Audit Independence and Role of the Frc in This Regard

Audited financial statements give financial reporting credibility in the capital markets and promote effective corporate governance. Audits ensure credibility of financial statements and reduce risks to investors. Therefore, auditors’ reports depend on independence of auditors for reliability. Independence of auditors ensures credibility of reports and confidence among investors and creditors depending on auditors’ reports. Auditors must be independent in both fact and appearance. Credibility demands that auditors observe fairness and remain objective in their opinions and ensure that financial statements conform to general and acceptable standards of accounting principles. In short, auditor independence gives value to financial statements, capitals markets, promotes effectiveness of capital markets when allocating resources, and reduces costs of capital to people who rely on audited financial statements (Australian Government, 2012).

John Carey noted “Independence, both historically and philosophically, is the foundation of the public accounting profession and upon its maintenance depends the profession’s strength and its stature” (Carey, 1970, p. 182). According to Carey, independence entails character and an individual’s state of mind. This concept extends to account for integrity, objectivity, and honesty among auditors.

There is also the Act of Sarbanes-Oxley that aims at eliminating issues of conflict of interest, checking the quality of works of auditors, and promoting financial integrity among stakeholders. Sarbanes-Oxley also looks at non-audit services that auditors provide. The Act puts it that auditors should not provide such services as internal audit, IT consulting, and actuarial works to their clients (Osterland, 2002).

In Australia, there are provisions that ensure independence of accounting organisations from their clients. These measures are available in the Corporations Act 2001, and they include Statement of Auditing Practice AUP 32 Audit Independence and Professional Statement F1 of the Code of Professional Conduct. Statement FI accounts for “professional independence of accountants while AUP 32 specifically deals with audit independence” (Financial Reporting Council, 2012). The auditor independence in Australia relies on comprehensive laws and professional standards in ensuring independence of auditors.

There are certain auditor independence roles that the Financial Reporting Council (FRC) must account for and ensure their effectiveness. FRC is the highest body that checks effectiveness of Australia’s financial reporting frameworks. FRC core roles include monitoring the effectiveness of auditor independence, overseeing the accounting and auditing standards in both private and public organisations and advising the government and professional accounting bodies on audit issues.

The FRC monitors and assesses the audit systems of Australia in order to “ensure compliance with the independence requirements of auditors” (Financial Reporting Council, 2012). The FRC monitoring process also establishes that systems and processes of professional accounting institutions and quality assurance tools meet the standards of auditor independence of Australia. It also looks into responses of Australian auditors who have undergone quality assurance reviews and incorporates such feedback into its reports. FRC also ensures that Australian auditors who undergo quality assurance reviews adopt and comply with the reports’ recommendations arising from such reviews. FRC also investigates disciplinary procedures for audit firms in Australia.

FRC also ensures overall compliance among “organisations, schemes, and other business entities with audit requirements as per the Corporations Act of 2001 and standards of auditing and accounting” (Financial Reporting Council, 2012).

FRC has the responsibility of providing advice and reports to the Minister and professional accounting firms regarding audit issues. The FRC also has the mandate of monitoring development in international auditor independence. This also involves evaluating the effectiveness of Australian auditor independence requirements with reference to changes in the international standards of auditor independence. In this regard, the FRC informs the Minister and accounting firms of Australia about such new developments and provide suggestions of how to improve Australian auditor independence. FRC also assesses and enhances teaching of business and professional ethics in accounting. It also assesses how subjects relate to Australian auditor independence. FRC also has Memoranda of Understanding (MoU) with professional accounting bodies and others responsible for regulating accounting firms to enhance performance of auditor independence.

The FRC also has the responsibility of setting standards of accounting and auditing. The FRC does this through monitoring activities of AASB and AUASB. Standards also focus on international best practices in accounting firms and how Australia professional bodies can adopt them. In addition, FRC also focuses on how these practices can enhance best interest of both public and private sectors. The FRC ensures that audit procedures are relevant and meet their objectives to both private and public organisations of Australia.

Auditor independence has developed in the international scene due increasing rates of capital markets amidst globalisation. Organisations have rooted for uniformity and harmonisation of auditing processes and financial reporting. This also extends to ethical issues among accounting firms. The main concerns focus on independence of auditors and conditions that may lead to auditor impairment.

Matters arising from 2006-07 independence report contained in the FRC Report on Auditor Independence 2007-08 and actions taken by FRC in regards to each matter, and a brief discuss of the FRC’s 2008-09 work programme.

The FRC proposed engagement of a consultant to review activities related to identification of parties, supply chain, roles, interrelationships and appropriate rewards and punishment that can shape stakeholders’ behaviours. In addition, the FRC proposed to compare “models of the UK and Australia against conceptual framework so as to propose necessary changes to the Minister for refinement of the Australian model” (Financial Reporting Council, 2012). After the evaluation of outstanding recommendations, the FRC decided that there was no need of engaging consultants.

