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Parliamentary Joint Committee on Corporations and Financial Services
16/02/2018
Oversight of the Australian Securities and Investments Commission and the Takeovers Panel

EDGE, Mr William (Bill), Chair, Financial Reporting Council

NIVEN, Mr Doug, Senior Executive Leader, Financial Reporting and Audit, Australian Securities and Investments Commission

PEACH, Ms Kris, Chair, Australian Accounting Standards Board

POWELL, Mr Stephen, Secretariat, Financial Reporting Council

PRICE, Mr John, Commissioner, Australian Securities and Investments Commission

SIMNETT, Professor Roger, Chair, Australian Auditing and Assurance Standards Board

[10:00]

CHAIR: I now reopen the hearing. Welcome. I now invite a representative of each body to make a short opening statement. At the conclusion of your remarks, I will invite members of the committee to put questions. We will start with ASIC.

Mr Price : Thank you to the committee for the opportunity to appear today. I'm here with ASIC senior executive Doug Niven. At the end of June 2017, ASIC issued a public report on its most recent findings on audit quality. We reviewed 93 audit files on a targeted basis during the 18 months to 31 December 2016 to form the basis of our report. In our view, in 25 per cent of the 390 key audit areas that we reviewed across the 93 audit files at firms of different sizes, auditors did not obtain reasonable assurance that the financial report as a whole was free from material misstatement. While we reviewed these 93 files, there are about 2,300 listed entities in Australia and more than 20,000 listed and unlisted entities that are required to have audits under the Corporations Act. In other words, the sample size for our audit review work is small and is targeted at areas where we believe there might be problems. For these reasons, we think great care is needed in generalising the outcomes of our report. The result of our work does, however, suggest that further attention is required to improve audit quality. Further, the level of adverse findings from our limited sample and the nature of our concerns from our findings are very consistent with those of international regulators with responsibility for audit oversight. This also suggests that ongoing attention to this area is warranted.

ASIC continues to work to improve audit quality through education, inspection and surveillances, and enforcement actions. Improving audit quality is a matter needing collective action by various parties in the financial reporting chain in order to be successful. We continue to work closely with the largest six audit firms to suggest improvements to their own internal action plans on audit quality. We're also working with other parties, including the Financial Reporting Council, audit and ethics standards setters, auditing committees, accounting standards setters, international regulators and accounting bodies.

ASIC also continues to address significant cases of deficiencies in audit work through enforcement activity. We have obtained enforcement outcomes against at least 20 registered company auditors over the last six years and against 33 self-managed superannuation fund auditors. In August 2016, we also cancelled the registration of a further 133 self-managed super fund auditors who did not lodge annual statements with ASIC after repeated reminders.

Finally, and very importantly, I should note that, even where ASIC believes that audit quality is not at the required standard on a particular matter, it does not follow that the financial reports being audited are materially wrong.

Separate from our audit work, ASIC reviews about 300 sets of financial reports of listed entities and public interest entities every year. We consistently require only about four percent of those financial reports to be restated. I hope that can assist with the committee's consideration of audit quality and I hand over now to my colleagues.

Mr Edge : Thank you for your invitation to appear before the parliamentary joint committee and to present evidence. I have been invited to attend this committee to provide information on audit quality in Australia in my capacity as chair of the Financial Reporting Council. The FRC is the peak body responsible for overseeing the effectiveness of the financial reporting framework in Australia and has a statutory responsibility to provide strategic advice to the minister and professional accounting bodies on audit quality in Australia. As part of my evidence today, I would like to provide the committee with an overview of the arrangements for regulating audit quality in Australia, how the FRC discharges its responsibilities for audit quality and the FRC's view on audit quality.

To assist the evidence I will provide the committee, I will briefly cover the auditing environment in Australia. Audit processes are overseen by the corporate regulator, ASIC, which conducts inspections of audit firms and registers individuals as registered company auditors. The professional accounting bodies—Chartered Accountants Australia and New Zealand, CPA Australia and IPA—enforce professional standards and conduct their own quality reviews of members; the auditing and assurance standards board, sets audit standards. The FRC, which I chair, oversees the Auditing and Assurance Standards Board and audit quality but does not have the power to direct or veto particular audit standards; and the government develops policy in the field.

