Part 2: Oversight of the auditing profession
Independent audits are an integral part of the financial reporting framework, and effective oversight arrangements are needed to maximise the value of the audit function.
This Part outlines options for the oversight of the auditing profession. Proposals have been developed in light of the recommendations of the Ramsay report, submissions received on the report's recommendations, and submissions received by the JCPAA's review of Independent Auditing by Registered Company Auditors.
Oversight of the auditing profession may include the following broad functions:
- Monitoring auditor independence - including ensuring an auditor is sufficiently independent of the client, financially, personally, and in their employment.
- Monitoring auditor competence - covering the teaching of auditing and professional ethics, as well as review of the procedures and practices of registered auditors to ensure they are up to standard.
- Investigation and discipline of auditors.
There were several key themes expressed in submissions on the Ramsay recommendations and to the JCPAA. These themes capture what the Government expects to achieve through the oversight of auditor independence.
- The importance of transparency to effective audit. Audits are only of value if they are both in fact, and perceived to be, independent of a company's management.
- The appropriate division of responsibilities between the professional bodies and Government.
- The need for timely advice to be provided to the Government to address the risk of audit failures due to the failure of policies or systems at the audit firm or company level.
2.3 Current structure for audit oversight in Australia
The Australian auditing profession operates under a co-regulatory regime. The three largest professional bodies, The Institute of Chartered Accountants in Australia (ICAA), CPA Australia (CPAA) and the National Institute of Accountants (NIA) have in place rules and professional codes of ethics that govern their members' professional conduct. ASIC is responsible for the registration of auditors. The Companies Auditors and Liquidators Disciplinary Board (CALDB), established under the ASIC Act, is responsible for the discipline of auditors.
2.3.1 The regulator's role in auditor oversight
Registration of auditors
ASIC is responsible for the registration of all company auditors. Any person wishing to practise as an auditor is required to make an application for registration in writing to ASIC. ASIC must then be satisfied that the person meets the requirements for registration as a company auditor, including educational and experience requirements, as well as being capable of performing the duties of an auditor and otherwise being a fit and proper person to be registered as an auditor.
Independence and professional ethics
ASIC plays no formal role in setting professional ethical standards and does not provide detailed guidance on how to conduct an audit.
Investigation and discipline of auditors
ASIC has the power to investigate suspected breaches of the law by auditors. If following its investigation ASIC is of the opinion that malpractice has occurred, it can apply to the CALDB to have the auditor's licence suspended or cancelled. The CALDB must conduct a hearing to examine the evidence and gather more evidence if required before it makes a finding and determines the appropriate punitive action.
The CALDB was established under the ASIC Act and has a chairman who is a legal practitioner appointed by the Minister, and members selected by the Minister from panels put forward by the ICAA and CPAA.
In addition to action by the CALDB, auditors can be litigated against in the courts if a duty of care can be established and a loss resulting from a breach of that duty can be substantiated.
2.3.2 The profession's role in auditor oversight
Registration of auditors
Membership of a professional accounting body is not a legal requirement to become an auditor. However, subparagraph 1280(2)(a)(i) of the Corporations Act provides that members of the ICAA or CPAA are considered to have satisfied the educational qualification requirements to be registered by ASIC as an auditor. In practice most auditors are members of at least one of these bodies.
Independence and professional ethics
The Auditing and Assurance Standards Board (AuASB) develops and publishes auditing standards, which are similar in format to accounting standards issued by the AASB. However, unlike accounting standards, auditing standards do not have the force of law and cannot be relied upon in court proceedings as representing a minimum standard of professional care and skill. The AuASB is funded and staffed by the accounting profession.
The ICAA and CPAA have also developed a Joint Code of Professional Conduct as their ethical code. It covers a number of issues including independence, confidentiality, and integrity. The Joint Code has recently been updated to reflect a revised ethical code issued by the International Federation of Accountants (IFAC) in November 2001. As with auditing standards, the Joint Code does not carry the force of law. Consequently, compliance can only be enforced on the bodies' own membership.
The NIA also has by-laws in its members' handbook governing conduct.
Investigation and discipline of auditors
There are no formal legal arrangements for the monitoring of audit quality. However, the professional bodies encourage members to take specific measures to ensure audit quality. AUS 206 'Quality Control for Audit Work' and the Joint Code of Professional Conduct contain guidance on this for members of the ICAA and CPAA.
The professional bodies investigate breaches of the auditing standards and ethical codes among their members, and may impose penalties of suspension or cancellation of membership.
2.4 Overseas structures for auditor oversight
2.4.1 The United States of America
On 30 July 2002 the United States President approved new corporate disclosure legislation, the Sarbanes - Oxley Act.
The Act established a Public Company Accounting Oversight Board (PCAOB). The new board is to be funded through a levy on all listed companies, its primary functions being:
- Registration of public accounting firms that prepare audit reports for issuers.
- Establishment or adoption (or both) by rule, of auditing, quality control, ethics, independence and other standards relating to the preparation of audit reports for issuers.
