TRANSPARENCY AND AUDIT REGULATION
By: James Sylph, Technical Director, International Federation of Accountants
This speech was given by Mr. James Sylph to the Fédération des Experts Comptables Mediterranéens Conference in Istanbul on 13 December, 2005.
Given the corporate scandals of recent years, the audit profession is now in the forefront of the minds of investors, businesses, regulators and others. Financial reporting, corporate governance and accounting and auditing practices must keep up with the needs of these groups. Effective regulation of the audit profession is one means of ensuring that the profession and the private sector keep pace with these challenges.
In addressing these challenges, the Fédération des Experts Comptables Mediterranéens and the International Federation of Accountants share common goals: facilitating communication and cooperation among accountancy bodies and with the larger business and regulatory community; providing technical assistance to accountants in all sectors; and promoting high quality standards of accounting, auditing and ethics. It is no wonder, then, that accountancy organisations in Mediterranean region are active in IFAC and that numerous volunteers from your member organisations serve on IFAC boards and committees – helping to develop high-quality international standards, encouraging convergence to those standards and undertaking all these activities in the public interest. We thank these volunteers for their support and dedication.
As the global organisation for the accountancy profession, with 163 member bodies in 120 countries around the world, IFAC firmly believes that effective audit regulation is critical to protecting the public interest.
Before I present IFAC’s view on regulation of the audit profession and what we are doing to support high-quality international standards for audits, I think it is important to understand the historical development of the profession’s regulatory structures and why, today, there is an increased global focus on them.
Broadly defined, regulation refers to the making and implementing of rules which direct or constrain the behaviour of a person or group of people being regulated. That said, I think it is important to acknowledge the role of the profession in the evolution of its regulation. In most developed nations, the licensing and regulation of the accountancy profession was founded through the initiative of practicing professional accountants who often sponsored legislation to set minimum requirements to be designated as a professional public accountant. Historically, leading practitioners then established a code of professional conduct and, eventually, accounting, auditing and other practice standards.
Through much of the 20th century, the requisite knowledge of professional practice standards that protected the public resided nearly exclusively with professional practitioners who founded professional associations to promote their profession and its standards. This led many government regulators who had the legal authority to mandate compliance to choose to adopt the standards of the professional associations by reference or as acceptable interpretations. Over time and in many countries, such as the United States, this approach evolved into a sophisticated system of government-sanctioned self regulation that for many years was considered adequate, efficient and protected the public.
In more recent years, businesses have become increasingly more complex and globalisation has taken hold. At the same time, to meet new marketplace needs professional accountants and their firms have expanded the range and types of business services they offered their clients well beyond the traditional attest and assurance and taxation advice. These changes, when combined with major public company failures involving inadequate corporate governance and perceived or adjudicated shortcomings in auditor performance, resulted in a widespread conviction of the need for re-examination of accounting regulation and standard-setting structures.
of the audit profession has typically been included as part of the
overall regulation of the accountancy profession and has covered the
• Education and admission standards;
• Audit standards;
• Ethical standards; and
• Disciplinary action.
• Monitoring of audit quality, for example, audit inspections; and
• Monitoring the self-regulatory activities of the professional accountancy bodies as they apply to audits and auditors.
Trends in Regulation
How can this regulation of the profession today best be carried out? In any number of ways and combinations. As I already mentioned, generally, the audit profession is regulated by the profession and/or the government. Where the regulation has been carried out primarily by the profession, it is often referred to as “self-regulation” and when it is carried out by the government, is often just called “regulation,” but for clarity, “direct regulation” is a better term.
It is important to keep in mind that there is no pure model of either self-regulation or direct regulation. The profession rarely regulates without some form of government mandate to do so, and similarly, the government rarely regulates without some form of interaction with the profession.