Australia's auditor regulatory regime is premised on the cooperation between ASIC and the professional accounting bodies—CA ANZ, CPA Australia and IPA. It is important to note that the FRC does not directly review audit files to determine audit quality in Australia. This is a role that is the responsibility of ASIC and the accounting bodies. How does the FSC perform its role on audit quality? The FRC undertakes its role in relation to audit quality by: engaging with and considering information provided by ASIC and the accounting bodies on the quality of audits conducted in Australia; engaging with accounting firms on what initiatives they are undertaking to ensure audits undertaken by their firm are of an appropriate standard; engaging with the Auditing and Assurance Standards Board on what changes to standards are necessary to address audit quality issues; and monitoring international developments in audit quality and assessing their potential impact on and usefulness for Australian practitioners and the financial reporting system.

The FRC uses the information gathered through the processes outlined above to provide its advice to the government on audit quality in Australia. This is formally provided to the government through the FRC's annual report. In addition, the FRC meets directly with the minister to discuss these issues on a periodic basis. In the FRC 2017 annual report, the FRC noted the lack of improvement found by the ASIC audit inspection review program and indicated the FRC will continue to work with key bodies to understand the root causes of the review results and remedial measures. At this time, the FRC did not propose any changes to the minister but believes improvements in the inspection results are required. In particular, the FRC has started specific bilateral consultations with the accounting professional bodies, the big four audit firms and other key industry bodies, to discuss their views on the ASIC report and audit quality in Australia. The FRC is currently analysing the feedback provided by these stakeholders with a view to finalising an action plan of initiatives involving collaboration between many stakeholders to help address the issues. The FRC acknowledges that considerable work has already been undertaken by audit firms and professional accounting bodies in this area. The FRC is working to ensure that any further steps proposed by the FRC builds on and complements the work already underway. I will be pleased to assist the committee regarding inquiries about the FRC's audit related functions.

Ms Peach : I appreciate the opportunity to participate in today's session. I've been invited here in my capacity as the chair of the Australian Accounting Standards Board so I thought it might be useful just to briefly set out our role and responsibility for financial reporting. The AASB develops issues and maintains financial reporting standards for all sectors of the Australian economy. This covers the for-profit sector such as the corporates but also includes the not-for-profit sector, which is the public sector and also charities.

Our objective is for financial reports to meet user needs, particularly for those who can't command information for themselves. We want to do that by ensuring that the financial statements provide relevant information to make sound investment but also accountability decisions. It's important to note that the AASB accounting standards do not specify which entities need to publicly lodge financial reports. Other regulators determine which entities need to lodge. Furthermore, other regulators are also responsible for enforcement of the standards we issue—such as ASIC here today.

Our role is to work with other regulators and help maintain confidence in the Australian economy. The way we propose to do that is to maintain an appropriate balance between user needs and the costs for preparers of financial statements. You might be wondering why we're here today. In developing accounting standards we consider, amongst many other factors, the auditability of those requirements. The standards are, in general, what we call principle based requirements, which means that in many areas they require the exercise of judgement to apply the requirements to particular transactions and circumstances of an entity. That means that differences of opinion between preparers, auditors and enforcement regulators can validly arise over the application of the standards. Where there are widespread interpretation issues that have been formally identified, the International Accounting Standards Board, from which we derive out Australian accounting standards, and the AASB have processes to resolve those interpretation issues.

We collaborate with the Auditing Standards Board, ASIC and other enforcement regulators to understand how our standards are being applied in practice, including those judgements required by the preparers, auditors and regulators. So we are aware that some standards that require significant judgements in their application appear more frequently in regulator reports on audit quality. However, to date, we have not been advised that the audit quality issue arise from ineffective accountable standards. Nevertheless, some of these accounting standards are about to be replaced. For example, we will have a new revenue standard very shortly. There are key aspects that are also subject to improvement projects or specific post-implementation reviews. For example, impairment testing of goodwill is currently subject to a review. This work is carried out in conjunction with the International Accounting Standards Board, where that's relevant. I welcome any comments or questions you may have.

