The risk that agents' (directors) self-interest deviates from that of the principals (shareholders).

When directors seek power and monetary reward, they may not necessarily wish to maximise profit or maximise shareholder value in the long run.

1) Using the directors' remuneration packages as incentives

2) Monitoring the directors' performance

3) Appointing an external auditor

It may encourage fraudulent financial reporting by the directors to meet targets eg inflating profits or revenue

Through the requirement of directors to prepare financial statements, ensuring a certain profit level is met before bonuses are paid.

However there is a risk that financial statements may not be prepared to give a true and fair view of the company's financial position. To mask where they have not acted in the shareholders' best interests

They will assess and report to the shareholders whether the financial statements show a true and fair view and have been prepared, in all material respects, in accordance with an applicable financial reporting framework

Costs borne to the shareholders to reduce agency risk, such are monitoring the performances of the directors.

Can include costs of audit, time taken in monitoring, bonuses and pay rises to align directors interests with shareholders

Makes sure a company's dealings with shareholders are fair and transparent

The board of directors is held accountable

The company deals responsibly with stakeholders

The company's focus is on the sustainable success of the company over the long term

1) Executive directors are responsible for the day-to-day operational management of the company and driving and overseeing the strategic direction of the entity.

2) The internal auditor is responsible for providing a check on the risks and related internal controls of a company, including those surrounding financial reporting.

3) The chairman is head of the board and has responsibility for chairing the board meetings, ensuring decisions are reached.

4) The chief executive officer is responsible for the executive director team and consequently is ultimately responsible for the day-to-day running of the company and implementing the board’s strategies.

1) The board should ensure that necessary resources are in place for the company to meet its objectives and measure performance against them. The board should also establish a framework of prudent and effective controls, which enables risk to be assessed and managed.

2) The board carry out an assessment of the emerging and principal risks.

3) The board should monitor the company’s risk management and internal control systems

4) The directors should explain in the annual report their responsibility for preparing the annual report and accounts, and state that they consider the annual report and accounts, taken as a whole, is fair, balanced and understandable

5) The board should state, in the financial statements, whether it considers it appropriate to adopt the going concern basis of accounting in preparing them, and identify any material uncertainties to the company’s ability to continue to do so.

6) the board should explain in the annual report how it has assessed the prospects of the company, over what period it has done so and why it considers that period to be appropriate

1) Bring together elements of best practice for risk management.

2) Prompt boards to consider how to discharge their responsibilities in relation to the existing and emerging principal risks faced by the company.

3) Reflect sound business practice, whereby risk management and internal control are embedded in the business process by which a company pursues its objectives.

4) Highlight related reporting responsibilities

Aims to stimulate boards' thinking on how they can carry out their role and encourage them to focus on continually improving their effectiveness.

Aims to assist company boards in making suitable arrangements for their audit committees, and to assist directors serving on audit committees in carrying out their role.

The audit committee should be made up of solely independent non-executive directors

It has a range of responsibilities relating to the financial reporting process, internal control review, internal audit and relations with the external auditor. The audit committee monitors and reviews the effectiveness of the internal audit department

1) Narrative Statement

The annual report should include a description of how the company has applied the principles of the Code in a manner that a shareholder can clearly understand

2) Compliance Statement

The company must state whether it has complied with all of the relevant provisions throughout the accounting period. If it has not complied with one or more provisions, the statement must include details of the relevant provisions and the reasons for non-compliance.

Key elements include

The required ‘comply or explain’ information in respect of the UK Corporate Governance Code

The composition and operations of the board and committees

Information on the group’s internal control and risk management systems in relation to the financial reporting process

If there is no internal audit function, the reasons for the absence of this function should be explained

Details of significant shareholders

The audit firm must be unbiased and objective. It should be free from any situation or circumstances that would make an informed third party think that it was partial towards the client

1) Small Companies

2) Small Charities

3) Dormant Companies

Companies are entitled to the audit exemption under the CA 2006 if they meet two out of the three following criteria:

1. Balance sheet total of not more than £5.1m - (the aggregate of the amounts shown as assets in the company's balance sheet)
2. Turnover (revenue) of not more than £10.2m and/or
3. They have not more than 50 employees.

the above conditions are met by the company:

1. In the company’s first accounting period
2. In the company’s current and preceding year

A public company (unless dormant)

A banking company

An e-money issuer*

An insurance company

A corporate body whose shares have been admitted to trading on a regulated market

A public sector entity (the vast majority of public sector entities must be audited)

Gross income is over £1m; or

Gross assets are over £3.26m and gross income is over £250,000; or

An audit is required by the charity’s constitution or due to trustee or donor preference.