The FRC had to evaluate whether there was “a need to make recommendations to the Minister and accounting professional bodies based on consultants’ report” (Financial Reporting Council, 2012). Consequently, the FRC considered recommendations and took appropriate actions. However, the Council incorporated pending recommendations into the 2008-09 work programmes.

The FRC decided to continue with reviews and analyses of levels of compliance related to “audit disclosure through consideration of information from bodies that have MoU with the Council” (Financial Reporting Council, 2012). The FRC relied on information from ASX and ASIC in handling this issue.

The FRC also decided to investigate fees auditors receive for both audit and non-audit services. This is because the council suspected that provisions of such services can lead to systemic problems. It looked at services in relation to monetary terms and decided to ascertain whether such services can impede auditor independence. The FRC examination showed that there were no cases of impediment to auditor independence or systemic issues.

The FRC believes in appropriate education for auditors. Thus, it encourages ASIC and professional accounting bodies to development educative programmes for auditors. Based on this issue, the Council has encouraged professional bodies and ASIC to expand and improve their educative programmes for auditors.

The FRC also embarked on a thorough examination of consultants’ reports from 2005-07. The Council reviewed findings and recommendations and incorporated them into 2008-09 work programmes.

The FRC also reviewed whether there is a need to make further “recommendations to the Minister and accounting bodies regarding disciplinary procedures and quality review programmes” (Financial Reporting Council, 2012). On these matters, the Council provided informal recommendations to professional accounting bodies.

The Council also showed interests in making recommendations to the Minister and professional accounting bodies regarding teaching and promoting professional and business ethics among all stakeholders. The Council provided its informal recommendations to professional accounting bodies and relevant stakeholders about promoting and teaching professional and business ethics.

The Council decided to pursue issues relating to “reviews and analyses of levels of compliance with audit-related disclosure requirements based on information obtained from MoU bodies” (Financial Reporting Council, 2012). The Council got MoU bodies’ reports and feedback during meetings for analyses.

Work Programme of 2008-09

The FRC work programme of 2008-09 includes “monitoring and assessing the adequacy and nature of systems that Australian auditors use so as to meet the requirements of auditor independence” (Financial Reporting Council, 2012). The FRC depends on ASIC for information for monitoring performance of this programme based on the content of the MoU. At the same time, the Council shall also monitor activities of the AQRB and consult where necessary.

FRC intends to assess and monitor the overall effectiveness and nature of audit systems, and review processes professional bodies use to plan and conduct quality assurance reviews of audit works. This will also focus on how such reviews relate to requirements of auditor independence in Australia. FRC shall also review actions that auditors who have undergone quality assurance reviews have taken in response to reports based on such reviews. The work programme also accounts for actions that professional bodies have taken as appropriate responses to quality assurance reviews. The FRC intends to continue with this role based on information it receives from “professional accounting bodies under the terms of the MoU” (Financial Reporting Council, 2012). It shall get such information from periodic meetings and rely on publicly available information from professional accounting bodies.

The FRC also intends to assess and monitor the overall “effectiveness and adequacy of investigation and disciplinary procedures in Australia” (Financial Reporting Council, 2012). In this regard, the FRC shall continue to conduct this function based on the reports it receives from professional accounting bodies under the terms of MoU and from meetings. In addition, it will also review publicly available information from professional accounting bodies.

The Council shall also monitor the overall compliance among companies, disclosing organisations and registered schemes that have the “responsibility of audit-related disclosure under provisions of the Corporations Act 2001 of the accounting standards in Australia” (Financial Reporting Council, 2012). The Council intends to obtain such information from auditors.

The FRC also intends to give the Minister reports and advice based on its assessment and monitoring of all matters that refer to professional accounting bodies. The Council shall provide such reports and advice as the Minister and accounting bodies require them.

The Council shall also provide reports and advice to professional accounting bodies on issues relating to quality assurance, investigation, and disciplinary procedures. In this context, the FRC intends to monitor developments on an ongoing basis in order to avail reports and advice as needed.

The Council also intends to monitor international development in the area of auditor independence. It shall assess the overall effectiveness of Australian auditor independence requirements based on the Corporations Act and provisions of the codes of professional conduct. Based on these developments, the Council shall provide the Minister and professional accounting bodies with advice and reports that have any necessary measures that can improve the Australian auditor independence. In this regard, the Council shall review available information, media reports, and information from Web sites so as to conduct this role. In addition, the Chairman and the Secretariat shall meet relevant bodies in other areas including overseas bodies to assess international developments for reporting and advising the Minister and professional accounting bodies.

The FRC shall also monitor and promote the effectiveness of teaching of professional and business ethics by professional accounting bodies or other organisations on their behalf, and how teaching these subjects relate to provisions of auditor independence. As a result, the Council shall rely on reports from consultants and their recommendations in order to perform this task. It shall also widely consult with professional bodies, APESB, and other stakeholders how best to implement those recommendations. At the same time, the council shall also seek audience with other stakeholders to develop an ethics education campaign.

On other issues that relate to provisions of non-audit services, the Council Secretariat intends to conduct research on such matters. In addition, it will also observe trends of fees that auditors of audited firms “receive for both audit and non-audit services” (Financial Reporting Council, 2012).

