EU audit reform (December 2013)
The European Union’s (EU) internal markets commissioner, Michel Barnier, signed the December 2013 EU audit reform into law. On December 17, 2013, EU member states and the European parliament came into a preliminary agreement about the new regulation on audit. The compromised texts were endorsed by COREPER in December 18, 2013. On that same date, commissioner Barnier welcomed the agreement reached between the two bodies on the reform of the audit sector. He claimed that the agreement formed the first step towards increasing audit quality and attracting more investors, which was an essential ingredient for economic growth in Europe. The main reason for the agreement between EU member states and the parliament was to promote effective functioning of financial and non-financial markets through strengthening the role of auditors. In addition, the agreement aimed at ensuring growth of economic agents and markets with more meaningful, transparent, and reliable information at an accepted cost.
The following discussion will analyze how the recent agreed EU Audit reform meets the objectives in providing audited financial statements that are reliable and independent as stated above.
Part one: Identify and describe the EU Audit Reform of December 2013. Explain how the reform will ensure the market will be provided with ‘more reliable, transparent and meaningful information.’
In December 17, 2013, the EU politicians stroke a last minute deal aimed at reforming the EU listed audit market. The EU audit reform was agreed in a discussion between EU member states and the parliament that forced all companies to change their auditors every ten years, however, auditors tenure have the possibility of being extended if specific criteria are met. According to the new agreement signed by commissioner Barnier, listed companies were expected to change their auditors every ten years, with an option of extending the period by another 10 years if there are tenders being carried out, and by 14 years if the company being audited has appointed more than one firm to conduct the auditing exercise (Crump 2014).
The reform will ensure the market will be provided with more reliable, meaningful, and transparent information through the following:
Improved audit quality:
The new rules required auditors to produce more detailed and clear audit reports that provided the relevant information to investors in order to minimize the expectation gap between what the company expects from an auditor and what an auditor should deliver. The International Organization of Securities commissions (IOSCO) claim that the audit quality and delivery of essential audit services is essential to investors and other stakeholders (IOSCO 2009). Quality audit services tend to attract more investors into a company irrespective of the amount of shares the company has. With the new rules, auditors will be able to promote their organizations and make Europe a more completive market for global investors in the near future (Boeckman, 2013).
The agreement introduced strict transparency rules for auditors that ensured stronger reporting obligations through their supervisors. In addition, the rule ensured effective communication between auditors and audit committee. With such characteristics of auditors, the markets will be more transparent and reliable. Auditors will be required to report their financial statements through their auditors meaning that company information will no longer be kept in private. Moreover, stakeholders from different member states will be involved in making decisions making the market a better place for any investor.
Accountability in any business is an important virtue that makes a firm grow and develop. In the past, auditors used to work on their own and make their own decisions on the type of report they ought to provide to stakeholders. This approach led to lack of accountability of many financial records leading to huge debts incurred by nations after the 2007 European financial crisis. With the new rules in place, the audit committee will be responsible for supervising the work of auditors according to the new EU audit reform. This will ensure strengthened competence in all audit processes. Moreover, company shareholders hold 5 per cent possibility of dismissing an auditor should she or he fail to meet the laid down rules. Those who are guilty of bleaching the new rule will face full administration force from the relevant authorities.
On the other hand, the new rules introduced a new regime into the EU member states whose companies were registered under the union. The prohibition of certain non-audit firms from providing non-audit services to their clients was a better move to improve EU market condition. The following move plays a role in limiting risk of conflicts of interests, especially when auditors are involved in decision affecting the management of a company. In addition, the move ensures a ‘self-review’ risk for auditors is minimized hence, allowing a transparent, reliable, and meaningful way of reporting company operations.
On the other hand, the reform will ensure EU market gets a more reliable, transparent, and meaningful information because of the introduction of a more dynamic and competitive audit market. The EU commissioner signed an agreement that ensured a single market for statutory audit. This rule will promote cross border mobility and coordination of auditors to meet the international standards on auditing hence making the firms more competitive both locally and globally. The presence of global completion will allow more investors to spend their resources because of the transparency nature of the EU markets. In addition, the rule provides more choices. The new rules restrict firms from third party clauses imposed on companies. The rule will introduce incentives for joint audit and tendering that will ensure no burdens are present for small audit firms. In addition, the concentration of audit market will be reinforced to ensure meaningful information is provided (Pollitt 2013).
Part 2: Critically evaluate whether or not the reforms will address the problems of independence and reliability of the audited financial statements
The December 2013 EU Audit reforms were introduced to address the problems of independence and reliability of the audited financial statements. A clear look at the rules introduces many questions as to whether the reforms will really address the intended problems. It becomes very confusing to realize that same audit firms are to be rotated in the same area questioning the type of reforms that will take place. However, from the statistics collected since December 2013, the EU member stated have improved their market standards compared to the period immediately after the financial crisis (Great Britain 2013).
