Following the passage of the Corporations Legislation Amendment (Audit Enhancement) Act 2012 (Audit Enhancement Act) the FRC adopted a strategic advice role in relation to audit quality. This advice may include matters relating to the effectiveness of Corporations Act 2001 (Corporations Act) provisions relevant to audit, the review processes undertaken by the professional bodies to ensure that auditor skills and processes remain at a high level and disciplinary processes undertaken to address any weaknesses in these areas. These three areas are addressed in this Chapter.
Audit contributes to and maintains confident and informed markets by enhancing the quality of financial reports. Under the Corporations Act, all disclosing entities, public companies (except some companies whose members' liability is limited by guarantee), 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.
Australia has comprehensive legislative and professional requirements concerning audit. The main legislative requirements are set out in the Corporations Act. ASIC is the key audit regulator under the Corporations Act and has responsibility for the surveillance, investigation and enforcement of the financial reporting requirements of the Corporations Act, including the enforcement of audit requirements. The Corporations Act also gives legal effect to the auditing standards developed by the AUASB. The professional accounting bodies set and enforce professional standards and are comprised of the Institute of Chartered Accountants in Australia (ICAA), CPA Australia and the Institute of Public Accountants (IPA). The auditing standards further require that auditors adhere to the relevant ethical standards as issued by the Accounting Professional and Ethical Standards Board (APESB).
The Audit Quality Task Force was reconstituted as the Audit Quality Committee in late 2012 to reflect the ongoing importance of issues pertaining to audit quality, and the audit quality responsibilities assumed by the FRC following the passage of the Audit Enhancement Act. The Audit Quality Committee is tasked with assisting the FRC through facilitating engagement with stakeholder bodies, reviewing international developments related to audit quality and providing input on the strategic advice provided to the Minister in relation to the matters noted above.
2.2. The Quality of audit
The FRC noted ASIC's disappointment with the results of the ASIC Audit Inspection Program Report 2011-12 (the ASIC Report) and welcomes the positive response from audit firms in developing action plans to further enhance audit quality in Australia. The FRC will monitor the follow-up action undertaken by ASIC and the sixth largest accounting firms, who comprise PricewaterhouseCoopers, KPMG, Ernst & Young, Deloitte, Grant Thornton and BDO.
During 2012-13, the FRC noted the work undertaken by the professional accounting bodies to improve audit quality, such as the review of guidance and training programs designed to drive improvement in audit quality among their members. The FRC notes that the audit quality review programs conducted by these bodies appear to be operating effectively to identify areas for improvement although this will be tested during the ASIC review in 2013-14.
The FRC further supports the collaboration between the professional bodies to address audit quality issues. The Joint Accounting Bodies published the 4th edition of the Independence Guide in February 2013, which significantly re‑wrote the existing Auditor Independence Guide. This guide provides comprehensive assistance to members of the Joint Accounting Bodies in public practice when dealing with auditor independence issues.
The FRC also monitored the adequacy of the teaching of ethics as it relates to audit quality by obtaining relevant information from the professional accounting bodies. Following a review of the information supplied, the FRC considers that the teaching of ethics by these bodies continues to be adequate.
2.1.1. Stakeholder engagement
The FRC and the Audit Quality Committee consulted widely with the audit profession during the year and sought information on audit quality matters from ASIC and the professional accounting bodies. The FRC also continued to review releases from the professional accounting bodies, accounting firms, international audit regulators and other stakeholders to further inform its audit quality role.
ASIC reported that its activities during the year included working with other audit oversight regulators to encourage the largest global audit firms to improve audit quality internationally through the International Forum of Independent Audit Regulators. ASIC also liaised with the Australian standard setter, the AUASB, and internationally, both directly and through the International Organisation of Securities Commissions, with a view to continued improvements to international auditing and auditor independence standards.
ASIC has written to certain audit committee chairs in Australia suggesting that they ask their auditors for the findings from ASIC audit firm inspections relating to the audit of their companies. Audit committees can contribute to audit quality by ensuring that auditors receive reasonable fees to support quality audits, that auditors are fully informed of risks that may impact on the audit, and that auditor independence is protected.