Gross income is £500,000 or more; or

Gross assets are over £3.26m; or

An audit is required by the charity’s constitution or due to trustee or donor preference.

Members (individually or in aggregate) who hold more than 10% of the company’s shares can veto the audit exemption. The veto must be done no later than one month before the end of the financial year in question.

Must include an additional narrative section in the SOFP

A statement that the shareholders have not required an audit using the shareholder veto

A statement that the company is entitled to the audit exemption

An acknowledgement of the directors’ responsibilities to maintain proper accounting records and to prepare accounts which give a true and fair view; and

A statement that the accounts have been prepared following the special provisions of the CA 2006 for small companies.

For an audit to be of value, the work of the auditor must be trusted – that is it must be credible

The credibility concept concerns the personal qualities of the auditor: competence, independence, integrity and ethics.

Competence - Auditors have a continuing duty to maintain their professional knowledge and skill at the level required to ensure that a client or employer receives a competent professional service, which is based on current developments in practice, legislation and techniques.

Integrity - Integrity means that the auditor should be straightforward and honest in all professional and business relationships.

Ethics and Independence - The auditor must not only be completely free from situations that could make their work less objective but must also be seen to be free from situations which could impact on the auditor’s independence.

If the auditor is not perceived to be independent, their audit report will be of little value even if they acted in a completely independent manner.

maintain and enforce rules that assess:

The eligibility of persons for appointment as a statutory auditor; and

The conduct of statutory audit work.

This includes:

• registration and disclosure of auditors;
• high standards of audit work;
• monitoring of quality;
• investigation and discipline; and
• accountability

• ICAS (Institute of Chartered Accountants of Scotland)
• ACCA (Association of Chartered Certified Accountants)
• AIA (Association of International Accountants)
• ICAEW (Institute of Chartered Accountants in England and Wales)
• CAI (Chartered Accountants Ireland)

There are four RSBs. An ‘appropriately qualified’ accountant must become a member of one of these RSBs if they wish to obtain statutory auditor status. The four bodies are:

• ICAS
• ACCA
• ICAEW
• CAI

Must hold a practising certificate from the relevant RSB

To obtain

Have completed at least 2 years’ post-qualifying experience; and

Are able to confirm compliance with the continuing professional development bylaws to the regulation and compliance overview department of the institute to which they are applying for registration; and

Have professional indemnity insurance.

T

• Hold an audit qualification
• Are ‘fit and proper persons’
• Hold a practising certificate
• Are a member of a registered audit firm
• Have adequate professional indemnity insurance

• Each of the principals (partners or directors) must be either a member of an RSB, a statutory auditor, an audit affiliate of an RSB or equivalent.
• The majority of its principals (partners or directors) must have an appropriate qualification, be a statutory auditor or equivalent.
• The firm has appointed an audit compliance principal (ie it does not require every principal to be an audit compliance principal).
• The firm must be ‘fit and proper’.
• The firm must have adequate professional indemnity insurance.

An individual who is responsible for monitoring that the audit firm has complied, and is likely to continue to comply, with relevant regulations, and whose identity is notified in writing to the relevant RSB, and who is the first point of contact with the relevant RSB in connection with regulations.

Form an independent opinion on the truth and fairness of the financial statement in accordance with the relevant financial reporting framework.

Confirm that the financial statements have been properly prepared in accordance with the Companies Act 2006.

Confirm that the information contained within the directors’ report (the strategic report) is consistent with the financial statements.

Confirm that the directors’ use of the going concern basis of accounting in the preparation of the financial statements is appropriate.

Returns have been received from branches not visited by the auditor.

