EC audit reform: What does it mean for CFOs?
Overall any reforms are likely to increase costs for companies
As if there are not enough business challenges to deal with at the moment the European Commission has been busy drafting plans for widespread reform of auditing because of fears over competition and quality of auditing stemming from the credit crunch.
With the widely leaked proposals finally public there was some good and bad news for British companies. But overall it looks like costs will rise for businesses.
The EC dropped its proposal of mandatory joint audits to the relief of British business and politicians. A source within the Department for Business, Innovation and Skills described this as "a real success" for the UK and BIS after it led a campaign encouraging other member states to lobby commissioners.
However, Clare Bury, one of internal markets commissioner Michel Barnier's top officials, has stressed that the EC would keep the issue of joint audits under review. "We still think joint audits are very important for getting more firms into the top end of the market, but some more fact-finding and analysis is needed," she said.
Even with joint audits off the table for now, many of the EC's proposals will restrict the current freedom listed companies, banks and insurers among others to appoint auditors of their choice.
The proposed requirement for mandatory auditor rotation remains however and is described by the EC as "the 'sine qua non' of the whole package" because "the other measures will not be sufficient to reinforce independence and professional scepticism".
While the basic proposal is for mandatory rotation after six years, the draft regulation reveals certain complexities. Companies' shareholders would appoint auditors for an initial engagement "that shall not be shorter than two years". This engagement would be renewable only once, the two engagements in total not exceeding six years. Companies may request approval to reappoint their auditors for up to another two years "on an exceptional basis" – making a potential maximum auditor term of eight years.
But mandatory tendering for audit contracts remains firmly on the table. At least one non-Big Four firm must be invited to tender – a firm earning 15 percent or less of its total audit fees from multinationals in the previous year.
If the plans, as drafted, go ahead listed company audits will become more expensive. The EC estimates that for organisations with a market capitalisation or balance sheet total greater than €100 million (£ ), costs could range from €90,000 to €150,000 a year.
The Hundred Group of Finance Directors – an influential group made of the top finance chiefs from Britain's leading companies - has put the rise of tendering and rotation for its member companies at between 5 percent and 30 percent of the audit fee, depending on the extent of the tender process.
A survey of the group's members found unanimous opposition to mandatory audit firm rotation, while less than 15 percent supported mandatory tendering based on a legislated time period.
The Hundred Group argues that auditor rotation risks a reduction in audit quality in the initial and final years of an appointment. It says regular audit partner rotation is sufficient to maintain "an independent and robust audit".
Vodafone CFO Andy Halford, chairman of the Hundred Group, said: "Taken together, the reform package will have the effect, both directly and indirectly, of reducing audit quality, particularly during the period of transition, increasing cost and diminishing the value of the audit opinion to investors, without any compensating tangible benefits."
The Hundred Group also opposes the EC proposal to split up audit firms' into audit and non-audit organisations. Pearson CFO Robin Freestone, chairman of the group's investor relations and markets committee, wrote to the EC in September, saying the group "... oppose[s] the creation of specialist audit firms as these will undermine the ability of firms to recruit the appropriate quality of audit staff, with consequent highly negative implications on long term audit quality."
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