The ICAA reported that audit quality remains a key priority and that insights into auditors' perceptions of audit quality are crucial to the continual improvement of audit. During 2013 the ICAA's activities in this regard included:
- In depth analysis of research into the perceptions of partners and staff of the large firms of the key drivers of audit quality. The overall results were included in the publication Preserving capital market confidence through audit quality. Analysis of the data showed that auditors at all levels are aware of the importance and implications of professional scepticism to the quality of their work. Both auditor scepticism and communication were rated as the top skills needed for the audit profession. In May 2013 this research was extended to mid-tier firms, surveying over 1150 partners and staff across 74 offices. The ICAA is currently collating the responses of these surveys.
- Promotion of audit quality framework papers which highlight drivers of audit quality with practical guidance on how firms can focus their systems in these areas. The benefit of audit: A guide to audit quality addresses the importance of effective communication between the audit committee and the external auditor. The Framework for managing audit quality sustainability describes a process for managing a sustainable audit process.
- The release of the paper Why business ethics matter in May 2013, highlighting the importance of integrating ethical management into business practices and systems.
- Exploration of options to assist Australian auditors in the conduct of their work, including funding an academic study on how firms apply professional scepticism in an audit context.
- The release of a summary of the views and impacts being raised in the debates about mandatory audit firm rotation in Mandatory Firm Rotation: Summary of Impacts in June 2013.
Guidance and support
- Guidance covering quality control, risk management, independence, applying professional scepticism, issues arising from quality reviews in addition to regular newsletters, summaries and articles in Charter magazine on financial reporting, assurance and quality control.
- Audit Conference program under the theme 'Leading with Integrity' in New South Wales, Victoria, South Australia, Queensland and Western Australia. Also a Public Practitioners Conference program in the Hunter Valley, Gold Coast, Torquay and Sydney.
CPA Australia reported that it identified audit quality and the need for constant improvement as being of upmost importance. During the year to 30 June 2013 CPA Australia's initiatives designed to improve audit quality included:
- A Guide to understanding auditing and assurance: listed companies provides a simple, plain language explanation of audit for investors and other stakeholders and was released in February 2013. The July 2013 report of the Australian Parliamentary Joint Committee on Corporations and Financial Services found that the guide addresses some of the very important expectation gaps that have been highlighted in the wake of recent corporate collapses.
- Initiation of a research program with the Accounting and Finance Association of Australia and New Zealand (AFAANZ) on audit independence and market structure in the ASX listed company market for audit services. The preliminary findings of this research have been provided to the FRC and a final report is expected to be published in late 2013.
- CPA Australia was the major sponsor of and presented to the 2013 International Symposium on Audit Research held in Sydney. This is the premier international forum for research into audit quality.
Guidance and support
- Working closely with ASIC to determine the best means to address the findings of the ASIC Report, leading to the development of new and enhanced activities towards the focus area of professional scepticism. CPA Australia informed its members about the findings of the ASIC Report — including audit evidence, professional scepticism and the use of experts — and incorporated relevant resources into its training programs, quality review program, podcasts, articles and other content.
- Comprehensive upgrade and relaunch of the Small Entities Audit Manual in April 2013. This provides easy to access information and programs that facilitate quality audits and reviews that are important to a range of entities, including associations, companies limited by guarantee, self-managed superannuation funds and trust accounts.
2.2.2. International developments
The FRC tracks international developments to better evaluate the adequacy of Corporations Act provisions relating to the conduct of audit, the auditing standards and applicable codes of professional conduct. The FRC reviews general media reports about audit quality issues, as well as material from key overseas oversight and standard setting bodies and other regulatory agencies.
During 2012-13, the FRC has observed with interest a range of developments in Europe and North America that have implications for audit quality. The more significant of these developments include:
- The US PCAOB continued to host roundtables to consider auditor independence and auditor rotation issues with key stakeholders during 2012 and early 2013. The PCAOB also adopted Auditing Standard No. 16, Communications with Audit Committees in August 2012.