- Conducting inspections of registered public accounting firms.
- Conducting investigations and disciplinary proceedings concerning, and imposing appropriate sanctions where justified upon, registered public accounting firms and associated persons of such firms.
- Performing such other duties or functions as the Board (or the Securities and Exchange Commission by rule or order) determines are appropriate to improve the quality of audit services.
- Enforcing compliance with the Sarbanes-Oxley Act, the rules of the Board, professional standards, and the securities laws relating to the preparation and issuance of audit reports and the obligations and liabilities of accountants with respect thereto, by registered public accounting firms and associated persons thereof.
2.4.2 United Kingdom
As in Australia, auditors in the United Kingdom must comply with accounting standards and stock exchange rules that carry the force of law.
The Audit Practices Board (APB) is the recognised auditing standard setter in the UK. The APB is funded by the professional bodies through the Consultative Committee of Accounting Bodies (CCAB) with members of the APB appointed by a panel consisting of the Presidents of the CCAB bodies, the Governor of the Bank of England, and the London Stock Exchange (LSE). Membership represents a diverse group of stakeholders. Standards issued by the APB do not carry the force of law. However, the constituent bodies of the CCAB have undertaken to enforce them within their membership.
Under the Companies Act 1989,(UK) the major professional bodies have been delegated the responsibility for registration of company auditors. The Act sets out criteria the bodies must address when assessing an application for registration.
The Financial Reporting Review Panel (FRRP) and the Department of Trade and Industry (DTI) share the role of investigating irregularities in financial reports. The DTI focuses on proprietary and small and medium listed companies while the FRRP focuses on larger listed companies. If the investigation finds the audit to be lacking, the auditor may be reported to their professional body.
The professional bodies through their Chartered Accountants Joint Ethics Committee, set ethical standards. A new Ethics Standards Board (ESB) has been established, with a chairman being appointed in February 2001.
The professional bodies are responsible for disciplining their own members, although serious cases can be referred to the Joint Disciplinary Scheme. An Investigation and Disciplinary Board has been established in an attempt to make regulation of auditors more independent of the profession.
The legal system in the UK allows for auditors to be sued through the courts in a similar fashion to the Australian system.
The DTI has published the terms of reference for a review of the way the UK's audit and accounting professions are regulated. The review will consider whether any structural improvements should be made to make the system more effective. Among other things it will examine the need for particular regulatory functions, who should carry them out, how they are funded, and whether current arrangements could be simplified. The review is to be completed by January 2003.
2.5 Options for oversight of auditing functions
Currently in Australia there is no independent scrutiny of an audit firm's procedures and processes to produce quality audits. The ICAA and CPAA do require members to participate in peer review programs. However, the results of these reviews and any remedial action are dealt with 'in-house' by the professional body.
The Government has considered a number of models for the oversight of the auditing profession, including:
- a new Auditor Independence Supervisory Board (AISB) as proposed in the Ramsay report;
- an expansion of the role of the existing Financial Reporting Council (FRC) to include the AISB independence oversight function in addition to its existing role of providing broad oversight of accounting standard setting;
- further expansion of the existing FRC to also include oversight of auditing standard setting and oversight of the disciplinary procedures of the accounting bodies;
- the co-regulatory model put forward by CPAA in a recent discussion paper, 'The Financial Reporting Framework - The Way Forward'; and
- the new United States model, the PCAOB, which would also include a formal role in the registration and disciplining of company auditors (as outlined above).
2.5.1 Auditor Independence Supervisory Board
The Ramsay report recommended that a new body, the AISB, be established to oversee auditor independence. This body would monitor issues such as international developments in auditor independence, the quality control practices of audit firms, the teaching of professional ethics by universities and professional accounting bodies, and the effectiveness of procedures within corporations related to auditor independence.
The AISB would be independent of the accounting profession. It would be established either as a company limited by guarantee or as a statutory body. Funding would be provided either directly by the professional accounting bodies for a fixed period on a 'no strings attached' basis or by an increase in the registration fee for auditors.
The AISB would comprise 12 members nominated by stakeholders from the financial sector as well as one representative each from the ICAA and CPAA, and three members representing the public interest.
The AISB would have no responsibility for the registration of auditors or the investigation and discipline of registered auditors. Responsibility for these functions would remain with ASIC and the CALDB.
Stakeholder comments on the AISB
Stakeholders generally supported the Ramsay proposal for an oversight body for auditor independence.
Some stakeholders considered that the AISB would be under-resourced to adequately perform the functions proposed for it, in particular the monitoring of audit firms and corporations. There was also a view that the AISB was focused too narrowly on issues of auditor independence which is a necessary but not sufficient condition for audit quality.
A number of stakeholders considered that there was no need to establish a new body when the functions of the existing FRC, which has a composition very similar to that envisaged for the AISB, could be expanded to include the oversight of auditor independence.
