The European Parliament and the Council of the European Union
have adopted an "audit reform package" that intends to
improve audit quality and transparency and to prevent conflicts of
interest. The most important feature of the new legislation is that
it prohibits Big Four-only contractual clauses requiring that the
audit be done by one of the Big Four firms. This calls for a more
flexible approach from both auditors and companies.
With this audit reform package, European legislators aim to open up the market beyond the dominant Big Four firms and to remedy auditing weaknesses revealed by the financial crisis. The package consists of a directive and a regulation.
Companies and audit firms have two years to prepare for the
Public interest entities (PIEs), such as banks, insurance companies and listed companies, will be required to issue a call for tenders when selecting a new auditor. To ensure that relations between the auditor and the audited company do not become too close, the European Parliament agreed on a mandatory rotation rule where an auditor may inspect a company's books for up to 10 years. This may be increased by 10 additional years if new tenders are issued, and by up to 14 additional years in the case of joint audits, i.e. when a firm is being audited by more than one audit firm. The Commission had proposed mandatory rotation after six years, but the European Parliament judged that this would be a costly and unwelcome intervention in the audit market.
The audit reform package will require audit firms auditing PIEs to provide shareholders and investors with a detailed understanding of what the auditor did and an overall assurance of the accuracy of the company's accounts. Furthermore, the package introduces a cap on the fees that audit firms can earn from the provision of permitted non-audit services to PIEs, including tax advisory services that directly affect the company's financial statements or services linked to the client's investment strategy.
Both the directive and the regulation will enter into force 20 days after their publication in the Official Journal of the European Union. The directive must be adopted by EU member states within 2 years from that date and the regulation will be effective 2 years from that date. The restriction on fee income from non-auditing services is to take effect within 3 years. The Federation of European Accountants has made a set of FAQs available.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.