 financial reporting surveillance program included consideration of certain audit-related disclosures. ASIC reviewed 151 directors' reports as part of the review of the 325 financial reports of listed entities with financial years ending between 30 June 2007 and 31 May 2008. As part of that review, ASIC considered the following audit related disclosure issues:

  • Did the directors' report include (including by way of cross reference to an attached document) an auditor's independence declaration?
  • Did the auditor's independence declaration contain any exceptions?
  • Did the directors' report include details of non-audit services where there was an indication that such services were provided?
  • Did the directors' report include details of non-audit services where it appeared that such services were provided and, where there were details of non-audit services, did the directors' report include an unqualified statement that these services had not affected the auditor's independence?

The results of ASIC's review showed that the majority of financial reports complied with the auditor-related disclosure requirements examined as part of the review. There were, however, a small number of financial reports that failed to comply with these disclosure requirements: the directors' reports of 11 entities did not include an unqualified statement that non-audit services had not affected the auditor's independence.

In addition, ASX informed the FRC that it had reviewed financial reports filed by listed entities with ASX under the listing rules during the financial year ending on 31 December 2007. ASX's review included an examination of the form and location of the auditor independence declarations required under section 307C and disclosed by directors under sections 298(1) and 306(2) of the Corporations Act. The review indicated that, as in previous years, the preferred format for almost all entities was for the declaration to be presented as a separate attachment to the directors' report on the auditors' letter head with a reference to the attachment in the directors' report.

As part of its 2008-09 work program, the FRC will continue to review, and analyse, the level of compliance with audit-related disclosure requirements by considering the information provided by the MOU bodies.

Provision of non-audit services

In the 2006-07 audit independence report, the FRC provided a preliminary assessment of data regarding audit and non-audit services fees for 84 public companies. The majority of these companies were included in the ASX's top 100 companies for 2005-2006. During 2007-08 the Audit Independence Committee considered further analysis of the 2006-07 data and concluded that there was no indication of trends that raised concerns in relation to auditor independence. The FRC Secretariat also analysed 2007-08 data on audit and non-audit fees paid or payable to the auditors of 406 entities.

The data provides figures for four categories of auditor services. These are audit services, audit-related services, other services, and taxation advice services. Having regard to the categorisation of the fees presented in the data, the FRC notes that:

  • fees for audit and audit-related services represented more than 75 per cent of the total fees of the auditors of 236, or nearly 60 per cent of entities, while the fees for these services for a further 25 per cent of entities were between 50 and 75 per cent of the total fees;
  • fees for other services represented more than 25 per cent of the total fees of the auditors of 65, or 16 per cent of entities. Of these, 19, or nearly 5 per cent of entities received fees for other services which represented more than 50 per cent of their total fees; and
  • fees for taxation services represented more than 25 per cent of the total fees of the auditors of 83, or 20 per cent of entities. Of these, 25, or 6 per cent received fees for taxation services greater than 50 per cent of total fees.

The FRC considers that the above data does not suggest any problematic trends for auditor independence. In 2008-09, the FRC proposes to continue monitoring trends in fees received by auditors of audited entities for audit and non-audit services provided to those entities.


5 Reports can be viewed at www.aqrb.org.au.

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