In general, the IFAC member bodies, the professional institutes, act under a delegation from their respective governments. The government has given legal recognition to the profession and has given the professional institute a set of roles and responsibilities and some form of reporting requirement. These responsibilities can include admission criteria, continuing education requirements, disciplinary provisions, standard setting and so on. Reporting requirements often take the form of annual reports by the professional body. Under self-regulation then, the government has delegated the responsibility for regulation to the profession and the profession regulates itself within that framework and then reports on its activities. There can be a greater or a lesser degree of government monitoring and oversight.
Direct regulation, for example, through the establishment of an audit oversight body, simply means that the government itself has assumed responsibility to regulate part, or, rarely, all of the profession. However, like self-regulation, this regulation is taking place within a set of roles, responsibilities and reporting arrangements that have been set by government and established in legislation. To be successful, the regulator needs to have an effective working relationship with the profession.
In discussing methods of regulation, it is important to remember that accountancy is a profession. That means that professional accountants have an overriding responsibility to the community in which they live, not just to their current clients or to themselves. So even in circumstances where there is total direct regulation, there is still a need for the profession to regulate the activities and conduct of its members to ensure that this responsibility to the community is fulfilled. The only caveat is that this regulation needs to be efficient and effective.
In IFAC’s view, there is no “one size fits all” solution and so the answer to the question “which option is best,” is the economist’s answer “it depends.” Regardless, the regulator must act in the public interest. Whatever regulatory framework is used, be it administered by the profession or government, it must give the regulator appropriate incentives to act in the public interest. Regulators must have a clear, overarching purpose and the ability to resist any moves towards regulation that are self-interested or motivated by special interest groups.
Serving the public interest means having regulations that achieve their aim of being effective and efficient without imposing unnecessary costs. The benefits of the regulation – that is, its effectiveness in protecting the public interest – must exceed its costs.
• The responsibilities of the regulator should be clear and objectively stated;
• The regulator should be operationally independent and accountable in the exercise of its functions and powers;
• The regulator should have adequate powers, proper resources and the capacity to perform its functions and exercise its powers;
• The regulator should adopt clear and consistent regulatory processes; and
• The staff of the regulator should observe the highest professional standards, including appropriate standards of confidentiality.
The choice between self-regulation and direct regulation primarily depends on who can meet the IOSCO principles and carry out the required functions most efficiently. For example, a professional body often has considerable expertise regarding the profession so it may be better placed to regulate where this expertise is needed. As well, the professional body’s separation from government can mean that it can react faster and more flexibly than a comparable government agency. In those countries where the profession needs to be strengthened, granting the profession self-regulatory powers can assist it in gaining the necessary expertise.
Direct regulation can be the most appropriate solution if there is a need for the regulator to be completely independent of the profession, or if it is considered inappropriate for the profession to carry out certain functions.
Taking into account these factors and differences in history, culture, commercial law and varying stages of economic development, we see at a national level a huge diversity of regulatory approaches. In some countries, particularly former command and control economies, in the former Soviet Union or in China, they are grappling with the issue of how the government can move away from direct regulation and increase the amount of self-regulation so that the national profession can be strengthened.
In recent years, two clear trends have emerged in regulation of the audit profession; a move towards direct regulation and, at an international level, pressure for regulatory convergence. The trend towards more direct regulation emerged out of the financial scandals of Enron, WorldCom and a loss of credibility in the profession. But this move is not without controversy as new regulations have often been expensive and cost estimates inaccurate. Take a well known example, the US Sarbanes-Oxley Act. This Act requires companies to report on their internal controls. The SEC estimated that the aggregate cost would be about US$1.24 billion or $94,000 per public company. Unfortunately, they were wrong. According to surveys, actual costs were around twenty times higher . As a result, questions have been raised as to what regulation is necessary and whether the increases in regulation are appropriate. Paul Boyle, CEO of the UK Financial Reporting Council, considers that “We are reaching a high point of regulation...there is widespread concern that regulation has gone beyond the point at which it is useful. The balance between investor protection and creating prosperity may have been overstepped.”
