This paper will critically analyse the current UK Auditing and Assurance framework including an in-depth overview of two of the thirty six International Standards on Auditing (ISAs) ISA 200 and ISA 210. There will also be an exploration of the regulatory bodies and of the Companies Act 2006, specifically around their control of the UK Auditing framework. An examination of the big four auditing companies in the UK will be performed KPMG, Deloitte, Ernst & Young and Pricewaterhouse-Coopers (PwC), focusing on their current monopoly within the UK auditing market.
An audit is the process of checking that the way a company presents information about its financial position is true and fair, and that any assumptions they include are reasonable. On completion of the audit an organisation can publish a set of 'audited accounts' - which is a detailed report of the financial position of the company which has been verified by its auditors.
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An independent and unbiased audit confirms that a company's claims about its financial position are true and fair. This is useful for various reasons, including giving investors and shareholders who are not involved in its day to day running a trusted second opinion on the organisation's financial statements and an insight as to how well it is being run. Company directors who are in charge of the finances of an organisation also feel rewarded and confident, when their financial statements are given an independent audit with a true and fair opinion. (www.trueandfair.org.uk/what is an audit. 2012:1)
International Federation of Accountants (IFAC) was formed in 1977 and includes over 160 bodies and two million accountants around the globe. Their mission is to support the profession of auditing and to be a factor in the development of international economies. IFAC also have a subsidiary board the (IAASB) International Audit and Assurance Standards Board they develop and promote the ISAs worldwide. IFAC itself is only a group of accountancy bodies and has no legal standing in individual countries. (www.ifac.org/about-ifac/organization-overview.2012:1-2)
The main aims of international auditing bodies in recent years have been to introduce new initiatives, the harmonisation of auditing procedures so that users of audit services are confident in the nature of audits being conducted. A focus on audit quality so that the expectations of users are met with adherence to a strict ethical code of conduct, and an improvement of the perception of auditors as independent unbiased service providers. To achieve this, auditors are required to adhere to regulatory quality guidance which includes a code of ethics, national corporate law and auditing standards.
The UK has a national regulatory body the Financial Reporting Council (FRC) which is independent and is responsible for governance and future investment within the UK. The FRC are involved within the creation of standards for corporate reporting and actuarial practice, they are enforced to achieve high accounting and auditing standards. These codes and standards are published to ensure that companies, auditors, actuaries and accountants adopt the same auditing and accountancy methods. (www.frc.org.uk/About-the-FRC.2012:1)
The national auditing standard setter the Auditing Practices Board (APB), have now been replaced by the Audit & Assurance Council (AAC), who have been brought under the control of the Financial Reporting Council after numerous worldwide accounting scandals e.g. Enron. This and similar problems within international auditing brought the end of self regulation. The codes and standards committee still continue to supplement and revise ISA's before issuing them within the UK.
Recent changes within the FRC include Urgent Issues Task force (UITF) which was disbanded in July 2012; other changes include the Professional Oversight Board (POB) which has been established to oversee the operation of the accountancy and actuarial professions. Accountancy Investigation and Disciplinary Board (AIDB) have also been established and their aim is to ensure appropriate standards are maintained by members and member companies. Changes within the UK auditing structure are made to ensure that they remain compliant with UK law including the Companies Act 2006. (www.icaew.com-guide-to-uk-auditing-standards. 2012:1-8)
Companies Act 2006 has brought about changes within the audit and assurance climate, the main one being the 'accounts and audit provisions of companies' this relates to exemption from audit for small limited companies who are able to meet a strict criterion. If they can meet two out of the three following conditions within their first financial year, turnover not more than £6.5m, balance sheet total not more than £3.26m and number of employees not more than 50 then an audit will not be a legal requirement. In future years the company will only incur a change if it fails two out of the three conditions for both the current and previous financial years. (www.accountancyage.com/aa/news/2203745/cable-lowers-audit-exemption-threshold. 2012:1)
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IAASB make it clear that an understanding of ISAs is important and fundamental to auditors internationally. All of the thirty six ISAs set out to show their objectives, requirements and also how to understand and apply the material contained within them.
The International Auditing and Assurance Standards Board's (IAASB) in 2004 undertook the task of updating ISAs for financial statements which was called Project Clarity. In 2009 the new ISAs were revealed and they included improved understanding and readability to make them more compatible and future proof within the UK framework of today. (www.frc.org.uk/Our-Work/Codes-Standards/Audit-and-assurance. 2012:1)
ISA 200 contains objectives that are required to be met when producing an audit of historical data. All other ISAs contain a request that they should be read in conjunction with ISA 200 because it is such an important standard within the ISA framework.
Elements of ISA 200 Include:
Objectives that clearly state the overall objectives of the auditor;
Definitions that clarify key terms relevant to auditing generally; and
Requirements that set out the conduct of an audit.
ISA 200 contains two objectives of the auditor, firstly to obtain reasonable assurance about whether the financial statements are free from material misstatement whether due to fraud or error; this will allow the auditor to give an opinion on whether the financial statements have been prepared in all material aspects. Secondly the auditor must report on the financial statements and communicate their findings in accordance with the ISAs requirements. (www.ifac.org/auditing-assurance/clarity-center/clarified-standards. 2011:1-22)
The five separate requirements within ISA 200 include:
Ethical requirement that the auditor will comply to all ethical codes within the jurisdiction that the audit takes place including quality control measures which underpins the conduct of an audit.
