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Accountancy sector audit regulations could impact fees

In December 2019, the Financial Reporting Council issued revisions to its Ethical Standard regarding auditing standards and rules that intended to strengthen auditor independence and improve overall audit quality. The more stringent standards prohibit auditors from providing recruitment and remuneration services, as well as barring auditor involvement in management decision making. Jessica McKeon, senior research analyst, and Nicole Hallas, research analyst at Audit Analytics, comment

The revised provisions also address the auditor’s ability to provide non-audit services to a public interest entity (PIE) client, such as a listed entity, credit institution or insurance undertaking.

Following the revisions, auditors of PIEs are now only able to provide non-audit services if they are closely linked to the audit, or if the services are required by law or regulation. However, providing non-audit services is subject to approval by the audit client’s audit committee, offering another layer to ensure that the non-audit services do not interfere with independence.

The change to the permitted non-audit services for PIEs aims to reduce the risk of a possible conflict of interest, in addition to refocusing the audit relationship on a high-quality audit rather than the commercial interests of the audit firm. This change to allowable non-audit services is significant, considering the FRC noted in the Developments in Audit 2019 survey that non-audit fees are the main source of income for audit firms.

Non-audit fees in relation to overall audit fees is of interest, as high non-audit fees are considered to be an auditor-independence concern. If an auditor earns a large amount of fees performing non-audit fee assignments, this dynamic may, over time, subconsciously undermine an auditor’s professional scepticism while performing an independent audit. However, there are many non-audit services that audit firms perform that do not impair independence.

Audit Analytics has found that non-audit fees, as a percentage of total fees, paid to external auditors in the UK have been steadily declining. In 2014, non-audit fees, including audit-related, accounted for 34% of total fees; in 2019, non-audit fees totalled just under 20% of fees.

Other recent changes in audit regulations include the reform of the EU Statutory Audit Market, which instituted mandatory auditor rotation for PIEs in the EU. Effective since mid-2016, the reform mandates that auditor tenure for PIEs be limited to 10 years, or 14 years for joint audits.

This change was made to address concerns that lengthy auditor tenure may undermine a statutory auditor’s independence and have a negative impact on professional scepticism. As a result, it is expected that there will be an increase in auditor changes.

According to Audit Analytics, 36 FTSE 350 companies changed auditors between 2017 and 2018. So far, between 1 January and 15 April 2020, 11 FTSE 350 companies have disclosed an auditor change, all rotation-prompted; for comparison purposes, there were seven during the same time period last year. Interestingly, of the changes so far in 2020, five were Big Four to non-Big Four, with BDO winning all five tenders.

Of the 36 FTSE 350 companies that changed auditor between 2017 and 2018, 21 saw an increase in audit fees. More specifically, companies that changed auditor saw an average 12% increase for audit and audit-related fees, and a 9% decrease for non-audit fees. Companies with the same auditor saw around a 15% increase for audit and audit-related fees, and roughly a 65% increase in non-audit fees. In total, fees decreased by 5.1% for those companies that switched auditor, and increased by 18.4% for those that did not.

Considering the recent changes to audit regulations, overall trends could change as a result of the new provisions affecting both auditor rotation and the types of non-audit services that can be provided.

The EU Statutory Audit Market reform requires mandatory auditor rotation, and the trend has been observed that companies that change auditor experience a decrease in non-audit fees, excluding audit-related, so a change in the amount of non-audit fees may be observed in the coming years.

This change may be amplified by the FRC revisions to the Ethical Standard, restricting the type of non-audit services that an audit firm can provide to PIEs in order to maintain independence.

 

 

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