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Guidance for auditor disclosure

The government has taken another step in using regulation and disclosure in
order to head off the perceived threat to auditor independence.

At the request of the DTI, the ICAEW has issued draft guidance Tech 04/06 for
companies and their auditors on how to comply with requirements to disclose
auditor remuneration in accounts.

Regulations in force for accounting periods beginning on or after 1 October
2005 made extensive changes to current practice regarding disclosure of auditor
remuneration. These changes include an increase in the amount of information to
be disclosed about non-audit work carried out by auditors, including extensive
disclosure of non-audit fees in prescribed categories, such as tax, IT, internal
audit, valuation and actuarial services, litigation support, recruitment and
remuneration, and corporate finance. There is also a catch all ‘other services’

Lynn Pearcy, a member of the working party, which drafted the guidance said:
“These disclosures have been introduced to address concerns about threats to
independence when an auditor derives a material amount of income from providing
non-audit services to an audit client.

However, the regulations are difficult to interpret in some areas. We believe
that our guidance will lead to greater consistency in company disclosures.”

Although they may not be complicated to understand they will be tiresome for
finance directors and auditors to comply with and get right.

Legal requirements

The technical release provides guidance on the application of the legal
requirement for companies to disclose in their individual and group accounts the
remuneration receivable by the company’s auditor and the auditor’s associates
for the audit of accounts and other non-audit services. It aims to ensure that
directors and auditors understand the nature and purpose of the requirement and
the basis for deciding into which categories and sub-categories a service
provided by the auditor falls.

The requirement is preserved for all companies to disclose auditors’
remuneration for audit services. In relation to other services, the regulations
require more extensive disclosure than was previously the case. The 1991
regulations required only a single aggregate figure for non-audit services and
this was restricted to amounts for services provided to the company and its UK

The regulations apply to all companies, including small and medium-sized
companies. However, SMEs do not have to make such extensive disclosures as other
companies, and are not caught by the non-audit service disclosure requirements.

In addition to legislative measures for disclosure, auditors are bound by the
Auditing Practices Board’s Ethical Standards. In particular, Ethical Standard 5
Non-audit services provided to audit clients imposes certain
constraints and safeguards in relation to the provision of non-audit services.
Ethical Standard 5 includes a definition of non-audit services, which excludes
services performed that legislation or regulation specify can be performed by
the auditors.

The information must be disclosed in the notes to the accounts. A
cross-reference to information given elsewhere within the annual report would
not be sufficient.

Disclosure is not required of remuneration for work performed for
‘associates’ and ‘joint ventures’, or other significant investments (as defined
in Schedule 5). However, the ICAEW says that additional voluntary disclosure may
be desirable as good practice if such interests are particularly material.

The regulations require disclosure of fees receivable by a company’s auditor
and associates of the company’s auditor from the company’s associated pension
schemes for services supplied to those schemes, whether or not the company’s
auditor or any of its associates is the auditor of the pension scheme.

Associates of a company’s auditor are defined in the regulations. The
definition is designed to capture a range of individuals and organisations with
connections to the auditor. Associates include any entity controlled by the
auditor or under common control, ownership or management, or otherwise
affiliated or associated with the auditor through the use of a common name, or
through the sharing of common professional resources.

For example, if a partner in an audit firm is also a director of a company
that supplies cleaning services to a client of that audit firm, payments for the
supply of those services are required to be disclosed in that client’s accounts,
within ‘all other services’. Each auditor will have to assess the specific
circumstances and apply judgements in deciding whether an associate relationship

Disclosure is not required of remuneration for work performed for
‘associates’ and ‘joint ventures’ (as defined in FRS9 Associates and joint
ventures, or IAS28 Investments in associates and IAS31 Interests in joint
ventures). But the ICAEW’s draft guidance says that additional voluntary
disclosure may be desirable as good practice if such interests are material.

Where, as part of the audit, work is undertaken within the audit firm by
non-audit professionals in relation to reviewing specialist work carried out by
others, such work is regarded as ‘audit-assist’ and, as such, the fee for such
work is included in the audit fee.

Where a single fee has been agreed for the audit and other services, the
auditor needs to provide a reasonable breakdown of the total fee into different

What next?

The guidance statement is not expected to change materially. However, this
technical release is unlikely to be the end of the change, as the 8th Directive
on Statutory Audit of Annual and Consolidated Accounts due to be implemented
across the European Union by 2008 will herald further reforms in this area. The
Regulations have been drawn up in the light of, but differ in detail from, the
disclosure requirements in the proposed 8th Directive. Nor is the disclosure
compatible with US Securities and Exchange Commission requirements.

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