House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Parliamentary Secretary to the Treasurer, the Hon David Bradbury MP)

Auditor independence functions

Outline of chapter

3.1 Part 1 of Schedule 2 to the Bill contains amendments to the FRC's auditor independence functions in Part 12 of the ASIC Act.

3.2 The Bill streamlines the auditor independence work of ASIC and the FRC by removing the existing auditor independence function from the FRC and, in its place, giving the FRC a role of providing the Minister and the professional accounting bodies with strategic policy advice and reports in relation to the quality of audits conducted by Australian auditors.

3.3 The FRC's revised functions include giving the Minister and the professional accounting bodies strategic policy advice and reports in relation to the systems and processes used by: Australian auditors to comply with relevant legislative and professional requirements; and professional accounting bodies for planning and performing quality assurance reviews of audit work undertaken by such auditors.

3.4 In conjunction with these changes:

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the FRC will be relieved of the requirement to prepare an annual report on the performance of its auditor independence functions. Particulars of any strategic policy advice and reports provided by the FRC as part of its revised functions will be included in the annual report to the Minister on the operations of the FRC; and

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the FRC's information gathering powers will be limited to obtaining information from the professional accounting bodies.

Context of amendments

3.5 A 2001 report by Professor Ian Ramsay proposing new auditor independence requirements for Australia also recommended the establishment of an independent supervisory board to monitor implementation of the new regime, compliance with it, and important international developments in the area of auditor independence.

3.6 Subsequently, as part of the CLERP 9 reforms introduced in 2004, the FRC was given specific functions concerning quality assurance reviews in relation to auditor independence. Under subsection 225(2B) of the ASIC Act, the FRC's functions include monitoring and assessing the nature and overall adequacy of:

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the systems and processes used by Australian auditors to ensure compliance with the auditor independence requirements; and

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the systems and processes used by professional accounting bodies for planning and performing quality assurance reviews of audit work undertaken by Australian auditors, to the extent those reviews relate to auditor independence requirements.

3.7 In addition, the FRC has responsibility for giving the Minister and the professional accounting bodies reports and advice about these matters.

3.8 Since 2004, ASIC has developed an audit inspection program that covers all aspects of audit quality (including auditor independence) and, as a consequence, the FRC has been able to perform its auditor independence function by relying primarily on information provided by ASIC. The information provided to the FRC by ASIC is also supplemented by material provided by other bodies, such as the professional accounting bodies and audit firms. In these circumstances, it might be argued that the FRC duplicates the work already being undertaken by others.

3.9 Action is therefore needed to rationalise the FRC's auditor independence function to eliminate duplication with ASIC's audit inspection program.

Summary of new law

3.10 The new law replaces the FRC's existing auditor independence function with a new function of giving strategic policy advice and reports to the Minister and professional accounting bodies concerning the quality of audits conducted by Australian auditors. Matters on which advice and reports can be given by the FRC include:

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the systems and processes used by Australian auditors to comply with: the requirements of the Corporations Act concerning the conduct of audits; the auditing standards; and codes of professional conduct; and

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the systems and processes used by professional accounting bodies for planning and performing quality assurance reviews of audit work undertaken by Australian auditors.

3.11 In conjunction with these changes, the FRC's information gathering powers will be limited to obtaining material from the professional accounting bodies. The FRC's annual reporting obligations also will be amended.

Comparison of key features of new law and current law

Detailed explanation of new law

3.12 The Bill repeals the FRC's current function of monitoring the effectiveness of auditor independence requirements in Australia and the associated function of giving the Minister reports and advice about these requirements. As part of this change, the Bill inserts new auditor quality functions in place of the current auditor independence functions. [ Schedule 2, Part 1, items 2 to 5, subsections 225(1 ) and ( 2B )]

3.13 Under proposed subsection 225(2B), the FRC's new audit quality functions include giving strategic policy advice and reports to the Minister and professional accounting bodies in relation to the quality of audits conducted by Australian auditors. 'Australian auditor' is defined in section 5 of the ASIC Act to mean an individual auditor, an audit firm or an audit company that is conducting, or has conducted, audits undertaken for the purposes of the Corporations Act and includes a registered company auditor who is participating in, or has participated in, an audit of that kind. It is the policy intention that the audit quality functions detailed in subsections 225(2B) and (2C) are to apply only in respect of Corporations Act audits.

