Time to Endorse the ISAs for

European Use: The Emerging

Markets Perspective
METKA DUHOVNIK

The Slovenian Institute of Auditors, Ljubljana, Slovenia

ABSTRACT The paper aims to support the endorsement of the International Standards on
Auditing (ISAs) from the perspective of an emerging market economy. Pointing to the
problems facing the Slovenian audit market as an example of a small market, the paper
tries to demonstrate the advantages of endorsing the ISAs for both emerging market
economies and the European market as a whole. At the same time, it stresses the
importance of a unied audit approach for the overall quality of auditing in Europe, and
of treating emerging market economies as an equal partner in international bodies that
issue auditing and accounting standards as a necessary condition for those standards to
also be applicable to a less developed market environment.
1. Introduction
Directive 2006/43/EC on statutory audits of annual accounts and consolidated
accounts (the Directive) requires statutory auditors and auditing rms in the
member states (MS) of the European Union (EU) to perform statutory audits
on the basis of international auditing standards. The 2006 Directive presumed
that such auditing standards would be adopted by the EU Commission in the
near future and allowed MS to impose additional requirements relating to statu-
tory audits of annual and consolidated accounts for a period expiring in June
2010. This period is now over and one would expect European endorsed auditing
standards to be in place already, but unfortunately, this is not the case. In the
Accounting in Europe
Vol. 8, No. 2, 129140, December 2011
Correspondence Address: Metka Duhovnik, The Slovenian Institute of Auditors, Dunajska cesta
106, SI-1000 LjubljanaSlovenia. Fax: +386 1 568 63 32; Tel.: +386 1 568 55 54; Email:
metka.duhovnik@amis.net
Accounting in Europe
Vol. 8, No. 2, 129140, December 2011
1744-9480 Print/1744-9499 Online/11/02012912 #2011 European Accounting Association
http://dx.doi.org/10.1080/17449480.2011.621387
Published by Routledge Journals, Taylor & Francis Ltd on behalf of the EAA.
paper, I try to analyse the possible reasons for and consequences of the situation
from the perspective of the emerging Slovenian market economy.
2. Historical Background
Currently, the only high-quality set of international auditing standards is the set of
International Standards on Auditing (ISAs) issued by the International Auditing
and Assurance Standards Board (IAASB) of the International Federation of
Accountants (IFAC). Although in 1977 IFAC began operations with all the
usual problems of an international body, by the 1990s it seemed to be having
success, particularly in the auditing eld. In 1991, the International Auditing
Practice Committee (IAPC), todays IAASB, renamed its international auditing
guidelines the International Standards on Auditing because the term standard
better reected IFACs position and authority (Humphrey, 2007b). In 1994,
IAPC issued an updated codied version of the ISAs (Humphrey, 2007a). This
was an opportunity for less developed and/or smaller countries like Slovenia
to adopt internationally acknowledged standards since they did not have
enough human and nancial resources to develop their own auditing standards.
At that time, Slovenia (after having gained its independence) began its transform-
ation from a planned to a market economy. For this reason, some important legis-
lation was enacted in the 199194 period. On the basis of the rst Slovenian
Auditing Act in 1993, the rst codied core set of ISAs became mandatory.
After 1993, the ISAs were translated into the Slovenian language and are today
mandatory in their current version. In the meantime, Slovenia also became an
EU member in 2004 and has since been obliged to enact the European legislation.
As described in the Policy Statement (2009) of the Federation des Experts
Comptables Europeens (FEE European Federation of Accountants), in 2004
the IAASB launched a project designed to improve the clarity of its pronounce-
ments. Upon the projects completion in March 2009, the nal result was a
package of 37 claried standards, of which 19 ISAs and the International Stan-
dard on Quality Control (ISQC) 1 were changed predominantly in terms of
their form (redrafted); 16 ISAs were changed in both form and substance
(revised and redrafted), and one, addressing communication of deciencies in
internal control, was completely new. Thereby, revised requirements were intro-
duced, regarding mainly:
. clear differentiation between a Fair Presentation Framework versus a
Compliance Framework;
. the auditors written and oral communication with management and those
charged with governance;
. audit materiality requiring professional judgement to be regulated in such a
way as to enable the auditors proper understanding of the concept;
. auditing accounting estimates providing a clear denition of the term
accounting estimate and its treatment in the audit procedures;
130 M. Duhovnik
. much better and clearer denition of related parties;
. audits of group nancial statements offering much better and much more
detailed support for the solutions indicated by the Directive (see IFAC,
2008, 2010a for details).