- In September and December 2012 CPAB released discussion papers for comment, Enhancing Audit Quality — A Canadian Perspective, in relation to auditor independence, auditor reporting and audit committees. These discussion papers were followed by the release in April 2013 of the 2012 Public Report on Inspections of the Quality of Audit that identified the importance of consistent audit processes for high quality audits.
- In January 2013 the UK Financial Reporting Council (FRC-UK) released the Sharman Implementation Consultation Paper, seeking input on proposed guidance and amendments to the International Standards on Auditing (UK & Ireland). The consultation paper addressed recommendations made by the Sharman Panel of Inquiry on going concern and liquidity risks in June 2012. The FRC-UK also implemented a 'comply or explain' set of proposals in October 2012, including mandatory audit tendering for FTSE 350 companies every 10 years and comprehensive reporting from audit committees on their activities.
- The IAASB released A Framework for Audit Quality in January 2013 seeking feedback on its effectiveness in explaining the factors that contribute to audit quality. During the period, the IAASB also continued working on the auditor reporting project following the 2012 release of the IAASB Invitation to Comment Improving the Auditor's Report. Auditor reporting proposals are forecast to be issued as standards and implemented from 2015.
- In February 2013 the UK Competition Commission issued its Provisional Findings Report seeking stakeholder feedback on possible systemic risks relating to competition in the statutory audit market. Possible remedies identified in the Provisional Findings Report include mandatory tendering, mandatory audit firm rotation, expanded reporting requirements and the prohibition of 'Big-4 only' clauses in loan documentation. The final report is expected to be published by October 2013.
- In April 2013 the legal affairs committee of the European Council (EC) voted in favour of proposed amendments including that audit firms be required to rotate after a maximum period of 14 years (and in specific circumstances 25 years). The European Parliamentary committee will now negotiate with members of the EC to agree on a final text for a bill to be voted on. The final legislation is not expected for a couple of years.
- In May 2013 the PCAOB released a briefing paper Discussion — Audit Quality Indicators. While their initial purpose was to seek input on possible audit quality indicators, they recognised the need to ground their discussion with a working definition of audit quality which they proposed as:
- 'meeting investors' needs for independent and reliable audits and robust audit committee communications on: financial statements, including related disclosures; assurance about internal control; and going concern warnings'.
The FRC will maintain a watching brief on these developments to determine how best to respond in order to improve audit quality in Australia. During 2012-13 the Audit Quality Committee considered a number of international audit proposals and assisted with the preparation of FRC submissions in response to matters that were of particular importance.
- In 2012-13 the Audit Quality Task Force developed a survey for the members of the ASA. The survey results reflected concern about the scope of auditor responsibilities and how retail shareholders interact with company information. The results of this survey were used to inform the FRC submission to the IAASB Invitation to Comment Improving the Auditor's Report. The submission highlighted the FRC's support for improvements in the communication of key audit information and the participation of the audit profession in the development of these initiatives. The submission further highlighted the importance of users understanding the role and responsibilities of audit. This submission contributed to the subsequent development of proposed revisions to international auditing standards related to the Auditor's Report by the IAASB.
- In May 2013 the Audit Quality Committee responded to the IAASB Consultation Paper A Framework for Audit Quality. The submission firstly highlighted the FRC's support for the development of a framework for audit quality and discussed the benefits of a working definition of audit quality. The FRC submission proposed a working definition of audit quality as 'the likelihood of the audit achieving the fundamental objective of the audit which is to obtain reasonable assurance that material misstatements in the overall financial report are detected, and addressed or communicated to relevant stakeholders' and responded to the consultation paper with this working definition in mind. Like the PCAOB, the FRC recognised the need for a working definition of audit quality that includes mention of its purpose so measurement can be more readily agreed. The submission also supported the acknowledgement that improving audit quality relies upon all participants in the financial reporting supply chain.
- The FRC's opinion was also sought by CPAB in response to the release of discussion papers on audit quality in Canada in late 2012. The FRC submission paid particular attention to the importance of a generally accepted definition of audit quality and the respective roles of the auditor, management and audit committee. The submission further highlighted the commonalities between the Canadian and Australian approaches to audit oversight.
