Over the last few years, the Government has announced a major overhaul of company audit regulations.
The reforms are set to give audit regulators greater powers and a broader mandate, which means more businesses will be affected than ever before. In light of these changes, organisations must familiarise themselves with new practices and processes.
Here’s what you need to know.
What are the upcoming changes?
In 2019, the Government announced that a new Audit, Reporting and Governance Authority (ARGA) would replace the Financial Reporting Council (FRC).
Funded by a levy on industry, the ARGA will be given stricter enforcement powers, such as banning failing auditors from reviewing large companies’ accounts.
The FRC has now progressed into its three-year transition process, which is set to end in 2026. The three-year plan aims to unlock investment to increase regulatory reach and establish new, robust methods for upholding them.
Here’s a summary of key changes:
The upcoming change will introduce the Audit, Reporting and Governance Authority (ARGA). The ARGA will be a statutory entity funded through a compulsory industry levy equipped with enhanced powers to request data without court orders.
Public Interest Entities (PIEs)
Previously, the definition of PIEs, borrowed from the EU, included companies listed on the stock exchange, banks, building societies and insurance firms.
Post-reform, this widens to large unlisted companies with more than 750 employees and exceeding £750 million in annual turnover. Consequently, these entities will undergo more rigorous scrutiny and transparency requirements.
In the current setup, the FRC sometimes lacks the power to act promptly against company directors.
The reforms will empower the regulatory body to probe and penalise directors of sizable enterprises if they neglect duties tied to corporate reporting and audit.
Holding accountants to account
While the FRC can probe and penalise auditors, its actions against other accountants are contingent on voluntary agreements.
Post-reform, the regulatory body will gain statutory powers, allowing it to oversee these professional entities and act against accountants in significant cases tied to corporate reporting.
Currently, companies aren’t obligated to illustrate their approaches to foreseeing and tackling future challenges. The reforms will mandate large PIEs to document their risk identification and mitigation strategies strictly.
They’ll also need to describe measures to prevent and detect fraud. Furthermore, large PIEs must validate the legality of dividend distributions.
Audit market dynamics
The reforms will require some companies to use audits outside the Big Four.
This measure aims to inject more competition into the market, building expertise and increasing the reach of new auditing requirements.
Extending audit scope
Companies currently aren’t mandated to disclose their methodologies for providing non-financial data in their annual statements.
Post-reform, large PIEs will need to clarify their procedures for non-financial data in annual reports, encompassing areas like climate impact, risk assessment, and internal controls.
Overall, the new rules will place a much greater emphasis on Environmental, Social and Governance (ESG) reporting.
Why are the changes being made?
According to the Government, corporate collapses of businesses like Carillion and BHS have “made it clear” that the auditing landscape needs to improve. Introducing a new regulator could reduce the risk of sudden big company collapses.
Lord Callanan, minister for corporate responsibility, also said the upcoming regulatory reforms would “ensure the UK sets a global standard”. He hopes to drive growth and job creation across the country by “restoring confidence” in auditing and corporate reporting.
The upcoming changes to the UK’s auditing regime could also help address the dominance of Big Four audit firms.
To tackle this problem, new measures will increase the role of smaller “challenger” firms in the audit process. This ensures a more diverse system and brings fresh expertise, crucial for a balanced and unbiased audit system.
Additionally, auditing responsibilities will expand beyond publicly listed companies, increasing accountability for directors and top executives.
The three-year plan
The FRC’s three-year plan specifies the following five goals:
- Upholding corporate standards: The FRC’s primary goal is to consistently maintain high standards in all areas related to corporate governance. This encompasses how businesses are managed, their financial reporting procedures, auditing methods, and actuarial work.
- Promoting improvement: The FRC and ARGA won’t just be an enforcement entity but a champion for positive change. The regulatory bodies will actively seek out and promote transparent corporate processes.
- Influencing global standards: The FRC and ARGA will actively shape global business standards. This facilitates the integration of international practices into the UK’s regulatory frameworks – vital in the post-Brexit era.
- Enhancing the audit market: The bodies will foster a diversified audit market by encouraging competition. This includes reducing the influence of the Big Four.
- Becoming a better regulator: Continuous improvement is at the core of the organisation’s ethos. The FRC and ARGA are committed to regular self-assessment, adapting to change, and maintaining transparency in all their actions.
Navigating the upcoming changes
As mentioned, the rules will roll out slowly, and the transition will take at least three more years, with the groundwork for new regulations to be completed by 2026.
However, many firms can expect more reporting obligations and greater attention placed on ESG matters. Directors and executives with significant control will also have increased liabilities, and ARGA will have more powers to investigate without court orders.