Principles, Practice and Cases

Seventh Edition

By Iain Gray, Stuart Manson, Louise Crawford

For use with The Audit Process. Principles, Practice and Cases, seventh edition by Gray, Manson, Crawford
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Chapter 4:
Audit regulation

For use with The Audit Process. Principles, Practice and Cases, seventh edition by Gray, Manson, Crawford
978-1-4737-6018-9 © 2019 Cengage Learning EMEA
Learning objectives
To describe the form of regulation governing the work of
auditors in the UK.
To explain the role of the various bodies involved in the
regulation of auditing.
To state and explain the requirements of the law on
appointment, resignation and dismissal of auditors.
To describe how the law attempts to strengthen the position
of the auditor.
To explain the professional guidance on appointment,
resignation and dismissal.
To discuss the process of audit tendering.

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The need for regulation

Regulation provides some assurance to users or consumers of a

service by a professional firm that certain standards are met.
The audit profession sets standards which individuals must
achieve before they are ‘licensed’ to act as auditors.
Setting of standards, to which audit practitioners must adhere,
ensures work is conducted properly – standards increasingly set
at an International level: EU, IASB and IAASB
Regulation helps to reduce risk for users of auditing service. Risk
is an important concept for auditors.
Regulation enhances confidence, replacing element of trust,
lacking when dealing with individual of whom little known.
Power the state cedes to a professional body dependent on:
– The state’s attitude towards a particular form of political
economy.
– The state’s opinion of the expertise, integrity and state of
development of the professional body.

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UK Regulatory System: background
Substantial changes in regulation of auditing over the past
20 years
In 2003 two reviews set up by government - Review of the
Regulatory Regime of the Accountancy Profession
(RRRAP) and – the Co-ordinating Group on Audit and
Accounting Issues (CGAA)
Following report of RRRAP Department of Trade and
Industry
issued a consultation document containing legislative
proposals on the Review of the Regulatory Regime of the
Accountancy Profession
Main concerns of CGAA were: auditor independence;
corporate governance and the role of the audit committee;
transparency of audit firms; financial reporting: standards
and enforcement; monitoring of audit firms; and competition
implications. 5
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In 2012 a new regulatory structure was introduced.

Current Regulatory System
Mission of the FRC ‘is to promote high quality corporate
governance and reporting to foster investment’.
Financial Reporting Council (FRC) structure is shown in Figure
4,1 (page 119) and FRC Executive Structure in Figure 4.2
(page 120)
The FRC board has two subcommittees – Conduct Committee
and Codes and Standards Committee.
Conduct Committee has three subcommittees – Corporate
Reporting Review Committee, Audit Quality Review Committee
and Case Management Committee.
Codes and Standards Committee has three subcommittees –
Audit and Assurance Council, Corporate Reporting Council and
Actuarial Council.
Elements of main concern for students of auditing are
monitoring of audit firms, disciplining audit firms and members,
responsibility for standards, and oversight of the RPBs and
RQBs. 6
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Conduct Committee
The role of the Conduct Committee is to oversee:
monitoring of the recognized supervisory and
qualifying bodies
audit quality reviews
corporate reporting reviews
professional discipline
oversight of the regulation of accountants and
actuaries.
Two of the Conduct Committee sub-committees are of
relevance to the discussion - Audit Quality Review
Committee and the Corporate Reporting Review
Committee.

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Audit Quality Review Committee (AQRC)
Role of AQRC is to help ‘ensure the consistency and
quality of FRC’s monitoring work’.
Monitoring the quality of individual audits is performed by
the Audit Quality Review Team (AQR)
Role of AQR team is to monitor quality of auditing by firms
that audit Public Interest Entities (PIEs) and other major
entities, such as large Alternative Investment Market (AIM)
companies.
When performing the review AQR team concentrate on
those areas where critical judgments are made in arriving
at the audit opinion.
FRC policy is to inspect larger firms annually with other
firms being investigated once every three years. FRC has
recently indicated it will increase the intensity in the way
they monitor the six largest audit firms.
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Corporate Reporting Reviews
FRC through the Conduct Committee ensures that the
provision of financial information provided by listed companies,
AIM companies and a few unlisted companies complies with
regulatory requirements.
Conduct Committee each year develops a programme for
review of annual accounts, based on ‘risk assessment
informed’ by what is perceived to be a ‘priority sector’.
Where a company is selected it will be investigated by
members of the corporate reporting review team who may
enter into discussions with the company about the
appropriateness of the accounting treatment that is contested.
If the company cannot be persuaded, as a last resort the
Conduct Committee will decide if they should apply to the
courts to have the financial statements amended. But almost
all issues are resolved at the initial stage.

