Audit watchdog with more muscle to replace beleaguered Financial Reporting Council
The last issue of the Audit & Accounting Alert reported on the innovative, forward looking approach of the United Kingdom’s Financial Reporting Council (FRC) in tackling the challenges of financial reporting in the age of artificial intelligence. Unfortunately, the auditor watchdog role of the FRC has not fared as well in keeping pace with the rapid changes in the accounting and reporting complexities of organizations subject to its oversight.
With collapses like that of Carillion plc, the second largest construction company in the United Kingdom, in early 2018, and severe criticism of the company’s audits performed by KPMG, the government commissioned an independent review of the FRC (known as the Kingman Review) to determine what went wrong, and the appropriate actions to take. Among the 83 recommendations from the review was a call to replace the FRC with a totally new, more powerful body.
The review characterized the FRC as “an institution constructed in a different era – a rather ramshackle house, cobbled together with all sorts of extensions over time. The house is – just – serviceable, up to a point, but it leaks and creaks, sometimes badly. The inhabitants of the house have sought to patch and mend. But in the end, the house is built on weak foundations.” To be fair, the FRC never had the needed authority to carry the clout that was necessary to be fully effective.
The review proposed that the new body, to be called the Audit, Reporting and Governance Authority (ARGA), can work if it:
- Has a clear and precise sense of purpose and mission;
- Is firmly focused on the interests of consumers of financial information, not producers;
- Is respected by those who depend on its work, and where necessary feared by those whom it regulates;
- Has the right powers and resources it needs to do its job; and
- Is able to attract the highest-quality people.
The British government has reacted favorably to the review and has indicated that steps will be taken expeditiously to implement most of the recommendations. Some can be enacted immediately and some after consultation, while others like the new ARGA will require legislation. Pursuant to those conditions, the government in March 2019 issued a consultation document to explain the process and seek input on various recommendations.
The response to the Kingman review moves forward as concurrent reviews weigh in. The Competitions and Markets Authority (CMA) is evaluating whether consulting services should be separated from firms performing audit services, and how best to increase the presence of audit firms beyond the Big Four into the marketplace. The Brydon Independent Review into the Quality and Effectiveness of the UK Audit Market will address the audit expectation gap between what users of financial reports expect and what auditors deliver along with their related responsibilities.
The United States went through a similar time of reckoning in 2002. As a result of the Enron and similar scandals, the Public Company Accounting Oversight Board (PCAOB) was established through the Sarbanes-Oxley Act by the US Congress to provide the Securities and Exchange Commission a robust watchdog over the auditors. Also, public companies were required to have their internal controls attested to by their directors and reported on by the auditors in addition to their financial statements. In fact, one of the recommendations in the FRC review was to consider measures similar to Sarbanes Oxley for the UK, as well as enhancement to the current Independent Auditor’s Report on the financial statements.
A look at how the PCAOB is currently applying its mandate is covered in a separate article in this issue of the Audit & Accounting Alert.
The anticipated changes described above will engender plenty of disruption on their own. With the added uncertainty of Brexit, the level of confusion filling the world in which the accounting profession operates, will be unprecedented for the foreseeable future. The FRC requires organizations to disclose the impact of potential Brexit unknowns in their financial statements. Auditors are inserting statements in audit reports alerting users that Brexit outcomes and related financial statement effects are not currently determinable.
Within the audit profession, the credentials authorizing UK auditors to practice in EU countries post-Brexit may come under question. Audit committees of UK-based companies may lose their EU-base directors. Possibly on the plus side, accounting firms may need to hire more professionals to provide needed assistance to clients dealing with Brexit-related issues.
In many ways, known and unknown, the prospect of Brexit is changing, and will continue to profoundly change, the landscape of commerce throughout the world.
Further details can be found at the FRC to be disbanded as government green lights new audit regulator.
Audit & Accounting Alert is a publication of Integra International intended to highlight emerging issues in the profession. The goal is to give Integra members an awareness of developments impacting the practice of Audit & Accounting enabling them to stay on the forefront of industry trends.This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors forspecific advice.
Editor Gerald E. Herter ~ HMWC CPAs & Business Advisors, 17501 E. 17th Street, Suite 100, Tustin CA