Accounts agree with the underlying records.

Proper accounting records have been kept.

Information and explanations necessary for the purposes of the audit have been received.

Directors’ emoluments (eg salary, bonuses, and pension contributions) and other benefits disclosures are complete

The right of access at all times to the company’s books, documents and supporting records

The right to require any directors or employees of the company to provide them with any necessary information and explanations.

The right to require any subsidiaries, incorporated in the UK, of the company (and their auditors if different) to provide them with any information they might need

The right to receive copies of all communications relating to any written resolution proposed to be agreed by a private company.

The right to receive all notices of any general meeting of the company and to attend such meetings

The right to be heard at any general meeting on any part of the business which concerns them as auditor

Any time before the company’s first period for appointing auditors (ie the first time a company requires an auditor).

To fill a casual vacancy (eg if an auditor has resigned during the term of office).

If the company had previously taken an audit exemption, it would not have an auditor. If it lost this exemption, and therefore required an auditor, the directors would be able to appoint the first auditors.

Public - An auditor will be appointed/reappointed at each annual general meeting (AGM) by the shareholders.

Private - deemed to have been automatically reappointed unless 5% or more of the shareholders object (or the auditors were first appointed by the directors). It is also possible that a company’s articles of association may prohibit automatic reappointment.

If any shareholders propose a motion to remove the auditors, a copy of this motion must be sent to the auditors.

An auditor has a right to make written statements regarding their removal and have these passed to the shareholders.

The auditor retains the right to attend the normal AGM of the company in the year in which they were removed

The auditor must be notified that they are to be replaced and the auditor has the right to make written representations regarding the failure to reappoint them and have these distributed to the shareholders

The auditor is required to send a letter of resignation and, where the company is a public interest entity (PIE), a statement of circumstances to the registered office of the company.

In the UK, public interest entities include:

• All UK entities that are listed on the London Stock Exchange or other regulated market (this does not include the AIM listed entities)
• All credit institutions regardless of whether they are listed or not
• All insurance undertakings regardless of whether they are listed or not

The auditor guarantees that the financial statements are 100% correct

When a company collapses it is the fault of the auditor

The auditor is responsible for the internal controls of the company

The auditor is responsible for the detection of all instances of fraud

The auditor is responsible for preparing financial statements

The auditor is responsible for checking compliance with all laws and regulations

The auditor is responsible to provide aid and advice to management

The shareholders appoint the auditor rather than the board.

The auditor’s remuneration is fixed by shareholders.

Publication of the detail of amounts paid to the auditor within the financial statements to enable consideration of the balance of non-audit and audit work in the context of auditor independence.

There are penalties in place for failing to provide the auditor with information relevant to the audit (eg on matters concerning independence).

The auditor is given the investigative and reporting freedom needed to perform his duties

Freedom from conditions and relationships which make it probable that a reasonable and informed third party would conclude that integrity or objectivity either is or could be impaired

The auditor must be independent and seen to be independent.

Integrity - A professional accountant should be straightforward and honest in all professional and business relationships

Objectivity - A professional accountant should not allow bias, conflict of interest or undue influence of, or undue reliance on, individuals, organisations, technology or other factors to override professional or business judgements.

Professional Competence and Due Care - Ensure that a client or employer receives competent professional services based on current technical and professional standards and relevant legislation.

A professional accountant should act diligently and in accordance with applicable technical and professional standards when providing professional services.

Confidentiality - Should not disclose any such information (intentionally or otherwise) to third parties without proper and specific authority unless there is a legal or professional right or duty to disclose.

Professional Behaviour - should comply with relevant laws and regulations, behave in a manner consistent with the profession’s responsibility to act in the public interest, and should avoid any action that discredits the profession

Overarching principles and Supporting Ethical Provisions

The audit firm shall behave with integrity and objectivity in all professional and business activities and relationships

In each related engagement, the firm and each covered person shall make sure they are free from conditions which would make it seem that their independence has been compromised to a third party.