When examining the clarity project, one rst notices that the claried ISAs are
better organised and more suitable in substance than the earlier ISAs. Besides, all
apply to audits of nancial statements for periods beginning on or after 15
December 2009. Irrespective of this, the European Commission (EC) is still
holding its endorsement back, although it unofcially proposed that the trans-
lation process of the claried ISAs be performed by professional institutions
in the MS by the end of the rst quarter of 2010 but without technical and
nancial support. Such a proposal has put the MS in an unequal position in
two different ways:
. rst, it differentiates EU English-speaking countries from EU non-English-
speaking countries; and
. second, taking into account that the translation work required is the same
regardless of the size of the country, the relative translation costs are greater
for smaller member states.
For a country like Slovenia with a population of 2 million and approximately
120 practising certied auditors, the ECs translation proposal was a substantial
technical and nancial burden. With the World Banks support and due to the
good cooperation of the Slovenski institut za revizijo (SIA Slovenian Institute
of Auditors) with IFAC and FEE, a high-quality translation of the claried ISAs
had been completed by the end of the rst quarter of 2010 (compare IFAC News,
2010, p. 4).
3. The Claried ISAs in the European Environment
In the absence of unied auditing standards within the EU, the question is how
many different sets of auditing standards might be reected in the auditors
reports of listed companies in the same regulated market in a MS. To be able
to explain how far such differences can go it would be necessary to analyse
not only the differences between auditing standards adopted in different MS
but also their practical application and the effectiveness of quality control pro-
cedures. While at this historical moment it is difcult even to accept the ISAs,
it is impossible to envisage standardised quality control procedures. For this
reason, I will try to analyse how far away from the ISAs auditing standards in
a MS might be.
The IFAC Member Body Compliance Program (IFAC, 2010b) identied eight
European MS (Bulgaria, Cyprus, Estonia, Latvia, Malta, Romania, Slovakia and
Time to Endorse the ISAs for European Use 131
Slovenia) where national law or regulation requires the use of ISAs as issued by
the IAASB in the auditing of general purpose nancial statements. In ve MS
(Czech Republic, Hungary, Ireland, Luxembourg and the UK), a national stan-
dard-setter has adopted ISAs as the auditing standards to be used in the
country, meaning that there are no separate local auditing standards. In nine
MS (Denmark, Finland, France, Germany, Italy, Netherlands, Poland, Portugal
and Sweden), ISAs have generally been adopted as the local standards but
there may be some national modications to them; changes, if any, are stated
to be in line with the spirit of the IAASB Modications Policy (IAASB, 2006).
For another ve MS (Austria, Belgium, Greece, Lithuania and Spain), the infor-
mation available does not allow an evaluation of whether the local adoption
process is reasonably up to date, or whether modications to or other differences
from the ISAs meet the requirements of the IAASB modication policy, or
whether the declared convergence with ISAs is still an objective not yet achieved.
By comparing the IFAC results with somewhat earlier results of the FEE (2006),
which tried to ascertain whether the national auditing standards were closely
related to the ISAs (e.g. by translation or limited transformation), we nd that
for eight MS in the rst group where law or regulation requires the use of ISAs,
the results are the same, with the exception of Estonias auditing standards,
which the FEE study of 2006 declared were not closely related to the ISAs.
For ve MS where, according to IFAC, a national standard-setter has adopted
the ISAs, the results of the FEE study are similar and demonstrate a close
relationship with the ISAs.
Nine MS from the IFAC Compliance Program that have made national modi-
cations to the ISAs are mostly declared by the FEE study as having national
auditing standards closely related to the ISAs. The exceptions are Poland and
Portugal, which declared themselves in the FEE study as having auditing
standards that are not closely related to the ISAs. In any event, it is likely that
the national standards in these countries are gradually approaching the ISAs,
which has become more evident in recent years.
In the last group of ve MS, the results are unclear for Austria and Spain.
While according to IFAC the information available is not adequate to evaluate
the adoption process, for the purpose of the FEE study these two states declared
themselves as having national standards closely related to the ISAs.
With regard to the current translation process, IFAC News (2010) suggests that
the translations of the IAASB claried ISAs have been approved for publication
in several languages by the Directorate-General for Translation (DGT) of the EC.
In August 2010, nalised translations of 36 ISAs and ISQC 1 were available in
seven ofcial EU languages (English, which is the source language of the
standards, Finnish, Lithuanian, Romanian, Slovakian, Slovenian and Swedish).
The DGT has itself performed the translation into the Maltese language, although
the translation has not yet been published.
