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USA New audit independence rules - are you impacted?
Recent changes to audit independence rules will impact businesses of all sizes, as the FRC increases the separation of audit and non-audit services and introduces further restrictions.
Recent changes to audit independence rules will impact businesses of all sizes, as the FRC increases the separation of audit and non-audit services and introduces further restrictions
The Financial Reporting Council, (“FRC”), has recently made significant revisions to its UK Ethical Standard and Auditing Standards and also effectively extended the definition of Public Interest Entities (“PIEs”). These revisions could impact the extent to which non-audit services (including tax, secondments, and accounting support) can be provided by your auditor. We anticipate the FRC may extend these provisions in due course to a wider sub-set of businesses.
What are the changes?
Extension to PIE audit restrictions
Recent changes which take effect from 15 December 2020, extend the provision of non-audit services restrictions applied to PIEs as follows:
- The majority of non-audit services (including tax but excluding a very limited list of other services) cannot be provided to Other Entities of Public Interest (“OEPI”). An OEPI includes:
- AIM-listed entities with market cap at or over €200m (on a 3-year average basis); -
- Very large private companies with over 2,000 employees, or with turnover of more than £200 million and gross assets of more than £2 billion;
- Private sector pension schemes with more than 10,000 members and more than £1 billion of assets;
- Lloyds syndicates
New restrictions for SME listed entities
With effect from 15 March 2020:
- There are also new restrictions on the provision of nonaudit services that can be provided to SME listed entities (below €200m market cap).
- All references to SME listed entities (below €200m market cap) have been removed from the new standard - this means all AIM/other listed businesses face further restrictions on what services their auditors can provide. For example, the provision of accounting/tax accounting services is now prohibited.
Blanket ban for Auditors on specific services
With effect from 15 March 2020, there is now a blanket ban for all entities in respect of the following:
- Internal audit work for an audit client and its significant affiliates
- Secondments to an audit client and its connected entities
- Contingent fees for all services provided to an audit client (e.g. R&D claims and Capital Allowances)
- Advocacy services for any audit client. For example, if HMRC open a tax enquiry, your auditor could provide information to HMRC to explain the tax position taken, but should HMRC disagree, your auditor will not be able to support you in defending that ongoing enquiry.
Pre-15 March 2020 engagements
The FRC has confirmed that where an auditor engaged before 15 March 2020, to provide previously permitted nonaudit services, and where work has already commenced, the auditor firm may continue to complete this work, in accordance with the original engagement terms.
Are further changes likely?
In recent years there has been increasing scrutiny on the audit industry, in part driven from a range of high-profile audit scandals. In addition to the FRC recommendations, the Brydon report1, released in December 2019, was an independent review into the quality and effectiveness of audit. The recommendations focused on re-defining audit, further segregation of audit and non-audit services and improving transparency.
The UK’s Competition and Markets Authority (CMA) also carried out a review in 20192, ultimately recommending the “Big Four” audit firms operationally separate their audit practices from non-audit services.
In our view, the clear direction of travel for larger businesses is that audit and non-audit services will continue to be separated to ensure a more independent and robust audit. The OEPI definition is also expected to be broadened to capture an increased number of businesses. Impact – what are we seeing? We are increasingly finding that larger businesses are separating their audit and non-audit services, even where no restriction exists, due to perceived independence concerns and what many Boards now consider as ‘best practice’.
Impact – what are we seeing?
We are increasingly finding that larger businesses are separating their audit and non-audit services, even where no restriction exists, due to perceived independence concerns and what many Boards now consider as ‘best practice’.
What action should businesses take?
Businesses should act now given some of the rules have already taken effect. Next steps may include:
1. Consider whether your business uses the same professional services firm for both audit and tax/ other non-audit services and whether there is an independence concern, perceived or actual?
2. Consider whether your business falls within the definition/list of an OEPI and whether the amended rules, or new FRC audit independence rules will apply to you.
3. If you are not impacted by the new independence rules, consider whether the Board are comfortable in using the same advisor for both audit and nonaudit services, given perceived independence and changing industry landscape.
4. If impacted by the revisions, consider potential solutions, which may be to begin the process of retendering the restricted service to another provider. This should be done as soon as possible to allow enough time for handover and completion of work.
Sources:
2 Statutory audit market study final report
If you are an existing audit client of Evelyn Partners, your team will be in touch with you to discuss these changes.
Frequently Asked Questions
What should I do if our auditor currently provides a now restricted non-audit service?
