1. IESBA Meeting London January 12-14, 2015
EU Audit Legislation
Liesbet Haustermans
Director – Deloitte
IESBA Meeting
London
January 12-14, 2015

2. Agenda EU audit legislation – Overview Date of application
Snapshot key provisions
PIE definition
Mandatory audit firm rotation
Non-audit services: scope, timing and restrictions
Non-EU controlled undertaking of EU PIE
Territorial scope of prohibited NAS
Other key points in legislation
Member State options

3. EU Audit Legislation EP plenary vote and Council adoption – April 2014
Overview
EU Audit Legislation
EP plenary vote and Council adoption – April 2014
EU Audit Legislation:
Regulation N°537/2014 on specific requirements regarding the statutory audit of PIEs
Directive 2014/56/EC amending Directive 2006/43/EC on statutory accounts and consolidated accounts
Publication in Official Journal on 27 May 2014, in 24 languages, each language version has equal binding force. Application date: 17 June 2016
Next steps: Member States to adopt legislation implementing options/secondary legislation completing the regulation/guidance
October 2010 – Green Paper “Audit policy: Lessons from the crisis”
November 2011 – Legislative proposals and impact assessment issued by European Commission
April 2013 – European Parliament: JURI report adopted
October/December 2013 – Trilogue negotiations
December 2013 – Preliminary agreement reached
April 2014 – Approval by the European Parliament and Council

4. Overview
EU Audit Legislation
European Commission FAQs published in June – very high level and September – some helpful points
EC organising Member State implementation workshops

5. Date of Application – Regulation and Directive
* Except where mandatory firm rotation transitional measures apply.
April
2014
27 May
17 June
2016
Adoption of Regulation and Directive
Publication in Official Journal
Entry into
force
+20 Days
Regulation comes into effect * Directive should be
transposed in national law
+2 Years
16 June
2014

6. EU Audit Legislation – Snapshot Key Provisions
Topic
EU Legislation
Mandatory firm rotation (MFR)
10 years maximum + Member State option to extend
to 20 years with tender or
to 24 years with joint audit
Opportunities to extend MFR where there is a tender or joint audit require individual Member States to enact legislation to be effective
Member States may stipulate MFR for a period of less than or equal to 10 years before extensions
Mandatory tendering (MT)
Only for renewals of existing appointments
Art.17.7: key audit partner rotation: 7 years on and 3 years cooling-off. Member States may require that key audit partners responsible for carrying out a statutory audit cease their participation in the statutory audit of the audited entity earlier than seven years from the date of their respective appointment.
The statutory auditor or the audit firm shall establish an appropriate gradual rotation mechanism with regard to the most senior personnel involved in the statutory audit, including at least the persons who are registered as statutory auditors. The gradual rotation mechanism shall be applied in phases on the basis of individuals rather than of the entire engagement team. It shall be proportionate in view of the scale and the complexity of the activity of the statutory auditor or the audit firm.

7. EU Audit Legislation – Snapshot Key Provisions
Topic
EU Legislation
Non-audit services (NAS)
Prohibited list approach
70% cap on non-audit services, applies to audit firm
Cooling-in period for 1 type of service
Audit committee approval required for NAS that is not prohibited
Scope of key measures: Public interest entities (PIEs)
EU companies listed on regulated market
Credit institutions
Insurance undertakings
Entities designated as PIE by a Member State

8. PIE Definition
Four categories of PIEs under the Directive article 2.13:
Entities with transferable securities listed on EU regulated markets (see lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2011:209:0021:0028:EN:PDF, as opposed to all markets in the EU) and governed by the law of an EU Member State
Credit institutions authorized by EU Member States authorities (i.e., banks whose business is to receive deposits or other repayable funds from the public and to grant credit)
Insurance undertakings authorized by EU Member State authorities
Other entities that a Member State may choose to designate as a PIE

9. Mandatory Audit Firm Rotation
Explanation
Audit firm’s appointment for statutory audit of PIE to last for at least one-year term which is renewable
Maximum duration of audit engagement not to exceed 10 years, unless a Member State decides to extend rotation period to:
Maximum 20 years in case of public tendering, or
Maximum 24 years in case of joint audit
Member State has the option to elect a maximum duration of less than 10 years
Competent Member State authority (for instance audit oversight authority and/or securities regulator) may extend auditor appointment on an exceptional basis for a further two-year term
Four year cooling off period after the end of the statutory audit services before audit firm can undertake the audit of the entity again
PIE to perform a transparent audit tendering process with close involvement of audit committee when a tender does occur