2.5.2 An expanded role for the Financial Reporting Council
Having considered the merits of the various models, the Government proposes that the existing FRC assume the following functions in addition to its current oversight role for accounting standard setting:
- oversight of auditor independence, as envisaged by Professor Ramsay for the AISB;
- oversight of auditing standard setting; and
- monitor and assess the adequacy of the disciplinary procedures of the accounting bodies.
The FRC was formally established in 2000 under Part 12 of the ASIC Act. It is currently responsible for the broad oversight of the Australian accounting standard setting process for the private, public and not-for-profit sectors.
- Its statutory functions include: advising the Government on the accounting standard setting process and the development of international accounting standards; appointing the members of the AASB (other than the Chair); approving the AASB's priorities, business plan, budget and staffing arrangements; and determining the AASB's broad strategic direction.
The FRC comprises senior-level stakeholders from the business community, the professional accounting bodies, governments and regulatory agencies.
- The current members of the FRC were appointed by the Treasurer on the nomination of the Business Council of Australia, the Australian Institute of Company Directors, the Securities Institute of Australia, the Investment and Financial Services Association, the ICAA, CPAA, the Australian Shareholders' Association, the Australian Stock Exchange, ASIC, and the Commonwealth, State and Territory governments.
Only minor changes to the FRC's composition would be necessary to accommodate an expanded role.
The proposed new structure is shown in the following chart.
Chart 1: Financial Reporting Oversight Board Structure
The AASB will continue in its current role of developing and issuing accounting standards and other pronouncements under the broad oversight of the FRC. Accounting standards will continue to carry the force of law under the Corporations Act.
The AuASB, which is currently funded and staffed by the accounting profession, would be subject to FRC oversight in the same way that the AASB is currently subject to FRC oversight. As the auditing standard setter, the AuASB would be independent, with the FRC unable to involve itself in the development of particular standards. The AuASB would be established under the ASIC Act and, like the AASB, funded jointly by governments, the accounting profession and business.
As envisaged in the Ramsay report proposal for an AISB, the FRC would:
- monitor international developments in auditor independence;
- advise the professional accounting bodies on appropriate standards dealing with auditor independence and whether it believes these standards have been properly implemented;
- monitor the nature and adequacy of systems and processes used by audit firms to deal with issues of auditor independence and advise on the adequacy of these systems and practices;
- monitor compliance by companies with the new auditor independence regime, including the adequacy of non-audit fee disclosure and the effectiveness of listed company audit committees; and
- monitor the adequacy of the teaching of professional and business ethics by the professional accounting bodies and universities as they relate to issues of auditor independence.
As envisaged by the Ramsay report in relation to the AISB, the FRC would monitor and assess the adequacy of existing investigation and disciplinary processes for the audit profession and advise the Government if it considers improvements are required.
This will involve a specific role in providing oversight of the disciplinary procedures of the professional accounting bodies. The FRC would have the power to refer particular matters that came to its attention to the CALDB.
However, it is not proposed that the FRC would have a direct role in disciplining members of the profession. ASIC will continue to have responsibility for the investigation and prosecution of auditor disciplinary matters. The CALDB will remain the sole body with the authority to conduct hearings into auditor misconduct and to take disciplinary action where appropriate (with the exception of the professional bodies in relation to their own membership).
The above structure would bring together, under a single oversight body, policy advising, monitoring and technical oversight functions for the key elements of the financial reporting framework. The use of an existing stakeholder body, with minor membership changes, will enable a relatively quick start-up and recourse to established funding mechanisms.
Having broad policy direction coming from a single overarching body should ensure coherent and effective oversight while protecting the independence of the two technical Boards within the structure.
As is currently the case, the expanded FRC would have statutory backing and its members would be appointed by the Government. One of its responsibilities would be to advise the Government on the issues for which it is responsible.
The FRC would have a dedicated secretariat staffed from within Treasury (which currently provides the secretariat to the FRC).
Australia's professional accounting bodies will continue to fulfil their present role with the exception that the auditing standard setter under the FRC will provide the authoritative source of auditing standards.
The FRC will liaise with the ASX Corporate Governance Council, which is developing a set of corporate governance standards of best practice for listed companies.
Should auditing standards be given the force of law?
It has been suggested that giving auditing standards statutory backing would make them easier to enforce. Currently, ASIC relies on broader statutory provisions. However, the structure and style of auditing standards are such that there would be practical difficulties in making them easily enforceable without significant redrafting.
Since 1995, the AuASB has been working on harmonising Australia's auditing standards with International Standards on Auditing (ISAs), a program that is now well advanced. With the recent commitments by the European Union and the Australian Financial Reporting Council to adopt international accounting standards by 2005, the momentum for international convergence of auditing standards has increased.
The Government believes that core audit standards should be given legislative backing to facilitate their enforcement by ASIC, consistent with international harmonisation objectives.
Proposal 1 - Expanded Financial Reporting Council
The Government will expand the responsibilities of the Financial Reporting Council (FRC), which currently oversees the accounting standard setting process, to oversee auditor independence requirements in Australia. The FRC will: