(a) We believe that this evidence would repay
careful analysis and assessment in the context of the Government's
response to the events of Enron. We therefore commend it to the
relevant bodies (paragraph 3).
(b) Although we recognise that we have rather
different arrangements from the United States for the oversight
of the accounting profession and for financial regulation, we
believe that it would be dangerously complacent to assume this.
What has happened in the United States has shaken confidence worldwide
in matters such as the independence of auditors from company management.
We agree with the Government that it is important to restore this
confidence (paragraph 5).
(c) As our evidence demonstrates, a lot of
work by Government, regulatory bodies, professional bodies and
others, is currently in progress. This report therefore necessarily
has something of an interim character to it. We shall continue
to keep developments under review and will return to this matter
in due course (paragraph 7).
The Government welcomes the Committee's report. The
Government agrees with the Committee about the need to avoid complacency
and acknowledges the interim nature of the Committee's report.
As the Committee will be aware, the interim report of the Co-ordinating
Group on Audit and Accounting issues (CGAA) was published on 24
July. The Government will consider carefully the Committee's conclusions
and recommendations as part of the further work referred to in
the CGAA report. The Government has asked the CGAA to deliver
a final report around the end of the year.
(d) We note the array of arguments against
auditor rotation. There would undoubtedly be additional costs
and some potential risks. Nevertheless, the absence of any kind
of rotation requirement leaves a perceptionand almost certainly
the realityof an undesirable cosiness between some firms
and their auditors. This poses even greater risks. We accept the
need for auditor or audit firm rotation in principle, and we want
the Government to produce proposals to implement it (paragraph
(e) We note that re-tendering is a regular
feature of many public sector appointments, and we have received
no evidence that this operates to the detriment of the quality
of work carried out. We consider that there is a good case for
requiring audit committees to look explicitly at rotation of audit
firms every five years. We believe that the audit committee should
be obliged to make a statement to shareholders on those occasions
when they decide to retain the existing auditor after conducting
such a five yearly review.
(f) We recommend that the Ethics Standards
Board considers urgently, in the light of the evidence we have
received, whether the existing provisions are adequate. We believe
that there is a good case for requiring rotation of the audit
partner/manager on an audit every five years, rather than the
present seven years. We also believe that there should be a time
limit preventing auditors from being employed by a firm which
they have audited. This should be at least one year (paragraph
The Government accepts the principle that there should
be rotation at least in respect of auditor partners. UK professional
guidance currently requires the audit engagement partner for a
listed company to be rotated at least every 7 years. The EU Recommendation
on statutory auditor independence, published in May 2002, recommends
as a minimum rotation of the key audit partners within 7 years
of appointment to the engagement team. The Institute of Chartered
Accountants in England and Wales (ICAEW) is changing its rules
to comply with this aspect of the EU Recommendation. The CGAA
has proposed that the maximum period before rotation of the audit
engagement partner should be reduced from 7 years to 5. The Government
agrees with this proposal and is discussing its implementation
with the Consultative Committee of Accountancy Bodies (CCAB).
On audit firm rotation, the CGAA concluded in its
interim report that the case for mandatory firm rotation as a
solution to the problems of auditor independence has not yet been
made. The CGAA has recommended that the evidence and the arguments
for and against mandatory firm rotation should be examined further
and that the case for mandatory re-tendering should be further
considered at the same time. The Government has asked the CGAA
to report on this further examination in its final report.
(g) Confidence in the independence of the auditor
is central to the integrity of the audit. Independence is clearly
open to question when auditors also perform a significant consultancy
roleespecially when the audit contract may have served
as a loss-leader to acquire this more lucrative business. We therefore
believe that there is a strong case for disclosure in relation
to non-audit work. We believe that the Audit Committee should
be required to assess the extent of non-audit work and should
be required to notify shareholders of any potential conflicts
of auditor interest. We recommend that the audit committees of
listed companies be required to publish details of audit and non-audit
contracts, giving a detailed justification of the arrangements
to shareholders (paragraph 17).