A person in a position to influence the conduct or outcome of the engagement. This includes:

Each member of the engagement team

Persons who provide engagement quality review

Any other person who is involved in the audit

A number of other individuals within the audit firm with supervisory, management and other oversight responsibilities

Comes under FRC Ethical Standard Part B Section 1 - General Requirements and Guidance

Self Interest - occurs when the accountant may be biased on account of a financial, personal or any other interest in the client

Self review - Self-review therefore refers to a situation whereby an auditor is assigned the task of auditing his own work or the work of a colleague

Management - A management threat arises when the audit firm undertakes work that involves making judgements and taking decisions that are the responsibility of management

Advocacy - An advocacy threat arises when the audit firm undertakes work that involves acting as an advocate for an audited entity and supporting a position taken by management in an adversarial or promotional context

Familiarity - A familiarity (or trust) threat arises when the auditor is predisposed to accept, or is insufficiently questioning of, the client’s point of view

Intimidation - An intimidation threat arises when the auditor’s conduct is influenced by fear or threats

1) Ethics Partner -

The ethics partner is responsible for ensuring the firm’s compliance with the Ethical Standard (ES).

They oversee the adequacy and communication of the firm’s ethical policies and procedures to all partners and staff.

They provide guidance on applying the ES in practice.

They must be consulted when judgements are made about whether the safeguards in place are sufficient to address potential ethical threats.

Communication with those charged with governance

Auditors of listed or public interest entities (PIEs) are required to ensure that the audit committee is provided with:

A written disclosure of relationships that may bear on the integrity, objectivity or independence of the firm

Details of non-audit services, including the fees charged

Written confirmation that the firm and each covered person is independent

Details of any inconsistencies between the ES and the policy of the entity for the provision of non-audit services

Details of any breaches of the requirements in the ES, and of any safeguards applied and actions taken to address any threats to independence

An opportunity to discuss independence issues

The engagement partner must also ensure that their consideration of objectivity and independence (including threats identified and safeguards put in place) is adequately documented in the audit file on a timely basis.

Financial relationships

Business relationships

Employment relationships

Family and other personal relationships

An auditor (or any person closely associated with them) or the audit firm should not hold any financial interest in an audit client or an affiliate of an audit client.

The FRC defines persons closely associated as a spouse (or legal equivalent), a dependent child, a relative with whom a house is shared for at least a year and a firm that is controlled by the audit firm.

EG Shareholdings in the audit client, Debt instruments, for example, debentures in the audit client, Share options

Threat of Self Interest

No exceptions for direct holdings.

EG Joint venture with audit client,

Distribution/marketing arrangements

Auditor leases office space from client or vice versa

Threats - Self Interest, Intimidation and Advocacy

Exceptions

Where the transaction is clearly not material to either party, in the normal course of business on an arm's length basis

Audit firms shall not enter into agreements with audit entities or their affiliates to provide partners or employees to work for them for a temporary period (ie on a secondment).

Threats - Management, Self Review

Exception - Staff employed by a UK National Audit Agency

No longer than 3 months, unless training contract then 6 months

Doesn't discuss provision of prohibited services

No management position

Where any member of the engagement team who was involved in an engagement in the previous year (or 2 years in the case of a partner) is going to be employed by a client, they must:

• Notify the firm of any situation
• Be removed from the engagement team; and
• Have a review performed of their work on both their current and most recent engagement.

Threats - Self Review, Familiarity and Intimidation

No exceptions

No partner on an engagement can join the client in a key management position

Either as a director on the board or as a member of the audit committee

Within a year (2 years for public interest entity) of the date they ceased to be a partner on the engagement

Threats - Self Interest, Familiarity and Intimidation

When a former director or employee who had influence in preparing financial statements, they should be excluded from any role that makes them a covered person

For a period of 2 years following the date of leaving the entity.

Significance of threat (and therefore need to extend exclusions) depends on:

• Position the individual held within the entity;
• Length of time since the individual left the entity;
• Position the individual holds in the engagement team or audit firm

Threats - Self Interest, Self Review, Familiarity

If a relative of a member of the audit team has a financial, business or employment relationship with the audit client, then this may cause a perceived or actual impairment to auditor integrity or objectivity

Threats - Familiarity, Self Interest, Intimidation

Long Association with Engagements and with Entities Relevant to Engagements

Over-familiarity with a client could lead to the auditor becoming sympathetic to the client and therefore being more likely to accept the client’s judgement without appropriate challenge

Threat of Familiarity, Self Interest, Self Review

Rotation of the audit partner should be considered after 10 years in the role.