However, not many MS had completed the translation processes and were thus
not well prepared to use the claried ISAs on the effective date. In spite of this, at
132 M. Duhovnik
least those countries where the ISAs are mandatory on a legal basis have to use
them for statutory audits of nancial statements for periods beginning on or after
15 December 2009. In the European capital market, these countries encounter
others using a different set of auditing standards with different requirements
and explanatory materials, also resulting in a different form of auditors report.
4. Emerging Markets Perspective
We can agree that auditing standards in almost all EU countries are closely
related to the ISAs. At the same time, we do not know the exact denition of
close relationship. However, without a detailed analysis it is unreasonable to
judge which EU countries did abide by the original date at which the claried
ISAs should have come into operation. On the other hand, the analysis is
almost impossible because quite a few EU countries are waiting for the action
of the EC. Here we can presume, with a high level of certainty, that the claried
ISAs were used (at least formally) for audits of 2010 nancial statements in EU
countries identied by the IFAC Compliance Program as countries where law or
regulation requires the use of ISAs as issued by the IAASB (Bulgaria, Cyprus,
Estonia, Latvia, Malta, Romania, Slovakia and Slovenia). These countries
belong to a special group inside the EU with several similarities. Most of them
entered the EU in 2004, with the exception of Bulgaria and Romania that
entered in 2007. The populations involved (except in Romania) are small, as is
the number of statutory auditors (see Table 1 for details).
Further, not all statutory auditors are necessarily practising auditors. In
Slovenia, some work, for example, at universities, at the Court of Auditors, in
business or as internal auditors.
Otherwise, all countries on the list are emerging market economies with a
short tradition in the area of commercial auditing, and with a similar political
background (compare Cassar and Ittner, 2009, p. 337). The origin of auditing
in these countries was very similar to what has been described for Russia
(Mennicken, 2010, p. 356).
Table 1. Population and statutory auditors in selected EU countries
Country Population (million) Number of statutory auditors
EU entry 2004 Cyprus 0.8 450, registered with ICPA
Estonia 1.3 376 natural person auditors
Latvia 2.3 150 certied auditors
Malta 0.4 690 holders of Practising Certicate
Slovakia 5.4 818 licensed auditors
Slovenia 2.0 184 certied auditors
EU entry 2007 Bulgaria 7.6 570, registered with ICPA
Romania 21.5 1536 individual auditors
Sources: FEE (2006, p. 152), European Union (2010).
Time to Endorse the ISAs for European Use 133
However, while the literature has included extensive discussions about
whether the issuers of international accounting and auditing standards were
more strongly inuenced by the Anglo-American approach to nancial report-
ing or the Continental European approach (see, for example, Flower, 1998;
Cairns, 1998; Nobes, 1998), there has been no discussion of the inuence of
this third group of countries on the international standard-setting processes.
Besides, these countries are very poorly represented in international accounting
and auditing bodies, even though they face serious problems in connection
with the use of the International Financial Reporting Standards (IFRSs) and ISAs.
5. Potential Difculties Arising from Not Accepting ISAs across Europe
Of course, translation is only the rst step in implementing ISAs. In Slovenia,
parallel to the translation process, the SIA started education activities relating
to the claried ISAs, but it was impossible to do so in much detail before the
translation process was completed, in spring 2010. At that time, two other
expected questions arose:
. How is compliance with the claried ISAs addressed in the existing audit
methodology?
. Where can one obtain auditing software that is compliant with the claried
ISAs?
Slovenia has no audit software providers. Expecting that the ISAs would be
endorsed inside the EU, Slovenia was hoping to be able to choose from audit soft-
ware providers inside the European market. Now the endorsement has been post-
poned, the hope of nding a useful tool to support audit procedures in small
Slovenian auditing rms on the competitive European market has vanished.
The question is whether small emerging market economies like Slovenia that
make the use of ISAs mandatory will be able to realise the advantages of the clari-
ed ISAs without the appropriate technical and professional support. We must be
aware that in a country like Slovenia there are much fewer users of audit software
and audit methodology than users of ISAs. Since big international network rms
(Deloitte, Ernst & Young, KPMG and PWC (the Big Four)) cover around 60%
of the auditing market, the interested audit software users are small Slovenian
auditing rms with on average approximately 80 statutory auditors. Regarding
ISA-compliant audit methodology and audit software, these small Slovenian
auditing rms cannot rely on the help of international networks as is the case
with the education process. On the other hand, the development of audit software
with integrated audit methodology would require a relatively well-organised and
expensive project with a huge amount of auditing and technical knowledge. This
problem also existed in the past and has been getting bigger year by year and has
reached its peak with the implementation of the claried ISAs.