(h) We believe that, as a general principle,
auditors should not be permitted to audit work done by themselves.
We recommend that certain non-audit-related services should not
be provided by a company's auditors and we want the Government
to produce proposals to enforce this, including a strict definition
of such services (paragraph 19).
The Government agrees that auditors must not only
be independent, they must be seen to be independent. A key recommendation
of the CGAA's interim report is that there need to be tougher
mechanisms to underpin auditor independence.
The Government agrees with the general principle
set out both by the Committee and the CGAA that auditors should
not audit their own work. The Government also agrees with the
principle put forward in the CGAA interim report that auditors
should not perform management functions or make management decisions.
These are among the principles that underpin the EU Recommendation
on Auditor Independence. They also already form part of the practice
regulations of the bodies recognised for the supervision of auditors
under the Companies Act 1989. The CGAA has recommended that further
work should be taken forward to look at how these principles are
best delivered in practice. The Government agrees with this recommendation,
which could lead to a further tightening of the work that auditors
should not carry out for their audit clients. This will be covered
in the CGAA's final report.
The Government agrees with the Committee's recommendation,
also proposed by the CGAA, that there should be a greater role
for audit committees in assessing and approving the purchase of
non-audit services from the auditor. The Financial Reporting Council
(FRC) has set up a group to develop the existing guidance in the
Combined Code for audit committees.
This group is liaising closely with Derek Higgs as
part of his review of the role and effectiveness of non-executive
directors, as well as taking into account the proposals to strengthen
the role and membership of audit committees set out in the CGAA
The Government agrees that there should be greater
disclosure of information about the nature and value of non-audit
services provided to audit clients. The Government will be consulting
on changes to regulations under the Companies Act to improve the
disclosure by companies of audit and non-audit services provided
by their auditors.
(i) We believe that an Accounting Standard
on revenue recognition and to control aggressive earnings management
should be introduced, on a national or an international basis,
at an early date (paragraph 22).
(j) We were disappointed at the leisurely approach
of the Accounting Standards Board. We believe that there are issues
for the Board that require action before 2005 (paragraph 27).
(k) Sir David expressed concern that the current
method of funding of the IASB could lead to indirect pressure,
through withdrawal of funding. He cited an example of a threatened
withdrawal of cash when American industrialists expressed disagreements
with IASB thinking on accounting for share options and other areas
where there are, or were likely to be, differences of view between
the Board and American interests. He considered that "ideally
the best way of funding us...would be to put a levy on registrations
around the world". We strongly support Sir David Tweedie's
robust stance in resisting such pressures (paragraph 28).
(l) We are generally opposed to the use of
share options as a significant source of remuneration in public
companies. We shall wish to take evidence on this later. We agree
with Sir David Tweedie that an International Accounting Standard
that properly reflects the value of such options should be agreed.
We believe that share options used for executive and other remuneration
and payment should be prudently accounted for as future negative
net income on a company's profit and loss account (paragraph 31).
(m) We support the concept of international
standards, a view apparently shared by a large majority of institutional
investors worldwide. We believe that Sir David Tweedie's evidence
indicates that there may be real difficulties in securing their
acceptance in some major areas, although we are heartened by Sir
David's view that all the core international standards should
be in place by 2005. Pressures to agree a comprehensive range
of Standards by 2005 must not dilute standards applicable in the
United Kingdom, particularly in relation to a 'true and fair'
view (paragraph 32).
The Government, like the Committee, supports the
concept of international standards and the need to ensure that
there is a robust set of standards in place by 2005. The Government
agrees with the CGAA that progress is needed in a number of key
areas of accounting as soon as possible. It very much welcomes
the positive engagement of the Accounting Standards Board (ASB)
with the International Accounting Standards Board (IASB) to improve
existing standards and develop new ones as quickly as possible,
whilst continuing to consult on proposals as required by due process.
