The Parliamentary Joint Committee on Corporations and Financial Services Inquiry into the regulation of auditing in Australia has released an interim report which makes ten 'substantive policy recommendations' to raise audit quality standards ahead of the release of the final report in September.

Key takeouts

  • Committee Chair James Paterson said that 'no new empirical evidence of systemic audit failure' has been found
  • The interim report includes ten 'substantive policy recommendations' aimed at addressing the 'trust deficit' in audit.  These include (among others): a) banning audit partners from receiving incentives for selling non-audit services to audit clients; b) that ASIC conduct a review of its audit inspection program and reporting; c) the publication by ASIC of individual inspection reports; d) new mandatory tendering requirements; and e) that digital financial reporting be made standard practice in Australia.    
  • Why release the recommendations ahead of the release of the final report in September?  Mr Paterson said that the committee has released the recommendations on an interim basis 'because the policy lessons have been clear form the hearings already conducted' and there should be 'no delay' in acting on them.   
  • The report makes no recommendation that audit firms be structurally split, though recommendation 3 recommends the development and introduction of a list of non-audit services that audit firms are explicitly prohibited from providing by the end of the 2020–21 financial year.  
  • Positive response to the recommendations: The Chartered Accountants Australia and New Zealand (CA ANZ) has issued a statement welcoming the release of the interim report and the recommendations, and encouraging the 'government, organisations and regulators to press forward with making these improvements in the framework'.  According to The AFR, the big four consulting firms are 'openly pleased' that many of their ideas were adopted by the Committee.  
  • Timing of the Final Report: The Committee is due to present its final report on 12 September. 

Overview: Interim Report

The Parliamentary Joint Committee on Corporations and Financial Services Inquiry into the regulation of auditing in Australia released an interim report on 27 February.  

Announcing the release of the interim report, Committee Chair James Paterson said that so far, the Committee had found no 'new empirical evidence of systemic audit failure', but that it was clear from the hearings and from the submissions received so far, that there is a 'lack of trust in the audit industry that must be remedied'.   

The report makes ten 'substantive policy recommendations' aimed at addressing this 'trust deficit' which the committee 'expects the government and various regulatory agencies to respond to in a timely manner'.

