Three prominent Canadian organizations concerned about European audit reforms

Certain European audit reforms emerging after several years of proposals, counter proposals, and much debate are cause for concern because they will have global implications, and perhaps, unintended consequences.

The following outlines Canadian concerns over European audit reform measures.

The opinion piece is jointly written by Kevin Dancey, president & CEO of Chartered Professional Accountants of Canada, Brian Hunt, CEO of the Canadian Public Accountability Board, and Stan Magidson, president & CEO of the Institute of Corporate Directors in Canada.

Issued: April 7, 2014


Three prominent Canadian organizations concerned about European audit reforms

Certain European audit reforms emerging after several years of proposals, counter proposals, and much debate are cause for concern because they will have global implications, and perhaps, unintended consequences.

Since 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 of the measures.

The Chartered Professional Accountants of Canada, the Canadian Public Accountability Board and the Institute of Corporate Directors in Canada are concerned about two reforms in particular: Mandatory firm rotation and further restrictions and caps on the provision of non-audit services by the auditor.

The European process started in the fall of 2010 with the release of a Green Paper on Audit Policy: Lessons from the Crisis which included a number of proposals to reshape the audit profession in Europe.
The stated intent was to address the threat of auditors becoming too close to a client because of long audit tenure, to reinforce the independence of auditors who receive substantial fees from non-audit services, and to provide companies a wider choice in deciding which audit firm to engage.

Let’s think about some potential effects of the European reforms:
  • Global regulatory convergence and consistency will be impacted if major countries outside of Europe do not adopt these measures. And indeed, even within Europe, countries will have the ability to diverge from the new requirements. As 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.”
  • Audit costs will likely increase as firms devote more resources to tendering for new work and take additional time to learn about new clients. Who 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 putting downward pressure on audit fees at the same time?
  • Choice of audit firm will be impacted. Some argue that these reforms will increase the number of audit firms that will compete for each engagement. However, audit firm concentration could just as likely increase. The reforms will also reduce the choices an audit committee has when changing auditors or identifying firms to provide non-audit services.
  • Change may be mandated at an inopportune time for the board of directors which may be precluded 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. Further, the measures could undermine an audit committee’s accountability and responsibility for assessing auditor performance.

The key questions: Will 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?

Indeed, 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 impacted. We hope they are correct. Time will tell.

In Canada, our focus on tackling audit reform has been 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 consensus on guidance for the Canadian market.

We had a very transparent process that resulted in some key recommendations to improve audit quality in Canada. Our outputs, which can be found at www.cpacanada.ca/enhancingauditquality make several key recommendations, all of which serve to increase audit quality:

1. Instead of mandatory firm rotation implement annual and comprehensive reviews of the external auditor.
2. Develop tools and guidance for audit committees to do annual and comprehensive (at least every five years) evaluations of the auditor.
3. Establish a protocol so that our audit regulator’s key findings on the inspection of a specific entity can be conveyed on a confidential basis to the audit committee.

In our view, annual and periodic comprehensive reviews of the auditor’s performance conducted by the audit committee are much more likely to improve audit quality than the European reforms as they focus on the auditor’s independence, objectivity and professional skepticism, and have the benefit of being aware of 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 timeframe that makes sense from the entity’s perspective; not at some arbitrary preset time.

Once mandatory rotation and other restrictions take hold in Europe they will have extra-territorial impact. This will not help in achieving greater regulatory convergence and consistency or the smooth running of capital markets. In addition, the European actions could frustrate efforts in other jurisdictions when it comes to tackling audit reform and enhancing audit quality.

Kevin Dancey, president & CEO of Chartered Professional Accountants of Canada, Brian Hunt, CEO of the Canadian Public Accountability Board, and Stan Magidson, president & CEO of the Institute of Corporate Directors in Canada.

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