The quality of an entity’s financial statements, supported (where required) by an external audit, is key to market confidence and informed investors and to the effective functioning of capital markets. While the external auditor has primary responsibility for the quality of the audit, directors and audit committees can put in place good practices that will contribute to audit quality.
At the end of November 2018, the Financial Markets Authority (FMA) published its Audit Quality Monitoring Report for the period from 1 July 2017 to 30 June 2018 (Report). The Report noted a number of areas that should be addressed in order to improve audit quality, including emphasising directors’ responsibilities for audit quality and improving auditor independence. At the same time, the FMA updated its handbook offering guidance for directors and shareholders of New Zealand FMC reporting entities about how to improve audit quality (Audit quality - a director's guide: November 2018) (FMA Guidance). The FMA Guidance sets out how directors can contribute to audit quality and what they can expect from the FMA and the external auditor. It covers matters such as the key things for directors to think about when selecting an audit firm, assessing the audit firm’s independence, co-operating during the audit process and evaluating the auditor’s performance at the end of the audit.
In January 2019, the International Organisation of Securities Commissions (IOSCO) published a report on good practices for audit committees in supporting audit quality (IOSCO Report on Good Practices for Audit Committees in Supporting Audit Quality: January 2019) (IOSCO Guidance). The IOSCO Guidance specifically concerns the role of audit committees of listed companies in supporting and promoting external audit quality.
In New Zealand, companies listed on the NZX must have an audit committee and the NZX Corporate Governance Code includes a number of recommendations for audit committees. Other FMC reporting entities (i.e. issuers of regulated products, fund managers, supervisors, registered banks, licensed insurers, etc) may choose to have an audit committee. An audit committee doesn’t replace the directors’ responsibility for financial reports but, as the main point of contact with the external auditor, an audit committee has an important role in the audit process and in supporting and promoting audit quality.
Among the good practices identified in the IOSCO Guidance for audit committees of listed companies in promoting and supporting audit quality are:
- Recommending the appointment of an auditor: The audit committee should determine the selection criteria in advance and assess tenders against that criteria independently of management. Auditor independence should be the key consideration and ‘opinion shopping’ should be avoided. The focus should be on audit quality and not on fee reduction.
- Assessing potential and continuing auditors: Auditors and the adequacy and appropriateness of their audit resources should be assessed by the audit committee. The matters that should be considered include: the auditor’s knowledge of the listed company’s business, the involvement of senior team members in the audit, the auditor’s geographical capabilities and how the engagement partner and team are accountable within their firm for audit quality.
- What matters should be considered in setting audit fees: The audit committee should consider the extent to which audit fees are consistent with the audit plan and a quality audit.
- Facilitating the audit process: Quality and timely reporting should be promoted by the audit committee seeking explanations and advice on the appropriateness of accounting treatment and estimates, keeping proper books and records and implementing appropriate systems and controls. Having these matters in place at an early stage will help facilitate a quality audit and reduce the risk of issues being missed due to deadline pressures.
- Assessing auditor independence: Audit committees should challenge management’s accounting treatments and estimates. The audit committee should oversee the development of policies on auditor independence, undertake procedures to satisfy itself on the independence of the auditor. Any non-audit services should be subject to the prior approval of the audit committee.
- Communicating with the auditor: The audit committee should have an open, meaningful and timely dialogue with auditors in relation to risks and issues in relation to the audit. The goal is to assist the audit committee and the auditor in performing their respective roles and conducting a quality audit.
- Assessing audit quality: An audit committee should assess audit quality with regard to enquiry, observation and how the auditor addresses findings by the FMA (as audit regulator).
The IOSCO Guidance also suggests that audit committees of listed companies consider voluntarily providing a public comment on their role in supporting audit quality. This could either be in documents accompanying the financial report or a separate statement on the company’s website.
The FMA has said that it expects directors of FMC reporting entities to read and consider the FMA Guidance carefully. The IOSCO Guidance is specific to audit committees of listed companies, but it will also be relevant to other FMC reporting entities by analogy.