10. Mandatory Audit Firm Rotation
Timeline for transitional measures (EC’s current interpretation)
Mandate in place < 11 years at entry into force and at least 10 years reached
Mandate in place  20 years at entry into force
Mandate in place  11 years < 20 years at entry into force
Entry into
force
Effective
Date
10 Years
But may be extended if Member State opts for extension
Adoption of
Regulation
Publication in Official Journal
9 Years
6 Years
20 Days
2 Years
End?
End
End
End
April
2014
27 May
2014
16 June
2014
17 June
2016 *
17 June
2020
17 June
2023
17 June 2024
* EC interpretation (2 September 2014 letter): mandates of less than 11 years that have reached 10 year mark (or less if Member State opts to reduce the 10 year period) by the effective date must end by that date, except if Member State opts to extend. Such mandates that have not yet reached 10 year mark by the effective date must end when the 10 year mark is reached.

11. Non-Audit Services (NAS) – Scope
Audit firms and network members prohibited from providing certain NAS
Such NAS not to be directly or indirectly provided by the audit firm or network members to the audited PIE, its parent undertaking in the EU or its controlled undertakings in the EU
Article 2.7: ‘network’ means the larger structure:
Which is aimed at cooperation and to which a statutory auditor or an audit firm belongs, and
Which is clearly aimed at profit- or cost-sharing or shares common ownership, control or management, common quality-control policies and procedures, a common business strategy, the use of a common brand-name or a significant part of professional resources;”

12. NAS – Scope
No definition in regulation of “parent undertaking” or “controlled undertakings”
EC September FAQs:
“parent undertaking” as defined in the Accounting Directive
“controlled undertaking” as defined in Transparency Directive
FAQ: The term "parent undertaking" is defined in point (9) of Article 2 of the Accounting Directive 2013/43/EU as an undertaking which controls one or more subsidiary undertakings. FAQ: The term "controlled undertaking" is defined in point (f) of Article 2(1) of the Transparency Directive 2004/109/EC as any undertaking (i) in which a natural person or legal entity has a majority of the voting rights; or (ii) of which a natural person or legal entity has the right to appoint or remove a majority of the members of the administrative, management or supervisory body and is at the same time a shareholder in, or member of, the undertaking in question; or (iii) of which a natural person or legal entity is a shareholder or member and alone controls a majority of the shareholders' or members' voting rights, respectively, pursuant to an agreement entered into with other shareholders or members of the undertaking in question; or (iv) over which a natural person or legal entity has the power to exercise, or actually exercises, dominant influence or control.

13. NAS – Timing
During a period covered by audited financial statements and until issuing of the audit report
Prior FY cooling-in period for one category of services: financial information internal control or risk management procedures or financial information technology systems
No transitional measures for NAS prohibitions:
Apply as from 17 June 2016 (EC September 2014 FAQ: will apply to the first financial year starting after the date of application)
Unclear what the impact is for cooling-in period – but general principle of non- retroactivity of EU legislation

14. List of Prohibited Non-Audit Services
EU Regulation (art. 5)
IESBA Code of Ethics (PIEs)
Tax services relating to:
Preparation of tax forms *;
Payroll tax;
Customs duties;
Identification of public subsidies and tax incentives unless support from the statutory auditor or the audit firm in respect of such services is required by law *;
Support regarding tax inspections by tax authorities unless support from the statutory auditor or the audit firm in respect of such inspections is required by law *;
Calculation of direct and indirect tax and deferred tax *;
Provision of tax advice *
Taxation Services that include:
• Tax return preparation: does not generally create a threat to independence if management takes responsibility for the returns including any significant judgments;
• Tax calculations for the purpose of preparing accounting entries (including the calculation of current and deferred tax liabilities or assets): prohibited if they are material to the financial statements on which the firm will express an opinion (except for emergency or unusual situations);
• Tax planning and other tax advisory services: prohibited where the effectiveness of the tax advice depends on a particular accounting treatment or presentation in the financial statements and
(a) The audit team has reasonable doubt as to the appropriateness of the related accounting treatment or presentation under the relevant financial reporting framework; and
(b) The outcome or consequences of the tax advice will have a material effect on the financial statements on which the firm will express an opinion;
• Assistance in the resolution of tax disputes: prohibited where the taxation services involve acting as an advocate for an audit client before a public tribunal or court in the resolution of a tax matter and the amounts involved are material to the financial statements on which the firm will express an opinion
Recital, 9 : It should be possible for Member States to decide to allow the statutory auditors and the audit firms to provide certain tax and valuation services when such services are immaterial or have no direct effect, separately or in the aggregate, on the audited financial statements. Where such services involve aggressive tax planning, they should not be considered as immaterial.

