\n\n\nCertain audit reforms emerging from Europe are cause for concern. They will affect accountants and businesses globally — and potentially create unintended consequences.\nSince the changes affect more than just Europe, all stakeholders with an interest in the smooth running of global capital markets and high-quality audits need to take note. \nCPA Canada, the CPAB and the ICD are concerned about two reforms in particular: mandatory firm rotation and further restrictions and caps on the provision of nonaudit services by the auditor.\nThe European process started in the fall of 2010 with the release of the Green Paper on Audit Policy: Lessons from the Crisis, which included a number of proposals to reshape the audit profession in Europe.\nThe stated intent was threefold: address the threat of auditors becoming too close to clients because of long audit tenure; reinforce the independence of auditors who receive substantial fees from nonaudit services; and provide companies a wider choice in deciding which audit firm to engage.\nLet’s consider some potential effects of the European reforms:\n\n Global regulatory convergence and consistency will be affected if major countries outside Europe do not adopt these measures. Indeed, even within Europe, countries will have the ability to diverge from the new requirements.\n\nAs the International Federation of Accountants warned in a release on January 7, the "failure [to refocus on regulatory convergence] is stifling business confidence, economic stability, and ambitions for a sustainable recovery." \n\n Audit costs will likely increase as firms devote more resources to tendering for new work and take additional time to learn about new clients.\n\nWho is going to pay for these increased costs? Will this time and effort distract from a focus on quality audits? Will it be especially detrimental if market forces are simultaneously putting downward pressure on audit fees?\n\n Choice of audit firm will be affected. Some argue that these reforms will increase the number of audit firms that will compete for each engagement. However, audit firm concentration is just as likely to increase. \n\nThe reforms will also reduce the choices an audit committee has when changing auditors or identifying firms to provide nonaudit services.\n\n Change may be mandated for a board of directors at an inopportune time, which may preclude a board from retaining the firm it believes provides the best quality audit. The board, with the approval of shareholders, should retain the right to decide on the auditor and when a change should be made. Furthermore, the measures could undermine an audit committee’s accountability and responsibility for assessing auditor performance.\n\nWill these reforms reduce risk, improve the audit profession, increase audit quality and effectiveness, better serve the entities that are audited, better meet investor needs and the public interest, and increase the likelihood of fewer audit failures in the future?\nWe believe that audit quality may in fact suffer. Firms and audit regulators in Europe will likely challenge this assessment and strive to ensure audit quality is not affected. We hope they are correct. Time will tell.\n \n\nIn the photo above from the left: Kevin Dancey, President and CEO of CPA Canada, Brian Hunt, CEO of CPAB, Stan Magidson, President and CEO of ICD.\n\n \nIn Canada, we have tackled audit reform by focusing on enhancing audit quality. We adopted a collaborative approach by assembling key stakeholders (audit, banking and securities regulators, directors and the audit profession) to assess the international proposals coming from Europe, the United States and elsewhere to see if we could reach a consensus on guidance for the Canadian market. Our process was highly transparent. Our key recommendations, which can be found at cpacanada.ca/enhancingauditquality, all serve to increase audit quality in Canada:\n1. Instead of using mandatory firm rotation, implement annual and comprehensive reviews of the external auditor. \n2. Develop tools and guidance for audit committees to perform annual and comprehensive (at least every five years) evaluations of the auditor. \n3. Establish a protocol so that our audit regulator’s key findings on the inspection of a specific entity can be conveyed confidentially to the audit committee.\nIn our view, comprehensive reviews of the auditor’s performance, conducted by the audit committee, are much more likely to improve audit quality than the European reforms. Our method focuses on the auditor’s independence, objectivity and professional skepticism. It is based on the audit regulator’s key findings. If areas for improvement are identified, they can be acted upon and monitored by the audit committee. If the audit committee’s expectations are not met, the audit can be put out to tender in a time frame that makes sense from the entity’s perspective, not at some arbitrary preset time.\nOnce mandatory rotation and other restrictions take hold in Europe, they will have extraterritorial impact. This will not help achieve greater regulatory convergence and consistency or the smooth running of capital markets. In addition, the European actions could frustrate efforts by other jurisdictions when it comes to tackling audit reform and enhancing audit quality.\nCANADA’S EFFORTS\nBack at home, the collective focus is on improving audit quality with greater guidance and transparency.\nA consultative effort by CPA Canada and CPAB, Enhancing Audit Quality (EAQ), was completed in 2013. The EAQ process reviewed reforms underway in Europe and outlined its own recommendations to improve audit quality, including annual assessments and comprehensive reviews of external audit firms.\nCPA Canada then went on to develop tools and guidance to facilitate the audit committee’s assessment of an auditor’s performance. CPAB developed a protocol to increase the amount of audit inspection information available to audit committees. Throughout this process, ICD engaged the director community to provide input and feedback.