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Professional Oversight Team
Professional Oversight team is the group that has responsibility
for regulation of auditors by the RSBs and RQBs.
RSBs perform their regulatory function under legally binding
agreements with the FRC.
Tasks delegated by the FRC to the RSBs include:
audit registration
monitoring of statutory audits of non-PIEs
continuing professional development
enforcement for the breaching of relevant requirements by
statutory auditors of non-PIEs including investigation and
imposing sanctions.
FRC monitoring activities designed to ensure delegated tasks
performed by RSBs in respect of statutory audit firms and
statutory auditors whom they have registered are carried out
satisfactorily.

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Professional Discipline 1
FRC Audit Enforcement Procedure (AEP) essentially
concerned with the situation where the standard of auditing
exercised by an audit firm or individual auditor falls below
what is expected - only apply to the audit of PIEs, large AIM
companies and any audit investigation the FRC decides to
take from an RSB.
When a complaint is made it will initially be investigated by
a Case Examiner whose role it is to determine whether the
case should be taken further.
The standards (known as Relevant Requirements) include:
standards of integrity, objectivity, professional competence
due care and professional scepticism as determined by
FRC
international auditing standards
any auditing standards, standards or procedures imposed
by FRC. 11
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Professional Discipline 2
Where the Conduct Committee considers further investigation
is merited, they can refer the case to be overseen by the Case
Management Committee or delegated to the appropriate RSB
or referred for investigation by the Executive Counsel.
FRC also operates an Accountancy Scheme under which FRC
investigates complaints of misconduct made about members of
a professional accounting body (or member firms).
Misconduct defined as ‘an act or omission, or series of acts or
omissions by a Member or Member Firm in the course of his or
its professional activities . . . or otherwise, which falls
significantly short of the standards reasonably expected of a
Member or Member Firm or has brought, or is likely to bring
discredit to the Member or the Member Firm or the
Accountancy Profession’
Only those complaints that may have a public interest element
are the remit of the FRC with any others being dealt with by the
appropriate professional accounting body. 12
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Role of RSBs & RQBs in the Regulation of
Their Members & Registered Audit Firms
Company law in GB recognizes two types of body to regulate the
auditing profession – RSBs and RQBs.
Role of RSBs - to maintain and enforce rules as to: (a) eligibility
of persons for appointment as statutory auditor, (b) conduct
of statutory audit work, binding on persons seeking
appointment or acting as a statutory auditor because they are
members of that body.
Role of RQBs - to enforce rules relating to (a) admission to or
expulsion from a course of study leading to a qualification, (b)
award or deprivation of a qualification (c) approval of a
person for the purposes of giving practical training or the
withdrawal of such approval.
Professional Oversight team is the group that has
responsibility for the regulation of auditors by the RSBs and
RQBs - one of the main concerns of the oversight team will
be in ensuring that the RQBs still comply with the
requirements imposed on them by the CA 2006. 13
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Monitoring role of RSBs 1
FRC has delegated a number of responsibilities to the RSBs,
specified in Audit Regulations and Guidance, including:
approval of firms as registered auditors;
approval of individuals as responsible individuals;
setting procedures for maintaining the competence of
responsible individuals.
And for non-PIEs:
monitoring the conduct of audit work;
investigating possible breaches of these [audit] regulations;
and
disciplining and sanctioning breaches of these [audit]
regulations.
Main objective of the audit regulations is to ensure that high
quality audit work is produced and the reputation of the
profession is maintained.

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Monitoring role of RSBs 2
RSB has the right of access to all aspects of registered audit
firm’s audit practice including audit engagement files.
Important initial step is a review of audit firm’s Annual Return,
including the audit compliance review (ACR) carried out within
the firm.
Purpose of ACR review is to ensure the firm is complying with
audit regulations and to add value to the audit practice by
improving its policies and procedures.
The ACR is concerned with areas of independence,
competence, professional indemnity insurance, appointment &
reappointment, fit and proper status and continuing eligibility,
and should be conducted annually.
If firm conducts its own thorough AQR this should help ensure
they are well prepared for the monitoring visit which will be
concerned with similar matters.