It also notes that the ASB has a heavy workload in actively pursuing
a convergence agenda to align UK standards with international
ones as they are agreed and that it has issued a large number
of exposure drafts of new or revised standards for public comment.
Regulation of the Accountancy Profession
(n) The regulatory structure of the accountancy
profession raises questions about rigour and independence. These
arise as a result of the regulatory process being funded by the
industry itself, and, in particular, in the way these funds are
collected. We welcome the efforts being made by the Accountancy
Foundation to improve the industry's regulatory regime. We recommend
that the Government give this issue urgent examination, and that
it considers the introduction of industry funding arrangements
similar to those which operate in the case of the Financial Services
Authority (paragraph 36).
(o) We believe, though, that the existing regulatory
framework of the accountancy profession is cumbersome and excessively
complicated. We consider that there is a strong case for a single,
independent, regulator, which is not only independent but seen
to be independent (paragraph 37).
The Government has announced, in response to the
interim report of the CGAA, an immediate review of the way the
accountancy profession is regulated, including the role of the
Accountancy Foundation and its related bodies. The terms of reference
of this review
were published on 9 September.
(p) In the context of our current inquiry,
a number of witnesses have proposed a much more proactive role
for the non-executive directors in relation to the auditing function.
Sir John Bourn suggested that non-executive directors should report
on a range of matters relating to the audit. He added "the
external auditors should know that this discussion with the non-executive
directors is an important part of his work, and that his ability
to satisfy the non-executive directors is crucial in the determination
of whether he stays the external auditor." We support this
idea. We also agree with Lord Sharman that the role and responsibilities
of non-executive directors might benefit from clarification (paragraph
(q) We believe that there is a good case for
an audit committee composed of non-executive directors, rather
than the board as a whole, to be responsible, in the case of quoted
companies, for selecting the firm of auditors to be put to the
shareholders for appointment, and for fixing the auditors' remuneration
(r) We expect the Higgs Review to produce proposals
which cover these important matters. We recognise that there have
been serious abuses of the practice of non-executive directors
undertaking paid work with the same company. We expect the Higgs
Review to address this issue positively (paragraph 41).
The Government agrees that it is important for companies
to have strong, effective non-executive directors. That is why
the Government asked Derek Higgs to review the role and effectiveness
of non-executive directors. The Government looks forward to receiving
his report. The CGAA has proposed in its interim reportand
the Government agreesthat the role of audit committees
must be strengthened and enhanced. As noted above, the FRC is
taking forward work to develop the Combined Code guidance on audit
(s) We welcome the fact that the Government
has now responded to the Company Law Review, but remain concerned
that there is no definite Parliamentary timetable for its implementation.
If it becomes clear that action is needed in the light of Enron
affair, we would not be happy for this to be delayed until comprehensive
legislation can be introduced. We consider that the Government
should give higher priority to this matter, not least because
of the threat identified by the Chairman of the FSA and arising
from the current proposals for the EU Prospectus Directive, to
the use of the Listing Particulars as a means of imposing new
requirements on listed companies. We recommend that, as a minimum,
the Government gives a commitment to publish draft legislation
in full in the course of the next Session of Parliament (paragraph
The Government welcomes the Committee's support to
modernising the framework of company law. This is a task of great
scale and complexity. The Government is consulting on proposals
for a draft Companies Bill as they are developed and intends to
bring forward legislation as soon as practicable. However, the
precise timing will depend on the Parliamentary timetable.
(t) We recommend that the Government refer
the United Kingdom operations of the 'Big Four' to the Competition
Commission. We also recommend that it give careful consideration
to whether it could assist in reducing concentration by placing
more of its work with suitably qualified and experienced firms
outside the 'Big Four' (paragraph 48).
