PROPOSED ADDITION TO INTERNATIONAL STANDARD ON AUDITING (UK AND IRELAND) 600 USING THE WORK OF ANOTHER AUDITOR

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1 Consultation Papers PROPOSED ADDITION TO INTERNATIONAL STANDARD ON AUDITING (UK AND IRELAND) 600 USING THE WORK OF ANOTHER AUDITOR ACTION TO BE TAKEN REGARDING INTERNATIONAL STANDARD ON AUDITING 600 (REVISED AND REDRAFTED) SPECIAL CONSIDERATIONS AUDITS OF GROUP FINANCIAL STATEMENTS (INCLUDING THE WORK OF COMPONENT AUDITORS) December 2007 The Auditing Practices Board

2 THE AUDITING PRACTICES BOARD LIMITED The Auditing Practices Board Limited, which is part of the Financial Reporting Council, prepares for use within the United Kingdom and the Republic of Ireland: Standards and guidance for auditing; Standards and guidance for reviews of interim financial information performed by the auditor of the entity; Standards and guidance for the work of reporting accountants in connection with investment circulars; and Standards and guidance for auditors integrity, objectivity and independence with the objective of enhancing public confidence in the audit process and the quality and relevance of audit services in the public interest. The Auditing Practices Board Limited discharges its responsibilities through a Board ( the APB ) comprising individuals who are eligible for appointment as company auditors, and those who are not so eligible. Those who are eligible for appointment as company auditors may not exceed 40% of the APB by number. Neither the Auditing Practices Board Limited nor the APB accepts any liability to any party for any loss, damage or costs howsoever arising, whether directly or indirectly, whether in contract, tort or otherwise from any action or decision taken (or not taken) as a result of any person relying or otherwise using this document or arising from any omission from it. The Auditing Practices Board Limited 2007

3 INVITATION TO COMMENT The APB is issuing Consultation Papers for public comment on: 1 A proposed addition to International Standard on Auditing (UK and Ireland) (ISA (UK and Ireland)) 600 Using the work of another auditor to reflect forthcoming legal requirements in relation to statutory audits of consolidated accounts. 2. The action the APB should take regarding the recent revision by the International Auditing and Assurance Standards Board (IAASB) of ISA 600, with the new title Special considerations Audits of group financial statements (including the work of component auditors). The update of ISA 600 is part of a wider IAASB project to update and reformat ISAs (the Clarity Project). The IAASB has stated that the whole suite of ISAs finalised as part of the Clarity Project will be effective for audits of financial statements for periods beginning on or after 15 December While the APB expects that these ISAs will be endorsed for use within the EU, the timetable for this has not yet been established and it is possible that this may be at a later date. The APB has not yet decided on whether, and if so when, to adopt the new suite of ISAs. The APB is not inviting views on this important issue at this stage. While the conclusion may well be that the implementation of the revised ISA 600 in the UK and Ireland should be coordinated with the whole suite of ISAs, the APB believes that ISA 600 merits separate consideration at this stage because: (i) Requirements and guidance on group audits in the existing ISA (UK and Ireland) 600 are relatively limited. (ii) The revision of ISA 600 by the IAASB has now been completed and, at a minimum, there will be two years before it is implemented internationally (other ISA in the Clarity Project have yet to be completed). (iii) ISA 600 (Revised and Redrafted) provides useful guidance on how to apply the risk model in ISAs (UK and Ireland) 315 and 330 in a group audit context. 3. The APB welcomes comments on any aspects of the issues addressed in the Consultation Papers and, in particular, the specific questions set out therein. 1

4 The APB would prefer to receive letters of comment in electronic form: these may be sent by to If this is not possible, please send letters of comment to: Keith Billing Project Director The Auditing Practices Board Limited 5 th Floor Aldwych House Aldwych London WC2B 4HN Letters of comment should be sent so as to be received no later than 7 March All comments will be regarded as being on the public record, unless otherwise requested. 2