15. List of Prohibited Non-Audit Services
EU Regulation (art. 5)
IESBA Code of Ethics (PIEs)
Services that involve playing any part in the management or decision-making of the audited entity
Assuming a management responsibility
Management responsibilities involve leading and directing an entity, including making significant decisions regarding the acquisition, deployment and control of human, financial, physical and intangible resources.
Whether an activity is a management responsibility depends on the circumstances and requires the exercise of judgment. Examples of activities that would generally be considered as management responsibility and that are thus prohibited include:
Setting policies and strategic direction;
Directing and taking responsibility for the actions of the entity’s employees;
Authorizing transactions;
Deciding which recommendations of the firm or other third parties to implement; and
Taking responsibility for designing, implementing and maintaining internal control.
On the contrary, activities, which are routine and administrative, or involve matters that are insignificant, generally are deemed not to be a management responsibility. Furthermore, providing advice and recommendations to assist management in discharging its responsibilities is not assuming a management responsibility
Recital 8: states that the type of services that might fall within ‘services that involve playing part in the management or decision-making of the audited entity include such things as: “working capital management, providing financial information, business process optimisation, cash management, transfer pricing, creating supply chain efficiency and the like.”

16. List of Prohibited Non-Audit Services
EU Regulation (art. 5)
IESBA Code of Ethics (PIEs)
Bookkeeping and preparing accounting records and financial statements
Payroll services
Preparing Accounting Records and Financial Statements
Comprise accounting and bookkeeping services, such as preparing accounting records or financial statements.
Prohibited: accounting and bookkeeping services, including payroll services, or preparing financial statements on which the firm will express an opinion or financial information which forms the basis of the financial statements

17. List of Prohibited Non-Audit Services
EU Regulation (art. 5)
IESBA Code of Ethics (PIEs)
Designing and implementing internal control
or risk management procedures related to
the preparation and/or control of financial
information or
Designing and implementing financial
information technology systems
IT Systems Services
Services related to information technology (IT) systems include the design or implementation of hardware or software systems. The systems may aggregate source data, form part of the internal control over financial reporting or generate information that affects the accounting records or financial statements, or the systems may be unrelated to the audit client’s accounting
records, the internal control over financial reporting or financial statements.
Prohibited where the services involve the design or implementation of IT systems that:
• Form a significant part of the internal control over financial reporting; or
• Generate information that is significant to the client’s accounting records or financial statements on which the firm will express an opinion

18. List of Prohibited Non-Audit Services
EU Regulation (art. 5)
IESBA Code of Ethics (PIEs)
Valuation services, including valuations
performed in connection with actuarial services or litigation support services
Valuation services
Comprise making assumptions with regard to the future developments, the application of appropriate methodologies and techniques, and the combination of both to compute a certain value, or range of values, for an asset, a liability or for a business as a whole
Prohibited where the valuations would have a material effect, separately or in the aggregate, on the financial statements on which the firm will express an opinion
Litigation Support Services
Litigation support services may include activities such as acting as an expert witness, calculating estimated damages or other amounts that might become receivable or payable as the result of litigation or other legal dispute, and assistance with document management and retrieval.
Prohibited where the service involves estimating damages or other amounts that would have a material effect, separate or in aggregate, on the financial statements on which the firm will express an opinion
Recital, 9 : It should be possible for Member States to decide to allow the statutory auditors and the audit firms to provide certain tax and valuation services when such services are immaterial or have no direct effect, separately or in the aggregate, on the audited financial statements. Where such services involve aggressive tax planning, they should not be considered as immaterial.

