NZSA Best Practice
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Independence of auditors The Enron affair has brought into focus the various conflicts that auditors may encounter during the course of their work. In recent years the expansion of the accountancy profession has increasingly graduated from pure accountancy and taxation work into specialist consultancy assignments involving a range of expertise requiring legal, economic, environmental, engineering, marketing and human resource qualifications. The quality of the tasks means that fees may be much greater than those normally associated with audit work. The perception During 1997 the writer prepared a table showing audit and other fees of New Zealand listed companies that were extracted from the annual reports of companies whose year end was 30 June 1996. Earlier this year, following the Enron situation, the subject was revisited. This time the analysis was expanded to include all listed companies whose annual reports were readily available. However in order to prepare a meaningful comparison with the table prepared in 1997 a separate summary has been prepared that incorporates those companies common to both surveys. This table is shown below. A major disparity that has a huge effect on the results is the corporate changes to the Fletcher Challenge group. If this group were eliminated from comparisons a pattern is evident. The pattern shows that the potential use by auditors of their position to introduce other income earning services to their practices is apparently increasing at an alarming rate. This was the scene that we were presented with earlier this year and we were so concerned that we wrote to each of the accounting firms of the Big Five Survivor Group members (The Survivor Group) seeking their comments. The exchange of correspondence, discussions, our subsequent confirmatory letter and their reply following these initiatives are available on our website. These documents should be visited so that a picture is obtained of the extent of this topic. The reality Our talk with the Survivor Group persuaded us that perhaps the engagement by auditors of other services for their clients was not after all the major issue that had been perceived by the market. However we still have concerns in this area. Readers should understand that the process is complicated and there are many diverging views that will probably not be completely reconciled. In this brief article I will cover the suggestions that have been proposed by various organisations around the world on this topic and bring you up to date with progress. I have endeavoured to list the matters in order of likely agreement by all parties. The problems Setting up an Audit Committee by Boards of listed companies Our discussions with the Survivor Group indicated that all agreed this was one of the most significant Corporate Governance requirements. The Group indicated that they may reconsider their appointment as auditor if the client is not persuaded to establish a proper audit committee. The Australian Ramsey Report to the Minister for Financial Services and Regulations recommended that all listed companies have an audit committee. It went on to recommend the composition of the audit committee and the adoption of a written charter, all of which should reflect international best practice. The recently elected President of the Institute of Chartered Accountants in England & Wales stressed a need to enhance audit committees. This covered the appointment of auditors, the role in setting policies for awarding non-audit work to the auditors, agreeing their remuneration plus reviewing the arrangement in place within a company for ‘whistle blowing’. Auditor replacement The Survivor Group supports the Australian Ramsey Report, recommending the establishment of an Auditor Independent Supervisory Board. In New Zealand it has been suggested that the Securities Commission scrutinise the process of auditor replacement. Communication of Independence to the Audit Committee The Australian Accounting Research Foundation recently published an Audit and Assurance Alert No 11 in which it was considered best practice for an audit committee to require representations to the committee from the auditor each year covering the subject of independence. A suggested letter was appended as an example for adaptation to particular circumstances. Effectively the letter represents a re-affirmation of independence to the Board each year. The EU recommendation mentioned below should also ensure that this becomes best practice. Audit partner rotation This matter was raised in our talks with the Survivor Group; the period discussed was seven years and this is agreed by the group. This subject is also covered in a recent European Commission recommendation with seven years again being the suggested timeframe. A number of other matters also raised in this paper were considered as being best practice that the Commission expects to be immediately applied. The matters recommended were: detailing for each audit engagement any potential risks or threats to independence; a cooling off period of two years before an audit partner is permitted to join an audit client; a written declaration confirming independence and the use of international standards of auditing. Auditor rotation This topic has been placed alongside partner rotation but political problems seem likely to impede auditor rotation. A recent survey by Financial Director covering a group of British FD’s found majority support for auditor (as opposed to audit partner) rotation. However there is no expectation that regulators will act. The survey findings were summarised in Accountancy Age under the heading ‘Auditor rotation - new ball please’. Some revealing comments were made when finance directors responded on a no names basis. One said ‘I think that there is an increasing risk that all listed companies will be forced to rotate. Every five years is probably the best period. The main drawback will be in year five, as any firm will be sensitive to a new firm coming in and being critical. An audit in that year will probably be hell!’ An equally perceptive comment came from another surveyed. ‘You probably need to rotate the audit partner, rather than the audit firm, every four years to ensure a new viewpoint is introduced on a regular basis. This happened to us recently and was refreshing’. A review of the subject by CFO Magazine summarises the USA picture. Here it appears that election year is unlikely to provide the atmosphere for compromise which all are agreed is a necessary component for reform. Disclosure of remuneration of auditors for audit and other services The Audit & Assurance Alert 11 discusses in some detail the type of work that should be included in ‘audit’ services and other fees. The suggestion is for entities to voluntarily provide enhanced disclosure of the type and nature of any non-audit or other services provided. Suggested wording for the enhanced voluntary disclosure is included in an appendix. The outcome Auditor independence is not new. It has been around for hundreds of years. It seems clear that well before the Enron debacle there had been discussions about auditor independence and how best to proceed. Where political agendas intervene it is more difficult to obtain consensus. The European Union has promulgated a broadly based best practice recommendation intended for review in three years’ time with the objective of producing regulation. Independence is ultimately in the mind of the auditor who will know if there are any significant factors that sway a true and fair view. Perhaps, with countries committed to a truly international accounting standard, the auditor will feel more comfortable in a business environment that is increasingly global in outlook. Encouraging international accounting standards is certainly a priority of this association. Oliver Saint Appendix Associated websites Accountancy Age
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