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European Audit Reform


Chief Financial Officers take heed: the European Audit Reform (EAR), expected to be adopted by all European Union Member States by June 17, 2016, affects American companies with a presence in, or with subsidiaries doing business across, the EU. The reform requires that publicly traded subsidiaries on an EU Member State stock exchange and registered in an EU Member State conform to new audit rotation rules and restrictions on non-audit services.  They must also verify that their audit firms are adhering to EU independence requirements. American companies must anticipate sweeping changes and coordinate with their European subsidiaries, as well as getting professional guidance from an accounting firm with EAR experience.

It is widely held that the primary responsibility for the 2008 Financial Crisis rested with bankers who packaged and sold subprime mortgages and the ratings agencies who sanctioned their creditworthiness. Subsequently, there was a perception that auditors had some culpability, too, by failing to identify going concern issues.  In response, the European Commission (EC) launched a consultation that paralleled those of the UK Financial Reporting Council and the Competition and Markets Authority, resulting in changes in audit firms’ service terms and limits on the services they can provide. [1]

In its review, the EC found that overconcentration among the larger, more well-known firms created adverse consequences from their dominant position and, in some cases, may have compromised the quality of audits.

For example, some firms were tarred with scandal when Enron and WorldCom went bankrupt. Investigations revealed that audit firms failed to report auditing errors, and passed on limited, and sometimes unreliable, information to investors.  Also, because these firms offered other services that generated more revenue than the audit, it was argued that the integrity of the audit was compromised. They tended to operate with the goal of reducing costs and avoiding legal proceedings at the expense of relaying accurate data so that investors could make informed decisions. [2]

The EC recognized that change was needed to ensure auditors were independent, objective, and committed to a relationship grounded in trust. They also noted the need for an integrated, sizable, and multi-player stable of auditors in the marketplace. After more than four years of legislative discussions, this expansive reform will ultimately affect all corporations domiciled in the European Union (EU) and American companies with subsidiaries that do business there.  The overarching goals are to strengthen the independence of audit firms, make the audit report more informative, and improve audit supervision throughout the EU. [3]

These changes are an important first step in establishing a competitive audit framework by introducing more players into the marketplace, and working towards reestablishing trust in financial reporting, enhancing audit quality, and encouraging a multi-player audit market. [4]

First and foremost, the EU proposes that auditors be rotated after 10 years for all public interest entities (PIEs).  At the end of that 10-year term, if a company issues a tender (request for proposal), that results in the original auditing firm being selected, then its engagement may be extended an additional 10 years, but not to exceed a total of 20 years.  If a joint audit is adopted, then the audit firm may be retained for an additional 14 years, for a total 24-year engagement.  However, individual Member States may enact even more rigorous rotation rules.

Another component of the regulation is limitations on non-audit services.  For example, fees for non-audit services may not exceed 70% of the average total statutory audit fees paid during the last three fiscal years.  As with the rules governing audit rotation, individual Member States may impose stricter requirements by adding additional prohibited services and/or raising the bar for those that are permitted.

The reform may also be construed as an endorsement of the concept of joint audit, and provides advantages to those companies that employ two auditors:  joint auditors may remain engaged for a total of 24 years, without the obligation to tender. [5]

The EAR also includes elements expanding the role of the Audit Committee and making the actual audit report more informative.  At the same time, there are provisions for increasing supervision and promoting cooperation among entities who oversee audits by creating a Committee of European Audit Oversight Bodies (CEAOB).

Though the EAR has not yet been fully adopted at Member State level in the EU, other non-European countries are nevertheless keeping a close eye on its future success as it could possibly serve as an alternative model for others to follow.

Change management is required for listed companies, financial institutions and insurance companies. CFOs need to know the requirements and the proper steps to achieve compliance. In this transition it is important to seek professional advice from an accounting firm with demonstrated expertise on this important EU-wide change.

[1] //economia.icaew.com/finance/february-2015/european-audit-reforms-keeping-the-objectives-in-sight#sthash.7t2lLV7c.dpuf
[2] Albert. Éric. Les <Big Four> en accusation. 3/10/2015
[3] //ec.europa.eu/finance/auditing/reform/index_en.htm
[4] Herbinet, David. European audit reforms: keeping the objectives in sight 2/25/2015
[5] Economia

 


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