19. List of Prohibited Non-Audit Services
EU Regulation (art. 5)
IESBA Code of Ethics (PIEs)
Legal services, with respect to:
• The provision of general counsel;
• Negotiating on behalf of the audited entity;
and
• Acting in an advocacy role in the resolution of litigation
Legal services are defined as any services for which the person providing the services must either be admitted to practice law before the courts of the jurisdiction in which such services are to be provided or have the required legal training to practice law. Such legal services may include, depending on the jurisdiction, a wide and diversified range of areas including both corporate and commercial services to clients, such as contract support, litigation, mergers and acquisition, legal advice, support and assistance to clients’ internal legal departments
The position of General Counsel is generally a senior management position with broad responsibility for the legal affairs of a company
Prohibited where:
• Acting in an advocacy role for an audit client in resolving a dispute or litigation when the amounts involved are material to the financial statements on which the firm will express an opinion;
• Appointing a partner or an employee of the firm as General Counsel for legal affairs of the audit client

20. List of Prohibited Non-Audit Services
EU Regulation (art. 5)
IESBA Code of Ethics (PIEs)
Services related to the audited entity’s internal audit function
Internal Audit Services
Internal audit activities may include:
Monitoring of internal control – reviewing controls, monitoring their operation and recommending improvements thereto;
Examination of financial and operating information – reviewing the means used to identify, measure, classify and report financial and operating information, and specific inquiry into individual items including detailed testing of transactions, balances and procedures;
Review of the economy, efficiency and effectiveness of operating activities including nonfinancial activities of an entity; and
Review of compliance with laws, regulations and other external requirements, and with management policies and directives and other internal requirements
Prohibited where internal audit services relate to:
A significant part of the internal controls over financial reporting;
Financial accounting systems generate information that is, separately or in the aggregate, significant to the client’s accounting records or financial statements on which the firm will express an opinion; or
Amounts or disclosures are, separately or in the aggregate, material to the financial statements on which the firm will express an opinion

21. List of Prohibited Non-Audit Services
EU Regulation (art. 5)
IESBA Code of Ethics (PIEs)
Services linked to the financing, capital structure and allocation, and investment strategy of the audited entity, except providing assurance services in relation to the financial statements, such as the issuing of comfort letters in connection with
prospectuses issued by the audited entity
Promoting, dealing in, or underwriting shares in the audited entity
Corporate Finance Services
Include assisting an audit client in developing corporate strategies, identifying possible targets for the audit client to acquire, advising on disposal transactions, assisting finance raising transactions, or providing structuring advice.
Prohibited where corporate finance advice depends on a particular accounting treatment or presentation in the financial statements and:
• The audit team has reasonable doubt as to the appropriateness of the related accounting treatment or presentation under the relevant financial reporting framework; and
• The outcome or consequences of the corporate finance advice will have a material effect on the financial statements on which the firm will express an opinion
Prohibited where services involve promoting, dealing in, or underwriting an audit client’s Shares
Recital, 8 : Services linked to the financing, capital structure and allocation, and investment strategy of the audited entity should be prohibited except the provision of services such as due diligence services, issuing comfort letters in connection with prospectuses issued by the audited entity and other assurance services.
FAQ: The Regulation allows the provision of assurance services in relation to the financial statements, such as the issuing of comfort letters in connection with prospectuses issued by the audited entity. In the same line of reasoning, due diligence is also one of the allowed non-audit services and can be provided to audit clients

22. List of Prohibited Non-Audit Services
EU Regulation (art. 5)
IESBA Code of Ethics (PIEs)
Human resources services, with respect to:
Management in a position to exert significant influence over the preparation of the accounting records or financial statements which are the subject of the statutory audit, where such services involve:
Searching for or seeking out candidates for such positions; or
Undertaking reference checks of candidates for such positions;
Structuring the organisation design; and
Cost control
Recruiting Services
Prohibited where the statutory auditor or audit firm would assume management responsibilities, including acting as a negotiator on the client’s behalf, and where the hiring decisions would not be left to the client
Prohibited with respect to a director or officer of the entity or senior management in a position to exert significant influence over the preparation of the client’s accounting records or the financial statements on which the firm will express an opinion:
Searching for or seeking out candidates for such positions; and
Undertaking reference checks of prospective candidates for such positions