In its interim report, the CGAA recommended that
the Department of Trade and Industry and HM Treasury consider
with the Office of Fair Trading whether there are any competition
implications of the high concentration in the market for audit
and accountancy services and whether any of the other proposals
in its report have competition implications. The Government has
accepted this recommendation and discussions are on-going. The
Committee's views will be considered as part of those discussions.
The allocation of Government work for accounting
and other assignments is made on the basis of open and fair competition
in line with Government procurement policy, based on value for
money, and EC rules. The general principles are set out in Chapter
22 of Government Accounting. Specific advice on the appointment
of accountancy firms to audit and other assignments in the public
sector is set out in Dear Accounting Officer (DAO) letter DAO(GEN)13/99,
a copy of which has been submitted to the Committee. This makes
clear that, in principle, appointments to audit and other accountancy
assignments are no different from any other public procurement.
(u) It is clear that the EU expects to be a
serious player in the ongoing debate about the role and regulation
of auditors, and the development of corporate governance standards
within the EU. We urge the Government to ensure that United Kingdom
interests, and regulatory standards, are fully protected in developing
common European approaches. In this context, we were concerned
by Sir Howard Davies' comments that the proposed Prospectus Directive
could undermine the present role played by the Listing Rules in
enforcing corporate governance requirements on listed companies.
Other groups have also expressed concern. We recommend that the
Treasury seek to ensure that the United Kingdom's standards of
financial disclosure and corporate governance are fully safeguarded
during negotiations on the Directive (paragraph 53).
The Government takes full account of the importance
of the international dimension in these areas and of the need
to protect and safeguard UK interests.
(v) We intend to follow the progress of the
proposals in the United States for a Public Company Accounting
Oversight Board and to consider whether a similar body would be
appropriate in the United Kingdom, possibly with reciprocal powers
The Government notes the Committee's conclusion.
The Government is also monitoring closely developments in the
(w) We share concerns about the problems of 'revolving
doors', whereby personnel involved in public sector contracts
move from the public sector to the profession, and vice versa.
We recommend a coolingoff period between employment in accountancy
or consulting firms or contracts with the Government (paragraph
The Treasury will discuss this recommendation with
the Cabinet Office and the Office of the Civil Service Commissioners,
as part of the further work being taken forward under the auspices
of the Coordinating Group on Audit and Accounting issues
GOVERNMENT REVIEW OF THE REGULATORY REGIME OF THE
TERMS OF REFERENCE
To review the current arrangements for the regulation
of the accountancy and audit professions; to consider whether
revised arrangements and structures are necessary to provide assurance
to the public that these are effective; and, if so, to recommend
what form they should take.
In particular, the review should look at:
- the regulatory functions that are necessary in
the public interest, and how they should be carried out, including
- the balance between professional self regulation
and independent regulation in carrying out these functions; and
the extent to which these should be on a statutory basis
- the case for taking a different approach to the
regulation of the accountancy profession in general and to the
regulation of auditors in particular
- the funding arrangements and in particular whether
these are consistent with the concept of independent regulation
- the responsibilities and accountabilities of
the various bodies, including the process of making appointments
In considering these issues, the review should also
have regard to:
- the principles of good regulation established
by the Better Regulation Task Force
- international developments, especially in the
United States and the European Union
- the requirements of the 8th EU Company
Law Directive and the Companies Act 1989 on the regulation of
- the relationship between these arrangements and
the work of the Financial Reporting Council (FRC) and its subsidiary
and the responsibilities of the Financial Services Authority in
relation to listed companies.
- the other work being carried out following the
interim report by the Coordinating Group on Accounting and Audit,
and the Secretary of State's Statement to Parliament of 24 July
The review should report by January 2003.
1 Page 9. Back
The Government's White Paper "Modernising Company Law (Cm
5553-I) published in July 2002 makes proposals for building on
the existing framework of the FRC to enable company reporting
requirements and enforcement to be kept up to date. Whilst this
Review must have regard also to the White Paper proposals, it
is not the intention that it will revisit those proposals. Back