The cooling off period and Audit rotation requirements contained in the short guide to the auditor independence requirements in the Corporations Act

According to Ramsay report, retired audit partners should take mandatory two years after his or her resignation from the audit firm. This is cooling off period. Cooling off period prevents threats to independence of auditors in cases where the retired auditor becomes a part of the board of an audit client, or before the retired auditor can become a director of a client (Australian Government, 2012).

The Corporations Act has this recommendation in Section 324CI. The Act imposes mandatory two years as cooling off period on all former partners and directors of audit firms before they can qualify as officers of audit clients. At the same time, Section 324CJ also imposes the same restriction on review or lead auditor of a licensed audit firm.

The Government provided an approach to the calculation of the two-year cooling off period in the SRS Act. This happened through amending Section 324CI(d) for auditors and Section 324CJ(d) for lead auditors or review auditors. According to this Act, the cooling off period begins when an auditor reports during the annual or half year financial reporting which are under Sections 308 or 309 respectively based on the participation of the former auditor or partner.

The cooling off period meant that an auditor, partner, lead auditor or review auditor could not immediately become an officer of the audit client after resignation. However, in the past, there were no search restrictions.

Auditor Rotation

The Corporations Act of 2001 has provisions for auditor rotation under Division 5 of Part 2M4. Auditor rotation was a part of the auditor independence reforms contained in the CLERP 9 Act. According to this provision, auditor rotation only affects authorised firms and registered schemes.

The basic requirements for auditor rotation are in time out rule of Section 324A(1) and the 5/7 rule under Section 342DA(1). Time out rules states that auditors who have provided significant services to audit clients for successive five financial years lack eligibility to continue providing such services to same clients, unless such auditors did not play significant roles for two successive years. This rotation affects both individual auditors and companies.

On the other hand, the 5/7 rule states that an individual may “not significantly serve an audit client for more than five out of seven successive financial years” (Australian Government, 2012). This rule aims at stopping individuals from evading the time out rule. The rule focuses on individuals rather than the audit company.

The Corporations Act 2001 limits ASIC power to conduct any modification of the rules. However, ASIC has relief power to declare how time out and 5/7 rules apply to individuals with reference to successive years of service. ASIC can apply its power in cases where rotation may be unreasonable to an individual, the audit firm, or the client audit.

Auditor rotation came as a result of accounting and auditing scandals that affected corporate throughout the world. Thus, auditor rotation is a means of enhancing auditor independence and the quality of their works.

Cameran, Vincenzo, and Merlotti have checked merits and demerits of mandatory auditor rotation from the point of view of regulatory bodies (Cameran, Vincenzo and Merlotti, 2005). On the same note, Nelson argues that mandatory audit partner rotation has reduced susceptibility of auditors to clients’ pressure due to developments in auditor independence regulations (Nelson, 2006). These studies support the idea that auditor rotation has benefits to both clients and audit firms. However, these studies also call for further research to determine effects of such regulations.

The concept of professional auditor independence is crucial to auditing. This is because the main role of an auditor is to promote credibility of financial statements of an organisation through expressing independent opinions. We must note that credibility and strength of independent audit rest on the fact that an auditor is independent of any external pressure. Thus, such works are free from bias or imposed constraints. In this sense, we see that independence of auditors depends on freedom from “conflict of interest, bias, prior commitment, or external influences” (Carey, 1970). In situations where auditors are not free or susceptible to such influences, then we may conclude that audit opinion does not depend on the provisions of facts alone, but also external interference.

Australian government has shown interest in reforms of audit and accounting regulatory environment so as to enhance disclosure to all stakeholders. Such regulatory measures have changed accounting and audit standards in order to enhance effective practices through promoting the independence of professional accounting firms.

After 2001 in Australia, there were growing concerns about the issue of audit independence due to failures of large corporations worldwide. Such failures led to development of auditor independence internationally. For instance, the International Federation of Accountants (IFAC) released its proposal that focused on enhancing ethical standards on auditor independence. The European Commission released a consultative proposal that aimed at enhancing greater uniformity regarding requirements among its member states. The US Securities and Exchange Commission (SEC) decided to review its rules regarding auditor independence so as to address matters concerning actions of auditors that led to serious financial scandals in the US.

References

Australian Government, 2012, Strengthening the financial reporting framework: Part 4: Auditor independence, Web.

Cameran, M, Vincenzo, D and Merlotti, E 2005, The audit firm rotation rule: Working Paper, Bocconi University, Milan, Italy.

Carey, J 1970, The Rise of the Accounting Profession: To Responsibility and Authority, 1937-1969, American Institute of Certified Public Accountants, New York.

Financial Reporting Council 2012, Annual Reports, Web.

Nelson, M 2006, ‘Ameliorating conflicts of interest in auditing: Effects of recent reforms on auditors and their clients’, Academy of Management Review, vol. 31, no.1, pp. 30-42.

Osterland, A 2002, Board Games, Web.