1. Vienna 14 March 2006 Andrew J. Popham Vice-President of FEE Partner, PricewaterhouseCoopers LLP The New Directive on Statutory Audit in the EU

2. Vienna 14 March 2006 Content 1.Who can be an auditor? 2.Changes in audit appointment 3.Ethics and Independence 4.Auditing Standards 5.Specific Rules for Public Interest Entities

3. Vienna 14 March 2006 1.Who can provide statutory audit services?  Statutory auditor can be  a natural person  a firm of auditors  In all cases, even when the appointed auditor is an incorporated firm, the audit report must be signed by a qualified individual.

4. Vienna 14 March 2006 1. Who can provide statutory audit services?  Conditions to approve a natural person to carry out statutory audits:  After having attained university entrance level,  To have:  completed a course of theoretical instruction,  undergone practical training (3 yrs) and  passed an examination of professional competence of university final examination level organised or recognised by the State.

5. Vienna 14 March 2006 1. Who can provide statutory audit services?  The Directive provides details on:  the content of theoretical knowledge and  practical training of auditors  EU Member States must recognise qualifications of other Member States.  But an aptitude test limited to the knowledge of local laws and regulations may be applied

6. Vienna 14 March 2006 2. Changes in audit appointment  Appointment and dismissal of auditors is regulated by EU company law  The auditor is appointed by the general meeting of shareholders  In public interest entities, the audit committee recommends the auditor to be appointed  Other systems are allowed provided independence of the auditor is preserved (for example where tribunals appoint the auditor provisionally when there is dispute between shareholders)

7. Vienna 14 March 2006 2. Changes in audit appointment  Dismissal only possible if there are proper grounds  Difference of opinion on accounting treatments or audit procedures cannot be proper grounds  Public oversight authorities must be informed of dismissal with adequate explanation  Resignation also possible when the auditor has proper reasons  Public oversight authorities must be informed of resignation with adequate explanation

8. Vienna 14 March 2006 3. Professional ethics  There must be principles of professional ethics in all Member States  These should cover at least the auditor’s  public interest function,  integrity,  objectivity  professional competence and due care  The European Commission has authority to legislate if appropriate, and then should consider the IFAC Code of Ethics.

9. Vienna 14 March 2006 3. Independence and objectivity  Independence is seen as a proxy for objectivity  The model is principles-based not rules-based  Based on analysis of threats and safeguards  Model put forward by FEE in 1998 and also used in the EU Recommendation (2002) in the IFAC Code of Ethics

10. Vienna 14 March 2006  If independence is affected by threats, the auditor must apply safeguards to mitigate them  If even after applying safeguards independence is compromised, the auditor shall step down.  Sources of threats  Self review  Self interest  Advocacy  Familiarity or trust  Intimidation  Response to significant threats must be documented 3. Independence and objectivity

11. Vienna 14 March 2006 3. Independence and objectivity  An auditor shall not carry out an audit if there is:  any direct or indirect financial, business, employment or other relationship between the statutory auditor, the audit firm or the network and the audited entity  of which an objective, reasonable and informed third party would conclude that the statutory auditor's or audit firm's independence is compromised.  Applies to the auditors carrying out the audit and those in a position to exert influence over the statutory audit.  In public interest entities, there is a prohibition on self review or self interest

12. Vienna 14 March 2006 4. Auditing Standards  EU Members States shall require auditors to carry out audits in accordance with international auditing standards adopted by the Commission  Adopted standards must :  Be generally accepted internationally with proper due process  Contribute to high quality auditing  Be conducive to the European public good  Adopted international auditing standards to be published in full in each of the official languages of the Community

13. Vienna 14 March 2006 4. Auditing Standards Behind the formal wording, objectives are :  To endorse a coherent set of standards. International Standards on Auditing (ISA) issued by IAASB are the only candidates  Based on the report of a technical committee which assesses the three conditions  Initial adoption of a body of standards is a target  Year after year, changes will be regularly endorsed  Auditing standards will be part of the EU system of law.

14. Vienna 14 March 2006 4. Auditing Standards Implementation at National Level:  Member States may impose additional audit procedures but only if these follow from specific national legal scope requirements  In exceptional cases where there is a serious legal problem, a carve out of ISA requirements could also be possible.  Two year transitional relief for Member State requirements that would be removed by ISA adoption

15. Vienna 14 March 2006 4. Auditing Standards For group audits, the group auditor:  Bears full responsibility for the consolidated accounts  Must review the work of subsidiary auditors and document that review  For third country auditors where there is no cooperation agreement between inspection bodies, take the steps necessary to make the subsidiary audit documentation available to the home country public oversight body (subject to legal reliefs)

16. Vienna 14 March 2006 5. Public Interest Entities  A fundamental principle of the Directive is that there cannot be substantial differences between audits of small or large companies.  However, public interest justifies additional rules on:  Transparency of audit networks  Audit committees  Internal control  Auditor independence  Frequency of quality reviews

17. Vienna 14 March 2006 5. Public Interest Entities  The audit committee is a sub-committee of the (supervisory) Board. The Directive allows some flexibility for national governance structures.  The main tasks of the audit commitee is to monitor  the financial reporting process and  the effectiveness of the internal control, internal audit where applicable, and risk management system  The audit committee is also the forum for the auditor to discuss audit matters with non-executive directors

18. Vienna 14 March 2006 5. Public Interest Entities  The discussions between the auditor and the audit committee should cover:  The statutory audit process  Material weaknesses in internal control in relation to the financial reporting process  Audit independence issues including provision of non audit services to the audited entity  The audit committee is also involved in the selection of the statutory auditor

19. Vienna 14 March 2006 5. Public Interest Entities  Specific rules on auditor independence cover:  Confirmation of independence in writing by the auditor  Disclosure of additional services to the audit committee and discussion with it of any threats and safeguards  Rotation of key audit partners within a maximum period of seven years  Prohibition for auditors from taking up key management positions in the audited entity until after two years’ quarantine

20. Vienna 14 March 2006 Andrew J. Popham Vice-President of FEE Partner, PricewaterhouseCoopers LLP The New Directive on Statutory Audit in the EU