The government has been working on a new set of audit reforms that are aimed at making the audit process more efficient and effective.
Here is what you need to know about them!
What are Audit Reforms?
Audit reforms are changes to the legal and regulatory framework governing corporate audits. These reforms aim to improve financial reporting, enhance shareholder protection, and ensure that audit reports provide reliable evidence of a company’s performance.
What Changes Does Latest Audit Reforms Include?
The upcoming reforms include initiatives such as:
1. New Audit Regulator
The Audit, Reporting and Governance Authority (ARGA) is the successor to the Financial Reporting Council (FRC), with a larger scope and more significant authority. For example, ARGA will have the power to divide accountancy firms’ audit functions from their non-audit services. This initiative has been designed to enhance accountability within these large companies while also improving quality assurance processes for stakeholders.
The consultation paper has outlined a broad scope of responsibility for ARGA, with the capability to monitor all components of annual reports and accounts as well as exercise investigatory powers. Additionally, it will keep track of audit committees and be able to impose fines or other sanctions on those who breach directors’ corporate reporting and audit-related duties. In rare cases where necessary, ARGA can even require an expert review at the expense of the company in question.
2. Reporting & Attesting Internal Controls
Despite the initial proposals that would have gone beyond what has been reported, the government’s ultimate plan is to bolster the UK Corporate Governance Code so an explicit statement from directors on assessing their internal controls can be made. This policy change will only apply to premium listed public interest entities (PIEs).
3. Dividends and Capital Maintenance
The government intends to provide more transparency for companies with 750:750 PIEs by requiring them to disclose their total amount of distributable reserves, as well as an explanation from the board concerning their long-term policy on dividends and other shareholder returns. Furthermore, this plan must also include how it will be applied during the current financial year. In the annual report, directors must explicitly confirm that interim and final dividends paid out during the financial year were legal.
4. Reporting on Resilience
Directors of 750:750 PIEs are mandated to submit an annual resilience statement (comprising the existing going concern and viability statements) that illustrates any matters they judge as a significant challenge for the company’s strength over short, medium, and long-term periods. Additionally, this report should contain an explanation on how directors derived their judgement of materiality. The government has presented an opportunity for organisations to establish the duration of the medium-term assessment period and perform a minimum of one reverse stress test instead of two.
5. Audit and Assurance Policy
Every three years, 750:750 PIEs must publish an audit and assurance policy along with a yearly implementation report. The government will no longer necessitate a shareholder advisory vote on the policy; however, it must include how stakeholders’ opinions were taken into account.
6. Fraud Detection
The government’s consultation paper outlines their plan to impose a requirement on 750:750 PIEs’ directors to report all steps taken that target fraud prevention and detection. Directors’ existing reporting responsibilities will remain constant, but auditors are now not obligated to include further information about the statement or the procedures they have used themselves in order to discover any material fraud and evaluate applicable internal controls.
In the interim, the government has asked for a regulator to assess if audit reports should provide more information on the auditor’s work related to internal controls and financial reporting. This area will be monitored closely and additional revisions may be required as needed.
7. New Sanctions for Director Wrongdoing
As predicted, the ARGA will now have enhanced power to look into PIE directors’ negligence of their statutory corporate reporting and audit duties. This includes fines, reprimands, orders to rectify any issues that may arise, declarations of non-compliance and temporary suspensions from serving as a director of a PIE.
Additionally, these enforcement powers can also be amended to apply towards other types of entities apart from companies if deemed necessary by ARGA authorities..
8. Audit Committee & Shared Audit Regime
In an effort to reduce the weight of new pressures on entities that become PIEs solely due to recent size-based thresholds, the government plans not to impose already existing requirements such as audit committee appointment, retendering every 10 years and auditor rotation every 20. As proposed in their consultation paper, for FTSE 350 companies there is a demand for appointing a ‘challenger’ audit firm alongside a larger company responsible for conducting substantial parts of statutory audits. ARGA will vigilantly observe and ensure that the requirements of FTSE 350 audit committees are met regarding the assigning and managing of auditors, as well as take action against directors for any violations.
9. Audit Profession
As an alternative to the creation of a new audit profession, supervised by ARGA, the government has chosen to mandate that professional bodies must significantly improve their qualifications, skillsets and training for auditors. This will cultivate ‘a more effective and distinctive audit profession’, as well as conditions which facilitate market development in wider external assurance services – such as through mandating PIEs publish an audit & assurance policy.
Overall, these changes are part of a broad effort by the government and ARGA to drive higher standards in corporate governance & audit quality.
As such, we can expect further regulations that ensure firms comply with audit standards, including improved reporting requirements to give more clarity on the extent and effectiveness of an auditor’s work. These changes will ultimately help ensure that PIEs produce accurate financial records, create greater trust in external assurance services and lead to stronger internal controls.