5 CONSULTATION PAPER PROPOSED ADDITION TO INTERNATIONAL STANDARD ON AUDITING (UK AND IRELAND) 600 USING THE WORK OF ANOTHER AUDITOR Background Article 27 of the European Statutory Audit Directive 1 (SAD) establishes provisions in relation to statutory audits of consolidated accounts. In summary these are that Member States shall ensure: (a) the group auditor bears the full responsibility for the audit report in relation with the consolidated accounts; (b) the group auditor carries out a review, and maintains documentation thereof, of audit work performed by other auditors for the purpose of the group audit. The documentation shall be such as enables the relevant competent authority to review the work of the group auditor. (c) when a group component is audited from a third country that does not have in place an arrangement under Article 47 for access to audit working papers by the relevant competent authority, the group auditor is responsible for the ensuring proper delivery, when requested, to the public oversight authorities of the documentation of the audit work performed by those third country auditors. The Department for Business Enterprise & Regulatory Reform (DBERR) has consulted on how these requirements should be included in UK law and is in the process of finalising the relevant regulations 2. Article 27(a) is already covered by ISA (UK and Ireland) 600 and Company Law. Article 27(c) is outside the scope of ISA (UK and Ireland) 600 as it concerns access to audit papers by public oversight bodies rather than the conduct of the audit itself. The Government has concluded that it should be provided for in the rules of the Recognised Supervisory Bodies, with statutory underpinning provided in amendments to Schedule 10 3 to the Companies Act Directive 2006/43/EC on statutory audits of annual accounts and consolidated accounts. Draft regulations were included for comment in the DBERR paper providing feedback on the results of the SAD consultation: Implementation of Directive 2006/43/EC on Statutory Audit of Annual and Consolidated Accounts (8 th Company Law Directive) Policy Conclusions and Draft Regulations - July The comment period for the draft regulations ended on 15 October Schedule 10 to the Companies Act 2006 sets out provisions applicable to Recognised Supervisory Bodies. 3

6 Article 27(b) is partially covered by the current ISA (UK and Ireland) 600 (paragraphs 8 to 14) but the documentation requirements are not as specific as they need to be to conform to the legislation. The International Auditing and Assurance Standards Board (IAASB) has recently finalised a revision of ISA 600 which includes specific documentation requirements relating to the documentation of the review of other auditors working papers. The IAASB has announced that its complete set of clarified ISAs, including the revised ISA 600, will be effective internationally for audits of financial statements for periods beginning on or after 15 December The Government is proposing to provide for the SAD requirements by amending Schedule 10 to the Companies Act 2006 to include provisions that a Recognised Supervisory Body must have rules and practices as to technical standards ensuring that persons appointed as statutory auditors to conduct audits of group accounts: (a) review for the purposes of such an audit the audit work conducted by other persons, and (b) record that review. In practice, Recognised Supervisory Bodies adopt ISAs (UK and Ireland) to provide technical standards for auditing. To ensure that ISA (UK and Ireland) 600 is compatible with Schedule 10 of the Companies Act 2006, the APB is proposing that ISA (UK and Ireland) 600 should be amended to include the new requirement set out below (proposed paragraph 14-1) to introduce specific documentation requirements relating to the review of work on group components performed by other auditors. The wording closely reflects that used in the IAASB s recently revised ISA 600. Effective Date It is intended that the proposed addition to ISA (UK and Ireland) 600 will have the same effective date as the proposed regulations implementing Article 27 of the SAD: - audits of financial statements for accounting periods beginning on or after 6 April Questions for Commentators Q1. Do you agree that the proposed addition to ISA (UK and Ireland) 600 is appropriate? If not, please give reasons. Q2. Will there be any practical difficulties the APB should be made aware of resulting from requiring the proposed addition to ISA (UK and Ireland) 600 to be effective for audits of financial statements for accounting periods beginning on or after 6 April 2008? 4

7 Proposed Addition to ISA (UK and Ireland) 600 Using the Work of Another Auditor It is proposed that a new requirement is established in new paragraph 14-1 as shown below (current paragraph 14 is shown for context). 14. The principal auditor would document in the audit working papers the components whose financial information was audited by other auditors, their significance to the financial statements of the entity as a whole, the names of the other auditors and any conclusions reached that individual components are immaterial. The principal auditor would also document the procedures performed and the conclusions reached. For example, working papers of the other auditor that have been reviewed would be identified and the results of discussions with the other auditor would be recorded. However, the principal auditor need not document the reasons for limiting the procedures in the circumstances described in paragraph 11, provided those reasons are summarized elsewhere in documentation maintained by the principal auditor s firm In the UK and Ireland, the principal auditor s documentation of the procedures performed should include the nature, timing and extent of the principal auditor s involvement in the work performed by the other auditors on components that are significant to the group as a whole including, where applicable, the principal auditor s review of relevant parts of the other auditors audit documentation and the conclusions thereon. 5