134 M. Duhovnik
However, audit methodology and audit software would solve only part of the
problems, since they provide more technical than substantial support in the audit-
ing process. Their advantage is that they leave the auditor no choice but to go
through all the necessary steps of audit procedures and to support his or her
opinion with sufcient and appropriate audit evidence. The disadvantage is
that they provide no guidance as to what constitutes appropriate professional jud-
gement and how this is to be exercised by the auditor during the auditing process.
For emerging market economies, professional judgement is especially crucial
in auditing fair value accounting estimates because market conditions do not
satisfy the fair value denition. The question is how the auditor can exercise pro-
fessional judgement in the case of the Slovenian capital market that has proven
itself to be inefcient, even in the weak form of the Efcient Markets Hypothesis
(Mramor and Valentincic, 2001, p. 79).
Due to their complexity, answers to questions regarding fair valuation in Slo-
venia have been dominated by auditors from the big international audit networks.
While one cannot say that they are not in line with the ISAs, it can be argued that
they were not always appropriate in the circumstances. For example, even though
this would be allowed by the ISAs, it was rare for a statutory auditor to conclude
that the estimation uncertainty associated with a fair value accounting estimate
was so great that the recognition criteria in the IFRS were not met and a fair
value estimate could not be made. The reason for this is probably the centrally
organised education of auditors belonging to the international networks. These
auditors largely rely on the circumstances in developed market economies. In
any event, it has to be recognised that a huge amount of knowledge is concen-
trated inside of the international network rms who jointly explore problems
and share solutions. However, small emerging market auditing rms and insti-
tutes or chambers are incapable of nancing representatives in international
bodies, and therefore cannot present their specic problems to a wider regulatory
audience. The return effect is that audits in the emerging market economies, even
those performed by the Big Four, are of a lower quality than they otherwise
could have been. This does not mean that the IFRSs and ISAs are not useful
in these countries but it certainly means they should have been employed in a
different way.
Without the positive effect of the developed market environment, the auditing
process performed in emerging market economies on the basis of mandatory
claried ISAs may become a process intended merely to satisfy the market for
the auditors information, regardless of the actual truth and fairness of the nan-
cial statements. To borrow Macintoshs philosophical classication of accoun-
tants for auditors, we can argue that this could lead to a large number of
bullshit auditors (BSers), who take the nancial statements prepared on the
basis of the prescribed nancial reporting framework and perform audit pro-
cedures, keep the ofcial conceptual framework in mind, closely follow the
whole corpus of ofcial audit pronouncements and dictums of institutions like
public oversight bodies, security market agencies, central banks and insurance
Time to Endorse the ISAs for European Use 135
oversight agencies, and create a standard audit narrative about the nancial state-
ments. However, in essence they are indifferent to the truth of the object they are
representing (Macintosh, 2009, pp. 157158). The BS nature of the auditor is
multiplied in an environment where legislation is unclear and much power
rests with civil servants who interpret the law (compare Sucher and Bychkova,
2001).
6. Possible Solutions
Possible solutions and their realisation can be observed in three different elds:
. audit software with an integrated audit methodology;
. solutions contained in international standards and rules; and
. education.
6.1. Audit Software with an Integrated Audit Methodology
Due to their limited size and nancial resources, the only way for Slovenian and
other small emerging market auditors to obtain better technical support is for
them to cooperate through professional institutions on the international level
and seek one or more software providers offering ISA-compliant software with
an integrated audit methodology. In the framework of such international
cooperation, emerging market auditors should become involved in the evaluation
and later on the distribution of the appropriate audit software.
6.2. Solutions Contained in International Standards and Rules
Small emerging market economies undoubtedly need a stronger involvement in
international accounting and auditing bodies to make the solutions feasible.
The solutions prepared by developed countries are not always useful for small
countries with different risks and inactive markets even if they have been
prepared for them.
The problem faced by emerging market auditors, auditing rms and pro-
fessional institutions is that they do not have enough human and nancial
resources to be represented on international bodies. The only way for them to
break through in this sense is via the Big Four networks. However, when
they become part of these, they no longer represent the small domestic market
but rather the policy of the international networks. For this reason, it would be
very helpful if international institutions were to clearly dene the objectives of
their effectively directed nancial support. Such objectives should be created
on the basis of appropriate professional research. Asking ministries about the pri-
orities without being aware of what the profession really needs is usually (at least
partly) a waste of money. The objectives should be stated in advance so as to
136 M. Duhovnik
enable ministries in small emerging market economies to choose objectives rel-
evant to professional development.
Financial support for professionals (not civil servants) to participate in inter-
national bodies would make those bodies solutions acceptable not only to devel-
oped countries but also emerging market economies.