CHAIR: Thank you. Now we'll hear from the Auditing and Assurance Standards Board.

Prof. Simnett : I welcome the opportunity to contribute to today's session. By way of background, the AUASB is responsible for developing, issuing and maintain auditing and assurance standards and supporting guidance that meets user needs and enhances audit and assurance consistency and quality in Australia.

The quality of financial reports is critical to achieve shareholder confidence in the Australian economy. While the primary responsibility for the quality of financial statements rests with the entity's management, auditors provide independent assurance about that quality. Quality standards and guidance facilitates clear expectations and aids consistency of practice amongst assurance practitioners, which, in turn, enables the objective of the independent audit to provide confidence in the quality of financial statements by issuing appropriate opinions supported by evidence and judgement.

As addressed by the FRC chair, the FRC's mandate includes providing strategic advice on the quality of audits conducted by Australian auditors. Under the FRC's strategic direction, the AUASB develops Australian auditing standards that have a clear public-interest focus, using the international auditing and assurance standards as our base, while appropriate modifications are made to account for legislative requirements or any other reasons that will result in significant improvement to audit quality in Australia. In addition, in order to facilitate audit quality, the AUASB develops principles based domestic auditing and assurance standards and guidance when there are perceived or actual gaps in the international standards, where Australian users require industry-specific guidance, or where there are no international standards. To make it clear, we set the auditing standards and ASIC is responsible for monitoring and enforcing the implementation of those standards.

In accordance with this public interest mandate setting high-quality standards, public input to the development of AUASB standards and guidance is paramount and is obtained through extensive consultation with stakeholders. Additionally, the composition of our board is representative of our stakeholders and incorporates diversity across expertise.

The AUASB is working closely with the FRC on their action plan of initiatives in relation to audit quality in Australia. Additionally, the AUASB has several strategic projects underway that specifically address audit quality matters. One of those projects explores ASIC's inspection findings. An important component of this project is to collaborate with ASIC to gain a better understanding of any implementation issues such as the clarity, or ambiguity, of existing requirements so as to inform the AUASB's standard-setting activities. I welcome any questions you may have.

CHAIR: Thank you. I might start with you, Mr Price. At what point does ASIC become involved in an investigation—it might be in your report, but say it for the public who are listening—and what's your interface with the other boards during that process of reviewing, say, one of the major audit companies who might not have followed the auditing standards?

Mr Price : What I'll do is give a bit of a background of our audit surveillance program, which is a rolling program, and I'll ask my colleague Mr Niven to supplement that as he sees fit. As I said, we conduct a rolling audit surveillance program in relation to audit firms of all sizes, and our audit surveillance reports come out on an 18-month cycle. In terms of selection of the matters that we look at, we have a risk targeting framework that we use to choose which audit files we want to look at. Let me be very clear: this is not a random selection process. We are deliberately targeting the audits of companies that we think may require a high level of judgement, or may entail a great deal of complexity.

Senator WHISH-WILSON: How do you pick those audit files?

Mr Price : We use a risk targeting framework. Mr Niven, did you want to comment at a higher level? I don't want to go into too much detail about our risk targeting system.

Mr Niven : The risk targeting is, to some extent, also tied in with our targeting of financial reports in our financial reporting surveillance program, where we review financial reports of listed public interest entities, as John mentioned earlier. We select 300 of those a year, and we're looking at roughly 65 audit files per year. The targeting, to a large extent, is a subset of the 300 that we select. They're focused on particular risk characteristics, which we publish in media releases ahead of each reporting season. It ties in largely with the areas where we have findings both in financial reports and audit inspections: asset values, impairment of non-financial assets, revenue recognition—I won't go through the whole list. We identify criteria that help us to identify audits that are most likely to be at risk in those areas—and there are other criteria; I'm trying to simplify it. Once we've selected a course, we may look at a financial report cover to cover, not just those specific areas. But we also do target, within the audit files, specific key audit areas that we look at, which may be the values of the assets, revenue and so forth.