You should firstly speak to your auditor, and then consider alternative providers for the now restricted services.
At Evelyn Partners we would be delighted to have an initial discussion with you about the restrictions, and how we might be able to support you with non-audit services going forwards.
We are a small, unquoted business, can my auditor still prepare our R&D claim?
Your auditor may still be able to prepare your R&D claim but they will not be able to do so on a contingent fee basis.
This means your auditor will no longer share the risk of a successful R&D claim with you. Many businesses prefer to pay for R&D services on a contingent fee basis, to ensure that incentives for the business and advisor are aligned to maximise the value of the claim, whist ensuring a robust claim with low chance of enquiry. If you want to continue to operate a contingent fee model, you will need to find a new provider.
In terms of timing, assuming a 31 December year end, if your auditor was engaged to prepare your R&D claim for the year ended 31 December 2019 on a contingent fee basis but had not begun work as at 15 March 2020, your auditor will not be able to continue with that engagement on a contingent fee basis.
We are short-staffed and need a temporary secondee to support with accounting and tax work – can our auditor help?
From 15 March 2020, your auditor is no longer able to provide a secondee to your business to support with any kind of task, whether tax or accounting or otherwise unless that secondment had already commenced prior to 15 March 2020.
This applies to businesses of all sizes, whether listed or not.
You will need to ask another provider for help with any secondment needs. Evelyn Partners regularly seconds staff from all areas of our business to clients, often to help with a particular project or busy time, or to fill a gap in the team where someone has recently left or clients are waiting for a new joiner to start.
How do the changes apply to UK companies with overseas parents?
There should be no impact on the audit or provision of non-audit services to an overseas parent, subject to any similar rules locally.
The impact in the UK will depend on how the audit of your group is structured, and if you have the same auditor in the UK subsidiary as for your overseas parent. Depending on your business profile (size, quoted/unquoted status), different rule changes will apply and we would be happy to discuss your specific circumstances with you.
We are planning to list on AIM – do we need to consider these rules?
Yes.
Once you are listed on AIM, your auditor will not be able to provide accounting or tax accounting support to you. You will need to find an alternative provider who can advise on these areas, and who can work alongside you and your auditors.
If your market cap will exceed €200m once listed on AIM, you will be considered an Other Entity of Public Interest (OEPI) and in due course be required to have a separate non-audit and audit service provider for all bar a very restricted list of services. You may therefore wish to consider separating these services prior to listing to prevent having to make a later change.
In addition, some of the changes impact all businesses, regardless of size and quoted-status, in particular there is a blanket ban for auditors on the provision of certain services including secondments, contingent fees and internal audit. These changes apply with effect from 15 March 2020.
Our company is listed on AIM but our market cap is consistently below €200m – do we need to consider the changes?
Yes.
Some of the changes impact all businesses, regardless of size and quoted-status, in particular there is a blanket ban for auditors on the provision of certain services including secondments, contingent fees, and internal audit. These changes apply with effect from 15 March 2020. Similarly, advocacy services cannot be provided by your auditor (there is an exception to this which allows smaller audit firms to continue to provide advocacy services to small firms).
There are also changes for SME listed entities, which would impact your business, again from 15 March 2020. These changes mean that your auditor can no longer provide accounting or tax accounting support to you. You will need to find an alternative provider who can advise on these areas, and who can work alongside you and your auditors.
Whilst your business would not be considered an OEPI yet, if your business is close to breaching the €200m threshold (on a three-year average basis), we suggest you consider these changes sooner rather than later to allow time to plan and make any changes. You also ought to consider whether there is a perceived independence threat, which may lead you to consider finding an alternative non-audit service provider.
For the definition of OEPI, are the thresholds looked at on a company by company basis?
The limits are looked at on a company-only basis, not a group-wide basis.
However, if your group meets, or is close to meeting, any of the thresholds for OEPI, you should consider whether to apply the principles of the new rules. We are seeing a number of businesses choosing to separate audit and non-audit services, where no restriction applies, due to perceived independence concerns, and best practice in the market.
Is a private-equity backed business considered to be a “private company” and therefore potentially within the definition of OEPI?
Yes.
A business that has private-equity investment could fall within the definition of OEPI if it has more than 2,000 employees, or turnover of more than £200 million and gross assets of more than £2 billion. These limits do not include the private-equity house or its other investments – each entity would be looked at on an individual basis. There are also some specific rules for fund management entities included within a private equity or venture capital LP fund structure.
DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
Ref: NTNPW052069
Disclaimer
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.