So we may see in the coming years a move towards less regulation and less costly regulation of the audit profession. In those countries that have increased the amount of direct regulation, the government regulator is likely to face increasing pressure to justify the benefits of its actions and to find less costly methods of regulation.
The pressure for convergence has come from an increasing realisation among regulators and the profession that capital markets are much more global and that convergence would assist in making the international financial system more efficient and robust. But regulating at an international level cannot simply mirror the national approach. There is no central government, no ability to levy or raise taxes and no ability to compel other nation states. Instead, at the international level, we are seeing increasing dialogue and cooperation between regulatory agencies and moves to express agreement through the development of principles.
IFAC is very supportive of these international developments and has been an active participant. A principles-based approach at an international level allows the focus of regulation to be on what needs to be achieved and allows for national differences in implementation. It is, therefore, more flexible and adaptable to individual countries and circumstances.
IFAC sets international standards for the profession in a number of areas including auditing and assurance. It has undertaken reforms to help ensure that IFAC’s standard-setting activities reflect the public interest and are fully transparent to those affected by the standards. One of the most important reforms has been the establishment of the international Public Interest Oversight Board (PIOB) to oversee IFAC’s standard-setting activities. IFAC considers that this oversight is critical to building credibility and confidence in international standards. The 10 member PIOB is chaired by a European, Professor Stavros Thomadakis from Athens and has two European members – Antoine Bracchi from France and Arnold Schilder from the Netherlands as well as two EC observers.
Setting of Auditing Standards
Auditing standards are a key factor in the regulation of the audit profession. If the profession is to perform high quality work in the public interest, it needs to have high quality standards that are set in the public interest. The primary duty of all professional accountants, wherever they work, is to serve the public interest.
So, what skills and processes are required to set high quality audit standards? First, and most obvious, is technical expertise. Those responsible for setting the standards need to have sufficient technical expertise and understanding of auditing and audit processes. This expertise is generally found within the audit profession, and is not limited to auditors in public practice.
Secondly, the standard-setting process needs to be informed by all those involved in auditing; the profession, companies, regulators and so on. So there needs to be input into the process from these groups.
As the technical expertise is found in the profession and the profession is responsible for carrying out audits, there is a potential for a lack of independence in fact or in appearance. This independence issue needs to be addressed if audit standards are to be acceptable to the wider community. Overcoming independence concerns means having a strong and robust process and public interest oversight.
Within IFAC, the International Auditing and Assurance Standards Board (IAASB) is dedicated to operating as transparently as possible. It is one of, if not the most, transparent standard setters in the world. IAASB meetings are open to the public and agenda papers, background documents and meeting summaries are posted on the IFAC website. Visitors can view project histories and may download audio recordings of the IAASB meeting proceedings. They can also download IAASB exposure drafts and view all comments made on those drafts by regulators, firms, standard setters and others.
The IAASB makes it a priority to reach out to other stakeholders including small- and medium-sized practices and other standards setters as we did in the recent Clarity Forum.
Public oversight of the standard-setting process through the PIOB is crucial as it assists in building creditability and confidence in international standards, which then contribute to confidence in the financial information produced by companies; in the examinations carried out by their auditors; and, ultimately, in the capital markets that rely on such information.
In IFAC’s view there is no “one size fits all” answer to the issue of how to regulate the audit profession at the national level.
A cornerstone of our free enterprise system is “freedom of choice.” Consumers are free to choose what they wish to purchase and from whom. This simple concept is the powerful engine that drives economies in free markets. At the same time, there is an appropriate role for government oversight in the free market process to ensure that the consuming public is not being misled or defrauded by unethical business practices. At IFAC, we recognise that the role of governments, as well as the role of the profession, will vary, but they should be guided by the principle of striking the right balance – to protect consumers without comprising free enterprise and without inflicting undue costs on the profession or the public.
It is critical that, regardless of whether there is self-regulation, direct regulation or some combination, that both the profession and the regulator act in the public interest and that the benefits of regulation outweigh the costs.
from "the accountant" magazine