Ten recommendations

  1. ASIC to review its audit inspection program and reporting: The committee recommends that ASIC: a) formally review the manner in which it publicly reports the periodic findings of its audit inspection program, giving appropriate consideration to approaches used internationally; and b) based on this review, develop and implement, by the end of the 2020–21 reporting period for its audit inspection program, a revised framework for reporting inspection findings, with a focus on the transparency and relative severity of identified audit deficiencies. (Recommendation 1)
  2. ASIC to publish individual inspection reports: The committee recommends that the Australian Government introduce, by the end of the 2020–21 financial year, through appropriate legislation, a requirement that ASIC publish all future individual audit firm inspection reports on its website once ASIC has adopted a revised reporting framework referred to in Recommendation 1. (Recommendation 2)
  3. New fee disclosure requirements and a clear list of services audit firms cannot provide: The committee recommends that the Financial Reporting Council, in partnership with ASIC, by the end of the 2020–21 financial year, oversee consultation, development and introduction under Australian standards of: a) defined categories and associated fee disclosure requirements in relation to audit and non-audit services; and b) a list of non-audit services that audit firms are explicitly prohibited from providing to an audited entity. (Recommendation 3)
  4. New requirement to declare that no prohibited non-audit service has been provided: The committee recommends that the Corporations Act 2001 be amended so that an auditor's independence declaration is expanded to require the auditor to specifically confirm that no prohibited non-audit services have been provided. (Recommendation 4)
  5. Banning audit partners from receiving incentives for selling non-audit services to audit clients: The committee recommends that the Australian Professional and Ethical Standards Board consider revising the APES 110 Code of Ethics to include a safeguard that no audit partner can be incentivised, through remuneration advancement or any other means or practice, for selling non-audit services to an audited entity.  (Recommendation 5)
  6. Disclosure of auditor tenure: The committee recommends that the Financial Reporting Council, by the end of the 2020–21 financial year, oversee the revision and implementation of Australian standards to require audited entities to disclose auditor tenure in annual financial reports. Such disclosure should include both the length of tenure of the entity's external auditor, and of the lead audit partner. (Recommendation 6)
  7. Mandatory tendering requirements: The committee recommends that the Corporations Act 2001 be amended to implement a mandatory tendering regime such that entities required to have their financial reports audited under the Act must: a) undertake a public tender process every ten years; or b) if an entity elects not to undertake a public tender process, the entity must provide an explanation to shareholders in its annual report as to why this has not occurred.  The committee further recommends that such a tender process be implemented by 2022 for any entity that has had the same auditor for a continuous period of ten years since 2012. (Recommendation 7)
  8. Formal review of the adequacy of existing reporting requirements in relation to the prevention detection of fraud: The committee recommends that the Financial Reporting Council oversee a formal review, to report by the end of the 2020–21 financial year, of the sufficiency and effectiveness of reporting requirements under the Australian standards in relation to: a) the prevention and detection of fraud; and b) management's assessment of going concern (Recommendation 8).
  9. Internal control framework requirement: The committee recommends that the Corporations Act 2001 be amended such that entities required to have their financial reports audited under the Act must establish and maintain an internal controls framework for financial reporting. In addition, such amendments should require that: a) management evaluate and annually report on the effectiveness of the entity's internal control framework; and b) the external auditor report on management's assessment of the entity's internal control framework. (Recommendation 9).
  10. Digital financial reporting: The committee recommends that the Australian Government take appropriate action to make digital financial reporting standard practice in Australia (Recommendation 10)

No need for 'structural separation of audit firms'?

Committee Chair James Paterson said that the committee considered international experience in making the recommendations and that this informed the Committee's digital reporting recommendation.  However, he said that the committee found 'no evidence to support radical measures which have been abandoned or discounted internationally, such as mandatory structural separation of audit firms.'  

Response to the interim report

The Chartered Accountants Australia and New Zealand (CA ANZ) issued a statement welcoming the release of the interim report and the recommendations, and encouraging the 'government, organisations and regulators to press forward with making these improvements in the framework'.  

CA ANZ Reporting & Assurance Leader Amir Ghandar said 'we believe these measures will improve confidence and quality in audit, as well as provide cover for the risks facing Australians'.

Seemingly commenting on recommendation 1, Mr Ghandar said that CA ANZ is 'optimistic that a holistic review of ASIC's audit inspection program, including more graduated insights on the severity of findings, will lead to better outcomes and constant improvement in audit quality.  Australians have a fair and reasonable expectation that auditing and other lines of defence will protect them from risks and shocks in their financial and consumer lives, and provide confidence, integrity and transparency in business.'

Big four firms:  The AFR reports that the big four firms are 'openly pleased' that many of their ideas were adopted by the Committee.  

[Sources: Parliamentary Joint Committee on Corporations and Financial Services, Regulation of Auditing in Australia Interim Report 27/02/2020; Senator James Paterson media release 27/02/2020; [registration required] The Australian 28/02/2020; [registration required] The AFR 27/02/2020; 02/03/2020;  CA ANZ media release 28/02/2020] 

Related news: UK audit developments

  • The FRC recently called on the UK's largest audit firms to voluntarily move to ring-fence their accounting functions from their consulting functions: The UK Financial Reporting Council (FRC) announced on 27 February that it has written to the UK's largest audit firms setting out its expectations for 'operational separation to bring about audit quality improvement and audit market resilience'.
  • The FT reports that KPMG UK has completed the disposal of its UK Pensions practice in response to enhanced regulatory scrutiny of auditing conflicts.

These and other related developments are covered in the 4 March issue of Governance News which is available on the MinterEllison website here.