Navigating the EU audit reforms: Non-Audit Services

Written by Hywel Ball, EY’s Managing Partner of Assurance, UK & Ireland

AFTER six-years of debate, consultation and drafting, the EU audit reforms are finally here. The rules apply to companies incorporated in an EU member state with equity or debt listed on an EU regulated market. Banks and insurance firms are also impacted, whether listed or not. But the question many are now asking is whether these reforms are here to stay.

Audit reforms are now enshrined in UK legislation. This also underpins the Financial Reporting Council’s (FRC) implementation of the changes. Brexit, when it comes, is not expected until the autumn of 2018 at the earliest, and no-one knows whether any of these recent changes will be maintained, repealed or replaced.

Even if the latter option is taken, the complexity and interconnectedness of the legislation with other laws, and the government resource required to replace them with something different, means that any changes may be a long time coming. It’s also worth bearing mind that if the UK ends up in the European Economic Area, this would in itself oblige the UK to retain the reforms. So whatever changes you have made or plan to make, in terms of audit and non-audit service provision, they should remain unaltered, at least for the time being.

Procurement strategy

One of the most important plans companies should be putting in place now, if they have not already done so, is a strategy for the procurement of professional services. I say this for three reasons. Firstly, if companies are affected by the reforms in the UK, they will have to switch auditor at least once every 20 years. Companies who appointed an auditor several years ago also face a requirement to switch sooner than others.

Secondly, the wider range of non-audit services which an auditor can no longer provide to its audit clients, means those clients will have to think more strategically about where they can source those non-audit services in the future. Thirdly, the services an auditor can still provide will be restricted. A 70% cap applies to the fees for these services, based on a rolling three-year average group audit fee. So it’s not just a question of how many non-audit services can be used from the auditor. It is equally important to consider how much of each permitted services can be used.

International procurement strategies

It’s also worth bearing in mind that, unlike some of the other EU member states, the UK (or the FRC to be precise) has taken things a step further. Group entities incorporated in the UK have to develop and implement truly international procurement strategies. This is because the UK’s prohibitions on certain non-audit services and the cap apply to audit firms and their networks worldwide.

So these services used by a group are caught up in these restrictions, and whereas other member states make use of the reprieve on caps (i.e., the cap only applies to non-audit services provided for three consecutive years) for UK entities the cap applies regardless. Also, audit committees in the UK which may have pre-approved permitted non-audit services in advance (e.g., in clusters or categories) no longer have that option, unless the individual service relates to a matter which is “clearly trivial”.

Audit committee oversight

If you happen to chair or sit on an audit committee, these developments should be front and centre of your agenda. Audit committees have a duty to oversee the independence of the auditor. They also have a responsibility to develop and communicate a policy on non-audit services, which includes the steps that will be taken to ensure the cap is adhered to by the audit firm and its network. Key to this of course is knowing which non-audit services are permitted and which ones aren’t. The FRC has published the EU’s list of prohibited non-audit services and also introduced the derogation on offer from the EU, allowing certain tax and valuation services to be provided subject to the approval of the audit committee.

It will take time and effort to get familiar with these changes. But the one thing we can be certain of from the off, is that it’s better to plan for professional services procurement now rather than later. A good place to start is to establish an accurate inventory of all the non-audit services your group uses from its auditor and prospective auditors worldwide. Companies should then establish which of these services will be needed in the future, and from whom would the group prefer to receive them.  Answers on a post card,