2.3. Review Processes
Australia runs a co-regulatory regime with ASIC and the professional bodies cooperating on the implementation of their review processes. For example, the ICAA and CPA Australia accept each other's quality review programs for the purposes of member compliance oversight.
2.3.1. ASIC Audit Inspection Program
The ASIC Report covers findings from inspections of 20 Australian audit firms substantially undertaken in the period between 1 January 2011 and 30 June 2012. The inspections focussed on audit engagement file reviews covering aspects of the audits of financial reports with 2010 or 2011 year-ends, and the audit firms' quality control systems. The next Report will cover the period from 1 July 2012 to 31 December 2013.
ASIC briefed the FRC on the key findings from the ASIC Report at the FRC's December 2012 meeting. The focus of the briefing was on how ASIC and the audit profession could best address the findings with an emphasis on the importance for audit firms of their primary responsibility for audit quality.
ASIC informed the FRC that they considered the findings 'disappointing' as they indicated that there had been no improvement in the findings from the previous 18-month inspection period, with an increase in instances where ASIC considered that auditors did not perform all of the work necessary to obtain reasonable assurance that the audited financial statements were not materially misstated. Three broad areas were specifically identified as requiring improvement by audit firms:
- the sufficiency and appropriateness of audit evidence obtained by the auditor;
- the level of professional scepticism exercised by auditors; and
- the extent of reliance placed on the work of other auditors and experts.
The ASIC Report proposed that audit firms should renew efforts to improve audit quality and the consistency of audit execution.
Following the release of the Report, ASIC asked the six largest audit firms to prepare action plans to address these matters. ASIC asked the audit firms to focus on improving the consistency of the execution of audits and to address the three broad areas requiring improvement identified in the ASIC Report. The action plans focussed on:
- the culture of the firm, including messages from firm leadership focusing on audit quality and consultation on complex audit issues;
- the experience and expertise of partners and staff, including increased and better use of experts;
- supervision and review, including greater partner involvement in working with audit teams in the planning and execution of audits, and new or increased real time quality reviews of engagements; and
- accountability, including impacts on remuneration of engagement partners and review partners for poor audit quality, often extending the responses to firm leadership.
The FRC notes that ASIC welcomed the response of the six largest audit firms. ASIC acknowledged that each firm had developed a genuine and comprehensive action plan to improve audit quality and had taken full ownership for the timely implementation of the plan and monitoring its effectiveness.
The audit firms will generally implement key aspects of the action plans for audits for the year ending 30 June 2013. The audit firms have been asked to monitor the implementation and effectiveness of the action plans, with ASIC to review the results of each firm's monitoring of initial progress in early 2014.
2.3.2. ICAA Quality Review Program
ICAA members who hold a Certificate of Public Practice (CPP) are required to undergo the Quality Review Program (the Program) in accordance with the policies and procedures governing the operation of the Program. This includes those members who provide audit services, including registered company and Self-Managed Superannuation Fund (SMSF) auditors.
The ICAA has informed the FRC that the Program seeks to assess whether practitioner members have implemented appropriate quality control policies and procedures in their accounting practices. The ICAA works in three key ways to promote continuous improvement:
- working closely with individual practices to remediate their policies and procedures, where these policies and procedures are not appropriate, to maintain compliance with standards and legal requirements;
- analysing review results in detail to direct Institute resources and services where they are most needed; and
- using the results and issues arising from the Program to inform advocacy with regulators and standard setters.
Practices with significant non-compliance issues are re-reviewed within one year. Practices that sign off on audits requiring registered company auditor (RCA) registration are reviewed at least once every three years. All other practices are reviewed at least once every five years.
During 2012-2013, 80 per cent of the practices reviewed were reported to have either met all of the professional standards and regulatory requirements as set by standard setters and regulators or showed levels of non-compliance that were not significant. This compares with 76 per cent of practices in the 2011-12 financial year.