Senator WHISH-WILSON: Do you go to the companies directly and ask them for the data, or do you take it from auditors like the big four accounting firms? How do you do that?

Mr Niven : We use a number of data sources. The public financial reports that are lodged with us are the underlying source of a lot of the information we're using for the targeting. It's not in a structured data format. We do use external providers for some of that data, which ultimately comes from the financial reports lodged with us. But we do use other information sources, including our own intelligence from other activities—auditors who we may have some concerns about from other things we have seen. I could go on about the data sources—there are a range of data sources—but primarily starting with the financial reports.

Mr VAN MANEN: What Senator Whish-Wilson is getting at is, if you identify an issue, who do you actually go back to to verify the data? I understand that you start with the financial reports, and that is perfectly understandable, but then do you go back to the audit firm? Do you go back through the audit firm back to the company's original source accounts that inform the audit firm? How deep do you dig to verify where your concerns actually lie and what's been the—

Mr Niven : As was mentioned earlier, the primary responsibility for the financial reports of course lies with the company, it's directors—management. So, if our concern is, as a part of our financial surveillance, we've identified a possible concern with the financial report, we are concerned about asset value because of particular indicators—it might be profitability or net assets compared to market capitalisation; there is a whole range of measures—we would go to the company in the first instance. We write to the directors and make inquiries of them. We will obtain relevant documents and we work through the process with the company. The quality of the audit may also be an aspect that we look at, because, if there's concern with the financial report, well, we're also concerned about the quality of the work that the auditors did. But that's a separate matter. We're not going through the auditors to deal with financial reporting matters as such.

Mr VAN MANEN: So if you identify an issue, you are going directly back to the directors of the company, effectively with a: 'Please explain. We've identified—'

Mr Price : If it's in relation to the financial reporting, that's generally right. Perhaps there is a bit of background that I should have provided right at the start. So, if I ask myself the fundamental question, 'Why do we care about this as a regulator?', the answer is, 'We care about this as a regulator because we want to make sure that financial reports of companies in Australia are seen as robust.' Why is that important? Because it affects the cost of capital. We are a net importer of capital, so people need to have confidence in our financial reports, otherwise that cost of capital goes up and everything gets more expensive. So what we are really focused on is making sure that financial reports in Australia are robust and people feel they can have confidence in those. That's the first limb.

There's a very important checking mechanism for financial reports. It's not just ASIC who checks it. There's an audit process. There's a checking process. The audit process is not meant to pick up every mistake. But you're meant to do enough work so that, if there's a material problem in the accounts, the likelihood is they will pick it up. So we focus on the financial reports to see if that's right. Then, if they look wrong, that leads us to the question: what happened to the checking process? Why is it us that has picked this up and not necessarily the audit firm? That's the way we think about the issue as a whole. I hope that sort of helps a bit explain how they interact.

Mr VAN MANEN: Yes, but, in the first instance, are you still going back to the company to 'Please explain', and then you follow up with the auditor?

Mr Price : Usually, if there's a financial reporting issue, that would be right. But, in some instances, even if there's a problem with the audit, the financials might be fine, if you see what I mean. We might say, 'someone did not do the level of checking we would have expected', but it has no impact on the financial reports at all. It didn't matter in that case. In that case, I think we'd be going straight to the auditor, not to the company.

Mr Niven : Perhaps I should add: there will be some instances where we pick up potential problems not just from the financial report. When we are reviewing the audit file, it is possible that we will identify some concern with the financial report. In those instances we still go back to the company, because they are the ones responsible for the financial report and the information in the market.

Mr VAN MANEN: Thanks, Chair.

Senator WHISH-WILSON: Can I just ask, in terms of your risk matrix, you said you didn't want to go into any detail, and I can understand why. But would it be fair to say high-risk targeting is based on previous or repeat offenders, referrals from other regulators—ASX, ATO? How do you actually—can you give us a broad idea of how you target these companies?