8 CONSULTATION PAPER ACTION TO BE TAKEN REGARDING INTERNATIONAL STANDARD ON AUDITING 600 (REVISED AND REDRAFTED) SPECIAL CONSIDERATIONS AUDITS OF GROUP FINANCIAL STATEMENTS (INCLUDING THE WORK OF COMPONENT AUDITORS) Background The APB s Position With Regard to Adoption of ISAs The APB supports the international harmonisation of auditing standards. In 2004, the APB took the decision to adopt ISAs for use in the UK and Ireland, supplemented where necessary to maintain the requirements and clarity of previous UK and Irish auditing standards when it issued the ISAs (UK and Ireland). Factors taken into account in reaching that decision included: the IAASB had recently introduced ISAs setting significantly strengthened standards in the critical areas of audit risk, fraud and quality control, and the expectation that Europe would adopt the ISAs in the foreseeable future. Since 2004 the APB has considered the two ISAs subsequently revised by the IAASB, prior to its Clarity Project, and evaluated whether they introduce significant improvements and should, therefore, be adopted for use in the UK and Ireland 1. The IAASB s Clarity Project was commenced in late The project is intended to improve the understandability of the ISAs, and eliminate ambiguities, through redrafting them with structural and wording changes and introducing a statement of the objectives of the auditor in each ISA. Some ISAs are being revised as well as redrafted. The intention of the IAASB is that all the ISAs redrafted in the Clarity format, including those that have been revised, should come into effect internationally on the same date recently announced to be audits of financial statements for periods beginning on or after 15 December The Statutory Audit Directive (Article 26) provides the platform for the adoption of international auditing standards in Europe under comitology procedures. However, no timetable for the adoption of international auditing standards in Europe has been established and it is possible that, if and when ISAs are adopted for use in the EU, this will be after the effective date established by the IAASB, i.e. later than audits of financial periods beginning on or after 15 December The possible difference in the timetables of the IAASB and the EU gives rise to an important issue for the APB to consider. The APB intends to consult in due course on whether it should wait until the full suite of clarified ISAs are adopted for use in Europe before adopting them for use in the UK and Ireland, or should adopt them earlier in line with the IAASB s timetable. Views on this are not being sought as part of this consultation. The APB is, however, aware that some of the revisions made to ISAs by the IAASB during the Clarity Project may address issues that are not covered by the current ISAs (UK and Ireland) or otherwise represent improvements to best practice. The APB 1 ISA 230 (Revised), which addresses audit documentation, has been adopted; ISA 700 (Revised), which addresses the form of the auditor s report, has not been adopted. 6

9 believes, therefore, that it should consider each ISA where major revisions have been agreed and consider whether it would be appropriate to adopt it early, update the corresponding current ISA (UK and Ireland), or explore other ways of introducing the material in the UK and Ireland, for example by way of non-mandatory guidance. The first of the revised ISAs for which the APB believes such consideration is necessary is ISA 600, which establishes standards and guidance relevant to the audit of group financial statements, and it is this ISA on which this consultation is focussed. The possible actions the APB could take are discussed in more detail below. The action that the APB takes after considering the responses it receives to this consultation may affect its approach to the consideration of other ISAs that are revised as part of the IAASB s Clarity Project. The Revision of ISA 600 ISA (UK and Ireland) 600, Using the Work of Another Auditor, adopts the text of the current ISA 600 issued by the International Auditing and Assurance Standards Board (IAASB), with some supplementary requirements and guidance. The IAASB has finalised a revision of ISA 600 with the new title Special considerations - Audits of group financial statements (including the work of component auditors). The revised ISA has been prepared using the IAASB s Clarity format and, in line with the IAASB position referred to above, is intended to come into effect internationally for audits of financial statements for periods beginning on or after 15 December The revision of ISA 600 by the IAASB commenced in 2003 in response to requests from several bodies 2 for specific guidance on the special considerations in the audit of group financial statements. After an extensive consultation process that included three exposure drafts the revision was completed in July A copy of the revised ISA can be obtained from the bookstore on the IFAC website ( It is significantly longer, with substantially more requirements, than the current ISA. The IAASB concluded that increased specification of procedures to be performed is necessary to achieve greater consistency in group audit practices where the group auditor takes sole responsibility 3. Possible Actions The APB welcomes the finalisation of the revised ISA and considers that it represents an important step in the global programme to revise auditing standards and enhance the quality of auditing. Although the APB is not aware of any significant general failings in group audits currently undertaken in the UK and Ireland, it nonetheless believes that there could be benefits from taking advantage of the material in the revised ISA; for example, it clarifies how the risk model underpinning the current ISAs (UK and Ireland) 315 and 330 applies in a group context. The APB recognises, however, that there are 2 3 Including the European Commission, the International Organization of Securities Commissions, the former Panel on Audit Effectiveness in the United States, and the International Forum on Accountancy Development. Current ISA 600 recognises that divided responsibility may be accepted in some countries. Under ISA 600 (Revised and Redrafted) the group auditor takes sole responsibility for the audit opinion on the group financial statements. It is already established in the UK and Ireland that group auditors accept such sole responsibility and this is made clear in supplementary text in the current ISA (UK and Ireland)