Auditors play a vital role in the present society by providing stakeholders with correct reflections of the genuineness of a firm’s financial statements (Zhang 2007; p. 362). The 2007 EU financial crisis has caused the union many losses since 2007 because it extended to the preceding years. Europe has been on the struggle to meet the debts built during the recent years, with the most affected countries being Spain, Greece, Ireland, Portugal, and Italy (Kelly 2011). Since the crisis, the global economy has experienced a stagnant economic growth causing instability to the EU fiscal policies. Despite the huge losses incurred in 2007, most banks received clean bills of health (European Commission 2007). The inspection report form EU member states revealed lack of professionalism by auditors, poor handling of financial statements, and lack of correct thinking in the audits of major companies. The long-lasting relationship between the auditor and their clients caused all these problems.
Statutory auditors play a significant role in certifying companies’ financial statements and ensure companies provide financial information that is in accordance with the standards and frameworks. The new rules have the ability to improve reliability and credibility of the audited statements for the EU listed companies. The most important firms that the rules target are the banks and the financial institutions. The independence and reliability of the audited financial statements however, remains a critical issue to be addressed by the new rules. The proposed rotations are expected to reduce the amount of time an audit firm spends in a single company in order to minimize repeated inaccuracies (Chasan 2014). The problem comes along whereby the listed companies exchange their financial statements and rotating auditors might not be effective enough if the same managers are to operate such firms.
The new rules are capable of addressing the issue of independence especially where independent auditors will be rotated after every 10 years. An independent public accountant performs the functions of transcending any employment relationship with a client. It is the responsibility of a firm to maintain a high level of independence by having a professional auditor. Independence is crucial to audit and the credibility of a financial report because, any operation carried out by an auditor without independence has no meaning. The EU member states discovered the high rate of dependency their listed companies have and came up with the EU audit reform. The major contribution of the report to the independence and reliability of audited financial statements is its ability to promote quality in auditing process. Even with the high rate of corruption and the competitive nature of the listed companies, auditors will be expected to provide detailed financial statements that are not prone to errors and inaccuracies (Jones 2014).
Did the EU member states and the parliament consider some companies could switch their auditors instead of employing new ones? This question limits the ability of these rules to address the problem of independence and reliability. There have been cases where companies plan to switch their auditors between the Big Four instead of employing new ones as stated by the audit reform law. This will lead to a slow growth of the dominated market in the accounting industry hence, limiting the reliability of the audited financial statements. On the other hand, after the 2007 EU financial crisis, integrity became an important virtual to the EU member states. Countries such as China, Korea, and India had undertaken the agreement very seriously during the first years. Europe, however, being the largest economy has failed to implement the rules to the letter leading to low quality audit services that tend to reduce investors confidence in the listed companies (Yao 2014).
Coming up with an international accounting and auditing standards is an essential developmental approach that investors in all sectors love. The global activities of many businesses and investment entities require firms that have the capacity to provide reliable audit reports over many years in order to gain more trust from investors. After the December 17 agreement between the EU member states and the parliament, listed companies were supposed to streamline their services and follow the new guidelines. The introduced rules played a significant role in improving the financial status of most EU member states that had undergone a state of recession since 2007. There was a tremendous loss in the credit markets forcing some countries like China to take huge loans from the United States to support their economy. Presently, China has grown too fast and attracted many investors a clear demonstration of the positive impact of audit reforms.
Initially, listed companies used to appoint their own audit committee without consulting shareholders. The new rules reversed the process whereby appointment of all audit committee must be in the presence of shareholders. The following move has reinforced the audit committee independence and improved on their technical competences because at least two of the committee members must be independent and at least one have knowledge of auditing. The above movement ensured more reliability in audited financial statements compared to the past. Even though some shareholders might come together and select a team of incompetent audit committee, rarely do such instances occur because the company management also screens the list of candidates to select the most competent ones only. Presently, EU listed companies have confidence in all their operations and are sure that their financial statements will balance because they are addressed by qualified people (Mendez & Bachtler 2014; pp. 746-750).
Finally, the EU audit reforms will address the problem of independence and reliable financial statements of the amendment of the Statutory Audit Directive. Public Interest Entities (PIEs) allow their auditors to operate at EU level. The EU level holds the responsibility of supervising all the audited materials based on harmonized framework in order for the process to be effective. Such measures could not take place were it not for the introduction of the new rules. Some member states criticized the EU commissioner Barnier for signing the agreement with the existing Directive that has been in force since June 2008. The problems and weaknesses that have been solved by the new rule were not anticipated after the financial crisis, and the 2008 Directive had no provision for such amendments. The amendment for the December 2013 does concern all audits including those of PIEs (European Commission 2014).
There is no doubt that the new EU rules on auditing have created a lot of positive impact to the markets of the member states. The discussion has revealed that before the introduction of the new rule most companies used to lose much of their revenues to audit firms. The discussion has also discovered that the recently agreed EU Audit reform meets the objectives by providing independent and reliable audited financial statements. The statistics collected from economic journals have shown an improvement in the economies of the EU member states, for instance China, Spain, and Italy. The paper calls for other companies that are in a union like the EU to follow the suit in order achieve a global competitive advantage and attract more investors to their countries.
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