The FRC has extended its independence rules for auditors, for types of services provided and the companies they are provided to. Explored here is what this means in practice.
The Financial Reporting Council (FRC) revised its Ethical Standard for audit at the end of last year, with a wide-ranging impact on more companies and audit firms than earlier amendments.
The previous standard worked on an exclusionary basis, so firms were not allowed to provide audit clients with services on a specified list. This has turned into a prohibition on the provision of all non-audit services, other than a narrow list of audit-related and regulatory reporting services. No longer can auditors of companies covered by the standard provide internal audit services, IT work (except where this forms part of permissible audit-related services) or tax advocacy of any kind.
They are also banned from providing any recruitment services, litigation support or playing any role in management decision-making.
More dramatic is the expansion of companies to which the new rules apply. The FRC made it clear last summer that it felt audit service prohibitions ought to extend to a wider set of companies than public interest entities (PIEs).
The new standard applies to what the FRC calls other entities of public interest (OEPI): these include large companies listed on the Alternative Investment Market, Lloyd’s syndicates, large private sector pension schemes and many other large private companies.
Companies that might fall into the OEPI category, and their auditors, need to know they are caught by the FRC’s rules, says Tony Bromell, Head of Integrity and Markets, ICAEW.
He says: “Unless they are subscribed to FRC news – and by definition these companies won’t be – they might not have noticed that they will now be subject to the same independence rules as PIEs.”
Firms that currently do not audit PIEs but find their clients caught under the OEPI definition are going to have to get up to speed, says Bromell. “All firms with OEPI clients have to contact them and explain what they will and will not be able to do in future,” he adds.
This can cause a problem for some large companies. “Some retailers look enormous but have a simple business and a small essential management team. So do fund managers. Dealing with a number of different advisers could have a huge impact on their managerial resources,” says Bromell. Those considered to be an OEPI will have slightly longer to adapt to the new non-audit service rules, which will start to apply for periods after December 2020 (March 2020 for PIEs).
Meanwhile, extending the definition of PIEs, as suggested by the Kingman report, could form part of the Department for Business, Energy and Industrial Strategy’s consultation on audit reform recommendations.
Bringing more companies into the PIE net could potentially bring in thousands of new PIEs and affect hundreds of audit firms. The consequences of being a PIE include governance, monitoring and audit rotation rules. Small listed entities and other companies caught in any new definition might wonder if continuing to do the audit work is worth it, says Bromell. “By and large there aren’t different audit rules for small and big PIEs: a company is either a PIE or it isn’t,” he says.
Extending the PIE definition could also cause a realignment in the professional services market, says John Boulton, Director of Technical Policy, ICAEW. “Firms that only do one or two of these audits need to ask themselves whether they can continue to service that market,” he adds.