10 issues of timing and the practicality of how this could be achieved. Arguments can be made for and against each of the options of: (1) Adopting ISA 600 (Revised and Redrafted) early (either as a whole or by updating the current ISA (UK and Ireland) 600); or (2) Not adopting ISA 600 (Revised and Redrafted) in the UK and Ireland until the full suite of Clarity ISAs is implemented. A possible compromise option, also with arguments for and against, would be: (3) Converting ISA 600 (Revised and Redrafted) to a Practice Note and issuing it to illustrate best practice, but without introducing mandatory new requirements 4. The Practice Note could comprise the whole of the substance of ISA 600 (Revised and Redrafted) or just those parts that provide guidance on the application of the audit risk standards. Early Adoption of ISA 600 (Revised and Redrafted) Arguments for There are two primary arguments for early adoption of the new ISA: (i) The requirements and guidance specific to the audit of group financial statements would be in line with the most up to date thinking and, in the opinion of the APB, the best available standard. (ii) The current ISA (UK and Ireland) 600, which adopts the text of the IAASB s current ISA 600, was written before the new risk model established by ISAs (UK and Ireland) 315 and 330 was implemented. The risk model provides the foundation to the audit approach and the new requirements and guidance in ISA 600 (Revised and Redrafted) clarify how it applies in a group context. Arguments against Arguments against early adoption include: (i) A new ISA in the Clarity format will not fit with current ISAs (UK and Ireland): - there are references to matters in other clarified and revised ISAs that are not included in the current ISAs (UK and Ireland), - there may be issues concerning the relative status of the objectives, requirements and application material, - the different style of layout may cause confusion. One way to overcome the format issues would be to update the current ISA (UK and Ireland) 600 to incorporate the substance of the new requirements and 4 The APB Statement on the scope and authority of pronouncements states that: Practice Notes and Bulletins are persuasive rather than prescriptive and are indicative of good practice. Practice Notes assist auditors in applying APB engagement standards to particular circumstances and industries and Bulletins provide timely guidance on new or emerging issues. Auditors should be aware of and consider Practice Notes applicable to the engagement. Auditors who do not consider and apply the guidance included in a relevant Practice Note should be prepared to explain how the basic principles and essential procedures in APB standards have been complied with. 8