Professional scepticism shall be performed throughout an audit with relevance to circumstances which cause the financial statements to be materially misstated, especially important in audit evidence.
Professional judgment should be performed within planning an audit of financial statements and is essential in enabling the auditor to make key decisions for e.g. materiality. The IAASB also consider sound professional judgement is a fundamental requirement when contentious matters arise when conducting an audit.
Sufficient appropriate audit evidence will be required to obtain reasonable assurance, the auditor will be required to find appropriate audit evidence to reduce audit risk to an acceptably low level and this will enable the auditor to draw reasonable conclusions on which to give a professional opinion. (www.accaglobal.com/en/member/cpd/auditing/cpd-articles/isa-200.html. 2012:1)
Final requirement of ISA 200 is the failure of the auditor to achieve their objective. If the auditor fails to express an unmodified opinion based on the evaluation of evidence obtained, the auditor is required to state the relevant findings that have caused the failure within the audit and fully document them.
The overall objective and requirements of ISA 200 are to fully support the audit of financial statements regardless of size or difficulty of the entity being audited. The IAASB recommends that ISA 200 should be used and fully complied with when conducting an audit.
ISA 210 is the Term of Audit Engagement Letter; this formulates the arrangement reached between the auditor and their prospective client. This letter also serves as a contract which outlines the responsibilities of both parties and is normally sent before commencement of an audit, this helps to avoid any misunderstanding within the terms of the engagement. It will also confirm an auditor's acceptance of the appointment and the objective and scope of the audit including responsibilities to the client. (www.frc.org.uk/getattachment/210-Terms-of-audit-engagements.aspx. 2012:1)
The auditor and client should also agree on the terms of engagement which should be documented within the audit engagement letter. The contents of the engagement letter should include for e.g. the objective of the audit financial statement and that management of the company have responsibility for the information within the financial statements, fee or billing arrangements.
A new engagement letter each year may not be required unless certain circumstances have changed since the original contract was agreed. The following changes could require a new letter to be drafted and agreed, client misunderstands the objective and range of the audit or if the company changes their senior manager or personnel responsible for governance of the company. (www.icaew.com/en/members/regulations-standards-and-guidance/practice 2012:1-2)
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The Competition Commission (CC) has recently held an inquiry into the dominance of the big four audit companies of KPMG, Deloitte, Ernst & Young and Pricewaterhouse-Coopers (PwC). The commission has examined the accounts of publicly traded companies after it was revealed that the big four, audit all but one company in the FTSE 100 list and that less than 30% have not had a competitive tender in 15 years to appoint a new auditor. (www.independent.co.uk/news/business/news/end-big-fours-domination-of-listed-audit-market.2012:1)
Grant Thornton the fifth largest audit company have accused the big four of building up cosy relationships with the 'City' due to their perceived brand strength, with some bankers even requiring particular auditors to be hired when they are appointed to advise a listed company. (www.independent.co.uk/news/business/news/end-big-fours-domination 2012:1)
The European Commission in Nov 2011 have issued new proposals for reform; their aim is to achieve a superior quality audit and an audit market that is open to all companies. In 2008 the financial disaster revealed problem areas within the audit system, audits produced by the big four within 2008 on the large FTSE 100 companies produced clean audit reports but further inspection of the audit reports since 2008 have revealed the poor quality of those audits.
Within the European Commission proposals, audit companies are to rotate after a maximum engagement period of 6 years (with some exceptions); there will also be a cooling off period of 4 years before the audit company may be used again by the same client. The period before which rotation is obligatory can be extended to 9 years if joint audits are performed, joint audits are not made obligatory but are encouraged. (europa.eu/rapid/press-release.2012:1)
Tendering procedures are set to become mandatory, companies will have to have a transparent tender procedure in place to allow for competition when selecting an auditor. The audit committee of the company should be involved within the selection process. (www.icac.org.jm/pdf/Presentations.2012:1)
The Impact Assessment Unit (IAU) has questioned the proposals for reform by the EC arguing that the reform of the audit market were "less clearly evidenced" than the problem areas identified by the Commission (www.accountancyage.com/aa/news). The IAU also questioned if the Commission's analysis had been factually correct due to the dominance of the big four audit companies within the market.
The role of the regulatory bodies within UK Auditing is very important. We should not underestimate the role they play in the regulation of finance within the UK. Trust and order have been a key objection within recent years and to facilitate this goal the auditing profession has introduced national and international standards.
Since the end of self regulation in the 1980s auditing has been heavily governed within the UK. The development of ISAs has been fundamental within auditing to ensure auditors in the UK and internationally apply the same objectives and control when producing an audit.
Global downturn of 2008 has highlighted some possible flaws within the European auditing framework. The European Union's publication of proposals within the audit reform (Green paper) has tried to address clarity to recent issues, but opposition against some of the more radical reforms from the profession need to be investigated before drastic changes are made. It is also important that the UK Parliament and the EC reflect on the new proposals and only make changes where the evidence is justified for the need for reform.
UK Financial Reporting Council Framework Structure