6.3. Education
In emerging market economies it seems that we have reached a level at which it is
possible to formally full all requirements of the Directive, but without having an
efcient education system in place. The problem starts with the basic education
provided by universities whereby students are acquainted with the Anglo-
American valuation models and techniques without being taught about their
actual usefulness in the local circumstances. On the other hand, university
programmes in the eld of auditing are mostly occupied with auditing rules
and do not teach students how to use different mathematical and statistical
methods for audit purposes. It is a real challenge for university professors in
emerging market economies to introduce the combined study of auditing and
mathematical/statistical methods that are appropriate for the circumstances.
The second problem of late professional development is strongly connected
with the absence of appropriate audit software with an integrated audit method-
ology to be available to current and future certied auditors. For this reason, pro-
fessional institutions from emerging market economies are intensively looking
for appropriate software in line with the claried ISAs to demonstrate to prac-
titioners how the audit process can be efciently supported.
The third problem in the education eld is how to foster education in the Train
the Trainers form, usually nanced with international funds. Education is often
organised in a pyramid system whereby trainers at the rst level, coming from a
well-developed market environment, are training second-level trainers with less
knowledge. These second- or even third-level trainers are coming to emerging
market economies to teach. In such a system, the original knowledge from the
rst level can rarely be transferred properly. Besides, the less developed the
environment, the more knowledge is required to nd the best solution.
In the Train the Trainers approach it would be necessary for domestic pro-
fessionals whose knowledge should not be underestimated to get in touch
with the rst-level specialists or, alternatively, to be taught as second-level trai-
ners able to exchange information with the rst-level trainers and transfer the
knowledge in a way applicable to the circumstances of an emerging market
economy. For example, it is not helpful for somebody from an American account-
ing background to train a Big Four auditor who is originally from, say, a Polish
accounting tradition, to teach Slovenians to use the ISAs. This is because the
second-tier auditor is likely to be inuenced by his or her own accounting tra-
dition in the understanding of the international rules. Direct communication is
Time to Endorse the ISAs for European Use 137
necessary and at the same time is the only way to nd the best solutions in a par-
ticular environment.
The ISAs endorsement in Europe cannot itself solve the problems of emerging
market economies. Yet it can bring about a unied European audit market with
audit tools and products available to all European countries, and offer emerging
market economies the basis for joining forces to inuence decisions of inter-
national standard-setters, and develop educational programmes and solutions
applicable to the circumstances of non-active markets.
7. The Benets for the European Market as a Whole
Emerging market economies are only part of the European market. For this
reason, the advantages of the claried ISAs should have been demonstrated on
the European level to stimulate their endorsement. Although empirical analysis
is impossible without claried ISAs in use, different authors (like Baker et al.,
2001; Combarros, 2000; Van Der Plaats, 2000; Whittington, 2005) have
offered quite a few arguments supporting the inclusion of the ISAs in European
legislation.
The situation in Europe is well demonstrated by Jeppessen (2010, p. 191): At
present the international accounting profession seems to prefer to overcome
resistance to auditing standard-setting by using two other forms of representation,
observation and public oversight boards. The efciency of these two instruments
for audit quality can hardly be proved especially in emerging market economies
where public oversight bodies are often state-owned agencies. Even in the USA,
analyses of auditing rm supervision since the Public Company Accounting
Oversight Board (PCAOB) began conducting its inspections shows that less is
known about auditing rm quality under the new regulatory regime (Lennox
and Pittman, 2010).
The problem often exposed in Europe that is, whether one size of claried
ISAs ts all audit clients is overestimated and is not a real problem even for
small emerging market economies. It should be made clear that we are not
talking about accounting but auditing standards, the use of which depends
upon the size and complexity of the client. With the size of the client and the com-
plexity of its operations, the problem of the ISAs scalability in the audit pro-
cedure is resolved by itself.
8. Conclusion
Although the view of a specialist from an emerging market economy might be
biased, the situation in the European market requires prompt action to maintain
an appropriate level of audit quality in Europe as a whole. The fact is that at
this moment in time the claried ISAs are the best instrument available to
unify the auditing approach in the European environment and to take the necess-
ary second step after the endorsement of the IFRSs. If Europe waits for an
138 M. Duhovnik
alternative solution it may happen that, due to the time lag in its application, the
overall quality of the European audit profession will be not on a par with the
quality of audits in the rest of the world.
Acknowledgement
The author would like to express her gratitude to the chief editor Ms Lisa Evans
for her contributions in preparing a more understandable nal version of the
paper.
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