If this is not carried out, an alternative safeguard should be put in place such as:

• Involving an additional partner who is not, or has not recently been, involved on the audit engagement to review the work; or
• Applying independent quality reviews to the audit engagement

Higher level of public scrutiny, for public interest and listed company audits: the engagement partner should be rotated after 5 years, with limited flexibility to extend to 7 years maximum

Can return to the role after 5 years

EQR rotated after 7 years and must not return to the role for 5 years

Key partners such as the tax partner must be rotated after 7 years and must not return to the role for 2 years

The independence of any other audit staff should be considered and discussed with the ethics partner after 7 years

Contingent fees are fees dependent on the outcome which may impair the auditor's independence

A fee that is still outstanding from a previous engagement may be perceived as a loan to the client and the audit firm might treat the client favourably to ensure the fee is paid.

Threats - Self Interest

If the auditor is receiving substantial fees for non-audit services from an audit client there may be a perceived threat to independence.

Self-interest, Intimidation

The total fees for non-audit services in relation to a public interest audit client are capped at 70% of the average of the fees paid over the last 3 years for the audit of the entity.

If an auditor is perceived to be dependent on a particular client, their independence is threatened. Their reliance on a client could also lead to an intimidation threat.

Self-interest, Intimidation

If total fees (audit and non-audit) are expected to regularly exceed 10% (public interest and other listed clients) or 15% (non-listed clients) of the annual fee income of the audit firm, then the auditor should resign or not stand for reappointment

Auditors should not be remunerated, appraised or given bonuses based on the selling of non-audit services to audit clients. The focus for evaluation and remuneration should be audit quality.

Self-interest

No exceptions

Self-interest

Advocacy

Intimidation

If litigation is in progress or is probable, the firm should either not continue with or not accept the audit engagement.

However, the firm is not required to resign in circumstances where an objective, reasonable and informed third party would not regard it as being in the interests of the shareholders (or equivalent) or otherwise contrary to the public interest

Familiarity

Self-interest

Gifts and hospitality can only be accepted where the value is clearly trivial to all parties (ie to the individual, the firm and the client)

• Identify and assess the significance of any threat to integrity, objectivity and independence;
• Identify and assess the available safeguards to eliminate or reduce the threats; and
• Consider whether an objective, reasonable and informed third party would consider that the objectivity of the firm or covered persons is compromised considering applicable threats and safeguards

Self-interest

Self-review

Management

Advocacy

• Having a separate team from the audit engagement team perform the non-audit service; and
• Completing an independent engagement quality review on the audit engagement.

Internal Audit not allowed, Tax Services on case by case, Corp Fin promoting shares, dealing or underwriting not allowed, Accountancy services where Audit firm takes management role not allowed

Tax services, including those relating to the preparation of tax forms, payroll tax and the calculation of direct, indirect or deferred tax (advocacy and self-review threat).

Services that involve undertaking the role of management (management threat).

Book-keeping and accounts preparation (self-review and management threat).

Payroll services (self-review threat).

Valuation services (self-review threat).

Designing and implementing internal control or risk management procedures (related to the preparation and/or control of financial information or designing and implementing financial information technology systems) (self-review threat and management threat).

Legal services (advocacy threat).

Services related to the entity’s internal audit function (self-review and management threat).

Reporting required by a competent authority or regulator under law (eg reporting on client assets).

Reporting on internal financial controls when required by law or regulation.

Reporting on the iXBRL (Inline eXtensible Business Reporting Language) tagging of financial statements has been developed to communicate information between businesses and other users of financial information, such as regulators, investors, analysts etc. iXBRL can be viewed on standard internet browsers and embeds ‘tags’ that give meaning to the figures and statements in a format that can be understood by a computer. It does not change what is being reported, simply how it is reported.

Reporting on government grants.

Reviews of interim financial information and providing verification of interim profits not otherwise required by law or regulation.