As expected, the European Commission’s draft regulation on audit concentrates on the audit of public interest entities (PIEs – mainly listed companies) and amounts to a concerted attempt to legislate for greater visible independence and competition in the audit market in this sector.
These are highly interventionist measures and some appear to have been framed without conclusive evidence that they are needed to pre-empt future audit failures. In particular, it is not clear how the act of enshrining many aspects of current professional and technical standards in legislation – for example, the requirement to conduct audits in accordance with professional scepticism – will serve to improve audit quality. While the EC is entitled to stress the public interest dimension of audit at this level, we also need to ensure that the eventual legislation takes into account the needs and wishes of companies and investors. The strong focus on PIEs means that comparatively little attention is given by the EC to the audit of small and medium-sized enterprises (SMEs). That is not to say, though, that what attention is given to that area is insignificant.
For the first time it is being proposed that small entities should be formally excluded from the scope of European Union law requiring accounts to be audited. This recognises the reality that the great majority of EU countries have by now taken advantage of the existing provisions in the Fourth Directive, which allow small entities to be made exempt from national laws requiring audit. The draft directive makes clear, though, that where a member state chooses to require small company accounts to be audited, those audits are to be deemed ‘statutory audits’ and will thus have to meet the various criteria set out in the directive, including in respect of eligibility to act. Similarly, if any small company chooses to have a ‘voluntary’ audit, the draft directive provides for that to be treated as a ‘statutory audit’, too. These provisions are positive in that they will help to provide certainty as to what an audit amounts to at this level. The draft directive confirms that all statutory audits, including ‘voluntary’ ones, are to be carried out in accordance with International Standards on Accounting (ISAs). However, the most significant provision as regards SME audits appears in articles 43a and b, which provide that member states are to be required to ensure that the application of audit standards to SMEs is ‘proportionate to the scale and complexity’ of the companies concerned. Thus the EC is envisaging some sort of modification of the existing requirements of ISAs as they are applied to SMEs.
If this proposal helps to maintain the long-term relevance of audit in the SME sector, then it can only be a good thing. Scaling back the requirements of ISAs is, however, an area fraught with technical difficulty, given that the extensive procedures set out in ISAs are currently seen as integral to the achievement of the key benchmark of reasonable assurance. The other aspect, which will need to be considered carefully, concerns the delegation of authority to the individual member states to decide what proportionality means in respect of SME audit standards in their jurisdictions. Apart from the question of whether member states are the right people to decide on audit standards, the danger is that we could end up with 27 different forms of SME audit requirements. If we are trying to maintain confidence in the credibility of published accounting information, including at the SME level, the last thing we want to do is to create any new cause for confusion. So while some rationalisation of the application of ISAs at the SME level is an attractive one, at least in principle, we should at least be aiming for a harmonised solution and one which does not create any new expectations gaps.
This article first appeared in Accounting and Business January 2012