23. Restrictions on non-audit services
NAS: Restrictions
Restrictions on non-audit services
Other NAS permitted to be provided to the audited PIE subject to audit committee approval (and application general principles of independence)
Member States may prohibit additional non-audit services and establish stricter rules for NAS which are not prohibited
Member States may adopt legislation allowing valuation services and certain tax services (= preparation tax forms; identification subsidies and tax incentives; support re tax inspections; calculation of direct and indirect tax and deferred tax and tax advice) providing that these services have no direct effect, or have an immaterial effect, on the audited financial statements
Fees for permissible NAS provided by the statutory auditor or the audit firm to the audited entity, its parent undertaking or its controlled undertakings for three consecutive financial years not to exceed 70% of the average fees paid in the last three consecutive financial years for statutory audits of the PIE and, where applicable, its parent or controlled undertakings, and of the group consolidated financial statements. Services required by EU or national legislation are excluded. Competent authorities may exempt audit firm from cap “on an exceptional basis” for maximum of two financial years
Cooling-in period for the design and implementation of internal control or risk management procedures related to the preparation and/or control of financial information or financial information technology systems applies during the fiscal year prior to the period covered by the audited financial statements
Estimation of the effect on the FS is comprehensively explained in the additional report to the AC in art 11.
Recital 9 : A statutory auditor or an audit firm should be able to provide non-audit services which are not prohibited under this Regulation, if the provision of those services has been approved in advance by the audit committee and if the statutory auditor or the audit firm has satisfied itself that provision of those services does not pose a threat to the independence of the statutory auditor or the audit firm that cannot be reduced to an acceptable level by the application of safeguards
EC FAQ on Cap: The calculation of the cap is based on the fees generated for non-audit services during the previous consecutive three years, provided that the audited entity was a PIE during those two three years as well. There are two basic requirements for this provision to be applicable: both audit services and non-audit services must have been provided by the same statutory auditor/audit firm to a given PIE for at least three consecutive years. If the statutory auditor/audit firm stopped providing audit services during any of those three years, the provision will not be applicable, as in that case those services would no longer be provided to the “audited entity”.
Article 4 refers to the provision of non-audit services, by the statutory auditor or the audit firm, to the audited entity its parent undertaking or its controlled undertakings. The geographical location of these entities, that are part of the group, is irrelevant. Every fee generated within the group must be taken into account, as that is the only way to ensure the statutory auditor’s or audit firm’s independence towards the audited entity and its group. The cap itself applies to a given statutory auditor/audit firm only. The fees generated by the services provided by members of the network are not relevant for the purposes of the calculation of the cap.
All calculations for the cap shall be done at group level – i.e. they need to take into account not only the audited entity but also, where applicable, its parent undertaking, its controlled undertakings and the consolidated financial statements of that group of undertakings.

24. Non-EU Controlled Undertaking of EU PIE
Special regime for services by network member
Threats & safeguards approach, assessment by the statutory auditor
But:
 deemed to impact independence, no mitigation possible:
Services that involve playing any part in the management or decision-making process of the audited entity
Bookkeeping and preparing accounting records and financial statements
Designing and implementing internal control or risk management procedures related to the preparation and/or control of financial information or financial information technology systems
 all other services on NAS list: threats & safeguards approach

25. NAS: Territorial Scope of Prohibited NAS
PIE – EU Member State A
EC September FAQ: Law of Member State where subsidiary is located, applies
NAS special regime
Sub* - EU Member State B
Sub* - Outside EU
* Non PIE