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Monitoring role of RSBs 3
In monitoring visit RSB will concerned with 2 main
aspects:
1. Matters of policy and procedures related to audit
firm. Basically monitoring visit is seeking assurance
the firm has in place robust systems which ensure
competence is maintained and that high quality audit
work is produced.
2. Examination of a number of audit files for review
by the monitoring team.
Team particularly concerned audit work supports
audit opinion given, there has been compliance with
ISA Standards, Company Law provisions & any
other regulations specific to company.
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Current regulatory structure (9)
Professional Oversight (PO)
The PO team took over from POB and its role in respect of
audit is to determine that RSBs and RQBs continue to
comply with the requirements imposed on them by CA 2006
for acting as regulatory bodies.
RQBs have to have rules and regulations in place relating to
aspects such as; practical training, examinations and entry
requirements.
The RQBs must also have arrangements for monitoring
compliance with the above.
Objective of disciplinary procedures is to ensure public
confidence in profession is maintained, protect the
public interest and maintain appropriate standards of
competence and conduct.
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European Union influence 1
A further regulatory body which has taken on increasing
significance in the last 30 or so years is the European Union
including:
The 4th Directive (1978) on annual accounts of limited
companies.
The 7th Directive (1983) requiring the publication of
consolidated accounts.
Statutory Audit Directive (2006) on transparency reporting,
auditor examination requirements, auditor independence and
systems of quality assurance.
These directives have been implemented via Companies Acts
or Statutory Instruments.
The 8th Directive (1984) on the independence of auditors.
Directive and Regulation (2014) on statutory audit of public
interest entities implemented in the UK via a Statutory
Instrument.
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European Union influence 2
There are a number of reasons why the EU considered there
was a need to reform audit:
Financial crisis had damaged the credibility of auditing;
Long length of audit tenure was thought to impinge upon
auditor independence;
Market for the audit of very large companies was too
concentrated;
Risk to the audit industry should one of the Big Four no longer
exist;
Deficiencies in the audit report.
Typical issues covered in the 2014 Directive were: Recognition
of audit firms; Continuing education; Professional ethics &
scepticism; Internal organization of statutory auditors & audit
firms, and Investigations & sanctions.

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European Union influence 3
Provisions in the regulations were more far-ranging and
involved considerable change in the audit market:
Auditor to provide a statement in the audit report about the
most important assessed risks of material misstatement
including that relating to fraud and how the auditor has
responded.
Auditor to explain how capable the audit is at detecting
irregularities.
Auditors to confirm that they remain independent and to give
details of tenure.
In public interest entities, an additional report be made to the
audit committee on such matters as scope and timing of audit,
deficiencies in internal control and accounting system, major
difficulties found in the audit, audit methodology used,
quantitative measure of materiality and qualitative factors in
setting materiality level.
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Further regulation of auditing by the law and accounting profession

To appreciate the legal rules on appointment, resignation and

removal of auditors – need to have a firm understanding of the
following:
– Individuals who can act and rules on appointment, removal
and resignation.
– The period for which the auditor is appointed.
– The statutory relationships between auditors and
shareholders.
– The statutory relationships between shareholders and
directors.
– The practical relationships between auditors and directors.
See Rosedale Cosmetics plc (Case study 4.1).

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The statutory and practical relationships
(1)
Figure 4.4

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The statutory and practical relationships
(2)
Figure 4.5

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Small companies
Companies Act 2006 contains provisions to reduce burden
of regulation on small companies. E.g. s. 477 provides that
a small private company may elect not to have an audit.
The criteria for being a small company is that it should meet
in the current year any two of: turnover not to exceed £10.2
million, balance sheet total not exceed £5.1 million, and
average number of employees not greater than 50.
There are also criteria for micro entities which reduce
regulatory burden.
Members holding not less than 10% of the nominal share
capital can, subject to giving due notice, require that an
audit be carried out.

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Audit tendering
Public Interest Entities (PIE) must put their audit out to tender
every 10 years and the maximum term of office for a firm’s
audit is 20 years.
Audit Committee leads on tendering process to appoint a new
auditor.
Tender process cannot preclude participation of non-Big Four
firms
Audit firm invited to tender should ensure they have: the
resources to undertake the audit including suitably experienced
staff; the expertise required; no ethical issues involved;
necessary resources and expertise in the countries where the
company’s operations are located; a suitable engagement
partner who has the necessary expertise and skills to work well
with management.
The audit firm should be able to show the company it has a
good understanding its operations in a presentation to audit
committee members and senior directors in the company. 25
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