Capital Quarter Winter 2020: Don’t get caught out by the Revised Ethical Standard

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The FRC’s Revised Ethical Standard was introduced in late 2019. It introduced revised and clarified rules for auditors and their ability to provide non-audit services to audit clients. Find out how they affect you.

Reviews into the practice of auditors have topped the agenda in recent years. They followed a series of high-profile scandals, where auditors were amongst those blamed for missing potential financial problems or fraud in blue chip companies that subsequently collapsed. Among many, these included BHS in 2016, Carillion in 2018 and Patisserie Valerie in 2019.

The Financial Reporting Council (FRC) issued its Revised Ethical Standard in December 2019. These recently changed rules apply more restrictions on what “non-audit” work auditors are able to do for a public interest entity (PIE) audit client. The restrictions were effective from 15 March 2020. The new standard also applies in full to engagements carried out under Standards for Investment Reporting (SIRs), such as for some reporting accountant engagements.
To be properly objective, it is important that the auditor is, but is also seen to be independent of the company that it is auditing and from the perception of an “objective, reasonable and informed third party”
The FRC has extended most of these rules to a broader sweep of client companies than previously. This wider group, referred to as OEPIs (other entities of public interest), must apply the restrictions to services beginning on or after 15 December 2020.

What do the changes aim to achieve?

The engaging of an auditor to provide other services (such as tax and accounting support) to the same company has the potential to impact on the perceived threat to the auditor’s independence. To be properly objective, it is important that the auditor is, but is also seen to be independent of the company that it is auditing and from the perception of an “objective, reasonable and informed third party”. The Revised Ethical Standard therefore seeks to strengthen the view of an auditor’s independence, by restricting what other services they may be able to offer to audit clients. And in doing so it aims to improve the overall quality of the audit and provide better investor protection.

What is an OEPI?

OEPIs are companies that do not meet the definition of a PIE but are still considered to be of significant public interest to stakeholders. These include:

• Large AIM-listed companies (with a market cap at or over €200m euros on a three-year average)
• Lloyd’s Syndicates
• large private sector pension schemes (with more than 10,000 members and more than £1billion of assets)
• Large private companies (with over 2,000 employees, or a turnover of over £200m and gross assets of more than £2billion)

From mid-December 2020 they are subject to all the same restrictions as PIEs except they will not be subject to the 70% cap on non-audit services.

What are the key revisions to the Ethical Standard?

  1. The introduction of a ‘whitelist’ of non-audit services which are allowed to be undertaken by auditors. This aims to be clearer than the previous, more ambiguous, blacklist of prohibited services (albeit that these still exist in law). Broadly, whitelist services are those which the auditor is obliged to provide by law or regulation, or those that are closely related to the audit (for example, interim reporting)
  2. A general ban on internal audit services, secondments, and contingent fee arrangements by external auditors and their network firms.
  3. The restrictions placed on gifts and hospitality being provided to or received from audit clients extends to those that may in future become audit clients.
  4. The restrictions on when certain tax work can be done for audit clients has been tightened, especially for listed companies.

What if a company has an existing contract for non-audit services?

Where an auditor was engaged and had commenced that non-audit service before 15 March 2020, transitional arrangements allowed them to complete their work under that engagement as per guidance in the earlier (2016) Ethical Standard. For OEPIs, the relevant date is 15 December 2020 with the new requirements coming into effect for periods commencing on or after that date. Again, there are transitional arrangements for the provision of non-audit services that were engaged and commenced before that date.

What next for reform of the audit sector?

The government has yet to make specific proposals for audit reform in response to the 2019 reviews by Sir Donald Brydon, Sir John Kingman and the UK’s Competition and Markets Authority (CMA). These reviews included recommendations for formal separation of audit and non-audit service lines, particularly among the Big Four audit firms.