3.14 Under proposed subsection 225(2C) the specific matters in respect of which the FRC can give strategic policy advice and reports to the Minister and professional accounting bodies are:

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the systems and processes used by:

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Australian auditors to comply with: the provisions of the Corporations Act dealing with conduct of audits; the auditing standards; and applicable codes of professional conduct; and

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professional accounting bodies for planning and performing quality assurance reviews of audit work undertaken by Australian auditors (and associated follow-up action by the bodies and auditors who have been reviewed);

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the investigation and disciplinary procedures of professional accounting bodies as those procedures apply to Australian auditors;

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the adequacy of Australian requirements in light of international developments in relation to audit quality; and

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the teaching of professional and business ethics by, or on behalf of, professional accounting bodies to the extent to which the teaching of those subjects relates to auditor quality.

3.15 Subsection 225(2C) provides that this list of matters is not intended to limit the matters in respect of which strategic policy advice and reports can be provided under proposed subsection 225(2B).

3.16 A significant difference between the FRC's current auditor independence functions and the proposed auditor quality functions will be the nature of the FRC's role. At present, the FRC's auditor independence function may be characterised as being of an operational or quasi-operational nature, supported by the FRC's information gathering powers. In contrast, giving strategic policy advice and reports in respect of the auditor quality functions is not intended to be of an operational nature. It is envisaged that the FRC will only be required to take action when it observes, or has brought to its attention, matters in respect of which advice or reports should be provided to the Minister or the professional accounting bodies.

3.17 Proposed subsection 225(2D), which provides that reports to the Minister and the professional accounting bodies under proposed subsections 225(2B) and (2C) are not legislative instruments, has been included in the Bill to assist readers, as the reports referred to in those subsections are not legislative instruments within the meaning of the Legislative Instruments Act 2003 . [ Schedule 2, Part 1, item 5 ]

Application and transitional provisions

3.18 The Bill provides that section 235BA, which requires the FRC to prepare in respect of each year a report on the performance of its auditor independence function, will continue to apply to the year in which the FRC's functions are changed. As a result, the FRC will be required to prepare a final report on the performance of its auditor independence functions covering the period commencing on 1 July 2011 and ending on the day on which the amendments to the FRC's functions commence. The Bill also provides that the final report is to be included in the FRC's annual report to the Minister for 2011-12, rather than being provided as a separate report. [ Schedule 2, Part 4, item 18, section 293 ]

Consequential amendments

3.19 In conjunction with the replacement of the FRC's auditor independence function, consequential amendments are being made to sections 5, 225A and 235BA of the ASIC Act.

3.20 The definition of 'auditor independence requirements' in subsection 5(1) will no longer be required and is being repealed. [ Schedule 2, Part 1, item 1 ]

3.21 Section 225A, which contains the FRC's information gathering powers, will be amended to omit the FRC's power to obtain information from auditors, audit firms and audit companies. This amendment will eliminate one area of overlap between the functions of the FRC and ASIC, as ASIC has equivalent information gathering powers. However, the FRC will retain its ability to gather information from the professional accounting bodies in respect of matters on which it is providing advice or reports to the Minister or the professional accounting bodies. [ Schedule 2, Part 1, items 6 to 13 ]

3.22 The requirement for the FRC to prepare a report on the performance of the auditor independence functions is being repealed as it will not be needed with the change to the FRC's functions. Information about any reports and advice the FRC provides to the Minister and the professional accounting bodies about the performance of its auditor quality functions will be included in the annual report prepared by the FRC pursuant to section 235B of the ASIC Act. [ Schedule 2, Part 1, item 14, section 235BA ]