For those practices showing a level of non-compliance that was not significant, the ICAA requires the practice to confirm in writing that the issues identified during the review have been addressed. The remaining practices are required to develop an action plan within two months outlining how they will address the identified issues, and to undergo a follow-up review within 12 months. Where an action plan is not provided or adequately implemented at the time of the follow-up review, a practice may be referred for investigation by the ICAA's Professional Conduct team.
These results came from the review of audit engagements files constituting audits of a range of entities, summarised as follows: listed entity (3 per cent), Corporations Act, excluding listed entities (30 per cent), SMSF (39 per cent) and non-Corporations Act/SMSF (28 per cent).
The ICAA further informed the FRC that there has been an increase in non-compliance (not systemic) with individual aspects of requirements mostly in relation to practices continuing to adapt their policies and procedures to the new requirements of the Clarity standards. These practices are required to confirm in writing that the issues identified have been addressed.
The ICAA is also enhancing its review approach for very small practices that conduct audit engagements to enhance audit quality at the smallest end of the profession. These practices will be subject to a more comprehensive review approach. This initiative is part of the overall objective of enhancing audit quality at all levels, regardless of practice size.
2.3.3. CPA Australia Quality Review Program
CPA members who hold a public practice certificate are subject to a Quality Review (QR) Program by CPA Australia.
CPA Australia's QR program adopts a cyclical, risk assessment approach to selecting members for review. Member selection is defined by the following criteria:
- Public Practice Certificate (PPC) holders who are either a RCA or SMSF auditor are subject to review every three years;
- all other members are reviewed on a four, three or one year cycle based on the outcome of their last review.
- members who receive a qualified report (assurance report) are reviewed after three years instead of four years; and
- members who are subject to further review (follow-up report) due to non-compliance issues are reviewed the following year.
For the year to 30 June 2013 the results of the QR Program were:
- 27.5 per cent Accept Reports with no departure from professional standards identified;
- 50.4 per cent Assurance Reports with minor departures from professional standards identified; and
- 22.1 per cent Follow-Up Review Reports where multiple departures from professional standards reported a breach of an audit standard identified. Any breach of an audit standard results in an automatic follow-up review the following year. Where breaches fail to be addressed, CPA Australia then treats the matter as a Professional Conduct matter and may pursue disciplinary options.
The majority of all auditing breaches identified by the QR Program related to audits of SMSFs and Queensland Building Services Authority (QBSA) review engagements. Education has been provided to members about the importance of perceived and actual independence, particularly with the compilation and audit engagements for SMSF and QBSA review engagements.
In the current review period (the 2013 calendar year) over 850 members are expected to complete a Quality Assurance review and 199 follow-up reviews are expected to be completed.
2.3.4. IPA Quality Review Program
The IPA has informed the FRC that it requires all members who are issued with a Professional Practice Certificate to undertake a Public Practice Quality Assurance Review (PPQA) every three to five years. Members who are Australian auditors must be reviewed every three years.
The IPA undertakes a review of around 500 members in public practice every year. For the year to 30 June 2013, all reviews were conducted using an online data collection program in relation to member practice and their client base. Reviews are still undertaken in a face to face situation and members must provide proof of their compliance with professional and ethical requirements of the IPA.
Due to the small number of IPA members who are RCAs, only one of the members reviewed was an RCA. There were no deficiencies discovered in the review of this member and the member was not required to undertake any additional action as a result of the review.
2.4. Disciplinary procedures
In undertaking its role in providing strategic advice on audit quality, the FRC reviews disciplinary procedures. For this purpose, ASIC and the professional bodies provided the FRC with relevant information on their disciplinary procedures for 2012-13. The FRC acknowledges and notes the work that is being completed by these bodies and will continue to assess the extent to which these procedures may impact upon audit quality.
Of particular relevance to the FRC's audit quality role, during the year to 30 June 2013 ASIC obtained enforceable undertakings in relation to the audits of Centro Properties and Centro Retail, ABC Learning Centres and Citigold Corporation. The penalties included undertaking not to practice as an RCA for a specified period of time and deregistration as an RCA. ASIC has made arrangements to pass draft Statements of Facts and Contentions concerning members of the ICAA and CPA Australia to those bodies to enable them to take appropriate disciplinary action.