11 guidance. However, this would require an extended period for development of an exposure draft and finalisation of a revised standard that might have a relatively short shelf life before being superseded by a standard endorsed by the EC. (ii) It could cause UK and Irish audit firms within a multinational network to be out of synchronisation with other firms in that network, potentially causing difficulties. Audit firms that are part of an international network develop methodologies that are designed to ensure compliance with ISAs. (iii) There are costs associated with the introduction of any new standard; the new standard is likely to result in additional work 5 and audit firms need to integrate the standard in their manuals and methodologies and provide appropriate training to staff. Introducing the clarity ISAs in stages would be likely to increase the total costs of implementation compared to a big bang approach. (iv) There is a risk, hopefully small, that the EC may ultimately endorse an auditing standard that differs from ISA 600 (Revised and Redrafted) within a few years requiring auditors to make more changes and increasing the implementation costs. Not adopting ISA 600 (Revised and Redrafted) until the full suite of Clarity ISAs is implemented As would be expected, the arguments for and against not adopting ISA 600 (Revised and Redrafted) until the full suite of clarity ISAs is implemented are generally the converse of those for early adoption. Arguments for (i) Whilst the baseline of best practice may be raised by early adoption, the APB is not aware of any significant general failings in group audits currently undertaken in the UK and Ireland that need to be addressed by implementing ISA 600 (Revised and Redrafted). (ii) There would be no disruption to the fit of ISA 600 in the body of ISAs (UK and Ireland) as a whole. (iii) Audit firms that are part of an international network using common methodologies that are designed to ensure compliance with ISAs can avoid practical difficulties that might relate to early implementation of a change in the UK and Ireland. (iv) Incremental costs of early adoption are avoided. (v) The risk related to possible endorsement of a different standard for use in the EU would be reduced. Arguments against (i) There is a prolonged delay in issuing material that clarifies how the risk model underpinning the current suite of ISAs (UK and Ireland) applies in a group context. 5 When the IAASB issued the exposure draft of ISA 600 (Revised and Redrafted) the APB asked some auditors to estimate the possible effects of the ISA on the cost of some of their current group audits. The responses generally indicated increases in the range of 1% to 5% of group audit costs. This was based on a small sample and the APB would not suggest that such increases would necessarily apply to all group audits. It is not expected that the changes made from the exposure draft to the final standard would result in an increase to these estimates, but that has not been confirmed. 9

12 (ii) There will be a delay in raising the baseline of best practice and enhancing the overall quality of group audits. Converting and issuing ISA 600 (Revised and Redrafted) as a Practice Note Converting ISA 600 (Revised and Redrafted) to a Practice Note could be done in way that enables the substance of the new requirements and guidance to be identified as best practice whilst avoiding issues relating to a lack of fit with the current suite of ISAs (UK and Ireland). For example, references to matters in other clarified and revised ISAs that are not included in the current ISAs (UK and Ireland) could be conformed or excluded. Arguments for (i) Enables clarification of how the risk model underpinning the current suite of ISAs (UK and Ireland) applies in a group context. (ii) Identifies best practice in line with the most up to date thinking on the best approach to group audits, without introducing mandatory changes to current requirements. (iii) Issuing the material in this form may enable the identification of implementation issues that can be addressed before the introduction of the revised standard. Arguments against (i) As the Practice Note would be significantly more detailed than the current ISA (UK and Ireland), there is risk of a lack of clarity of what audit regulators expect of audit firms. (ii) Their will be associated costs for firms that implement the guidance in their manuals and methodologies, similar to the introduction of a standard. Other factors for commentators to consider Audit inspections In forming their views, commentators may wish to note that the FRC s Audit Inspection Unit (AIU) has informed the APB that even if ISA 600 (Revised and Redrafted) is not promulgated in some form by the APB, and notwithstanding its effective date set by the IAASB, the AIU may draw on or refer to it as a source of best practice guidance on group audits and have regard to it in conducting their reviews and making recommendations on audit quality to firms. Guidance for audit committees The recently published Final Report of the Market Participants Group 6 on Choice in the UK Audit Market includes the recommendation that: 6 The FRC established the Market Participants Group ( MPG ) to provide advice to the FRC, including identifying and assessing possible actions which market participants could take to mitigate the risks arising from the characteristics of the market for the audit for major public interest entities in the UK. The Final Report on Choice in the UK Audit Market was published on 16 October 2007 and can be obtained from the FRC s website ( 10

13 The FRC should provide independent guidance for audit committees and other market participants on considerations relevant to the use of firms from more than one audit network. The development of this guidance is expected to take into consideration the requirements of ISA 600 (Revised and Redrafted). There is a danger that guidance for audit committees might not correspond to equivalent guidance for auditors. Questions for Commentators Q1 As a general principle, should the APB promulgate those revised clarity ISAs that would result in strengthened auditing standards in the UK and Ireland ahead of the date set out by the IAASB for international adoption, either as (a) new standards, or (b) in the form of non mandatory guidance? Please give reasons for your view. Q2. With respect to consideration of ISA 600 (Revised and Redrafted), which of the three options do you believe is most appropriate and why? (1) Adopt early. (2) Not adopt until the full suite of Clarity ISAs is implemented. (3) Convert to and issue as a Practice Note. Q3. With respect to consideration of ISA 600 (Revised and Redrafted), do you have any alternative proposals the APB should consider? If yes, please explain them. 11

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