26. Other Key Points in Legislation
Audit committee (AC) and reporting
PIEs must have AC composed of non-executive members
Responsibility for auditor selection procedure – at least 2 choices and duly justified preference
More comprehensive report from auditor directly to the audit committee (incl. results of audit, declaration of independence, materiality, judgment explanations about events that may cast significant doubt on the going concern, significant deficiencies in the internal financial control system/accounting system, significant matters involving actual or suspected non compliance with laws and regulations or articles of association)
Recital, 18 : It is important that the role of the audit committee in the selection of a new statutory auditor or audit firm be reinforced, in the interest of a more informed decision of the general meeting of shareholders or members of the audited entity. Hence, when making a proposal to the general meeting, the administrative or supervisory body should explain whether it follows the preference of the audit committee and, if not, why. The recommendation of the audit committee should include at least two possible choices for the audit engagement and a duly justified preference for one of them, so that a real choice can be made. In order to provide a fair and proper justification in its recommendation, the audit committee should use the results of a mandatory selection procedure organised by the audited entity, under the responsibility of the audit committee. In such selection procedure, the audited entity should not restrict statutory auditors or audit firms with a low market share from presenting proposals for the audit engagement. Tender documents should contain transparent and non-discriminatory selection criteria to be used for the evaluation of proposals.

27. Other Key Points in Legislation
Audit procedures and reporting
Compliance with international audit standards
All statutory audits to have statement on any material uncertainty related to events or conditions that may cast significant doubt on ability to continue as a going concern
For PIEs only - description of the most significant assessed risks of material misstatement; statement that no prohibited NAS were provided; number of years in place
Recital, 18 : It is important that the role of the audit committee in the selection of a new statutory auditor or audit firm be reinforced, in the interest of a more informed decision of the general meeting of shareholders or members of the audited entity. Hence, when making a proposal to the general meeting, the administrative or supervisory body should explain whether it follows the preference of the audit committee and, if not, why. The recommendation of the audit committee should include at least two possible choices for the audit engagement and a duly justified preference for one of them, so that a real choice can be made. In order to provide a fair and proper justification in its recommendation, the audit committee should use the results of a mandatory selection procedure organised by the audited entity, under the responsibility of the audit committee. In such selection procedure, the audited entity should not restrict statutory auditors or audit firms with a low market share from presenting proposals for the audit engagement. Tender documents should contain transparent and non-discriminatory selection criteria to be used for the evaluation of proposals.

28. Other Key Points in Legislation
Cooperation between EU Member State auditor oversight authorities - New Committee of European Auditing Oversight Bodies (CEAOB); composed of one member from each Member State and one member appointed by the European Securities and Markets Authority (ESMA)
Dialogue between regulators and auditors with shared responsibility for effective dialogue
Annual meeting between European Systemic Risk Board (ESRB) and auditors of global systemically important institutions - at least annual
European passport for the audit profession - key audit partner carrying out the audit to be duly approved as a statutory auditor in that other Member State
Prohibition of clauses limiting choice of auditor
Penalties – dissuasive penalties to apply to auditors and audit firms if statutory audits under EU law are not carried out in conformity with the Directive and Regulation (by member states)
Audit market – monitoring and reporting by competent authorities and competition authorities every 3 years, ultimately EC report to Council, ECB, ESRB and EP where appropriate
Recital, 18 : It is important that the role of the audit committee in the selection of a new statutory auditor or audit firm be reinforced, in the interest of a more informed decision of the general meeting of shareholders or members of the audited entity. Hence, when making a proposal to the general meeting, the administrative or supervisory body should explain whether it follows the preference of the audit committee and, if not, why. The recommendation of the audit committee should include at least two possible choices for the audit engagement and a duly justified preference for one of them, so that a real choice can be made. In order to provide a fair and proper justification in its recommendation, the audit committee should use the results of a mandatory selection procedure organised by the audited entity, under the responsibility of the audit committee. In such selection procedure, the audited entity should not restrict statutory auditors or audit firms with a low market share from presenting proposals for the audit engagement. Tender documents should contain transparent and non-discriminatory selection criteria to be used for the evaluation of proposals.

29. Member State options
The Regulation and Directive contain over 50 Member State options, including:
Expanding the PIE list
Reducing the length of the initial engagement period to less than 10 years
Extending the initial engagement period by a further 10 or 14 years (tender or joint audit)
Adding to the list of prohibited NAS
Establishing stricter rules setting out the conditions under which permitted NAS may be provided
Allowing the exception for valuation and certain tax services
Stricter rules on the fee cap …
Exercising these options will lead to a patchwork of different regulation throughout the EU
Will be costly and complex for PIEs and the statutory auditor and audit firms to manage
Expectation that countries which have in the past adopted stricter rules may continue to do so.