Mr Niven : Yes. We take into account a broad range of data sources, which can include some of the things that you've mentioned. So, yes, it could be—perhaps I should explain it this way: we review 300 financial reports proactively, and that's targeted and can take into account that information. In addition, we may look at financial reports on what we call a 'reactive basis', where we have received complaints or other specific intelligence and we're making inquiries based on that. So, yes, we can use those data sources partly in our targeting for the proactive spells but also specifically to follow up a matter with a company because of a complaint or referral from another regulator or something like that.

Senator WHISH-WILSON: The reason I ask the question, Chair, was I just wanted to know, you mentioned surveillance, Mr Price, but do you have any capability at all to do your own surveillance on audit quality? Do you have the ability to do forensic accounting, for example, with it in-house or would you have to outsource that?

Mr Price : We do do the audit quality reviews in-house. And in fact recently we've taken some steps to retain the services of a retired ex-partner of one of the big firms to assist us in our work. But we have quite an experienced team that goes through and does that analysis.

CHAIR: We've seen some high-profile failures of companies attributed to lack of auditing standards—Harris Scarfe, Dick Smith and I know there was a big one in Western Australia; I am just trying to remember the name of it—where the auditors did say, 'We didn't do the job properly'. What sort of penalties do they get and at what point—when there are massive failures to the investors and the stockmarket and the credibility of Australia, as you said, to draw capital—do we withdraw the licenses of these guys?

Mr Price : In terms of the regulatory penalties that attach to failure of audit, I might actually take that on notice. I will note that the government is currently conducting an enforcement review of ASIC, and one area that we raised as an area worthy of consideration was looking at some of the penalties around these types of things. But there is a broader point that I think is important for the committee to understand, and that is, in terms of the liability of audit firms more generally, there is liability capping for these firms. They are part of a professional standards scheme. In addition, following the failure of Enron and Wellcom, an idea called 'proportionate liability' was introduced. Certainly there can be civil law suits against audit firms, and there are, and they are often settled for substantial sums of money. But there is a sort of legal framework around proportionate liability and liability capping that is important to bear in mind when you think about the overall regulatory framework.

CHAIR: You will get back to us on notice. But it is very hard to understand how these auditing firms can charge so much money for major corporations and stuff up so greatly, and get to the point where the firms fall over, and it's all past the post then. The horses have bolted and all of the shareholders' investments are gone because of lack of auditing standards. And then they continue to operate.

Mr Price : I think it is important to remember that there will be circumstances where people within the management of companies have taken deliberate steps to withhold information or hide things from auditors. And, while audit isn't meant to be a checking mechanism, it is not meant to pick up every fraud either. That is a really important point. So I think the point you raise is a good one. We are concerned where auditors are not doing their jobs, but it also has to be remembered that in some cases that can be as a result of deliberate wrongdoing on the part of company management.

Senator WHISH-WILSON: What was it in the case with Enron? Was their off-balance-sheet debt? Was it just lack of actual accounting standards that let that go on for so long? I know there were big prison sentences attached to it.

Mr Price : Yes. I will probably let some of the other members answer. Enron is a little while ago. Doug, can you—

Mr Niven : It is a little while ago and there were various facets to it. One thing I would mention is that Enron was reporting under US accounting standards, which are different from the standards in Australia. One of the concerns at the time was—and I won't recall all of the precise facts—there were very precise rules as to when you had to include things on balance sheet in the US, rather than principles, and Chris referred to principles before. The difficulty sometimes with rules is that they're very bright-line and easy to enforce but it is possible to structure things to work around those rules; whereas if you have principles based standards—and our standards are relatively principles based, perhaps more principles based than to the US standards—you deal with some of those issues because you have to follow the underlying principles to get to the right financial reporting result. There was much more to Enron, of course, than that, but I'm hoping that's what you were asking about.

Senator WHISH-WILSON: That's fine. I was just interested in whether they changed the accounting standards after Enron. That's probably what I should have asked.

Ms Peach : Yes, there were changes made to the financial instrument standard as a result of some of those issues that came out of the global financial crisis.

Mr Niven : Also the standard around when you consolidate other entities and include their underlying information in your financial report.

Ms BUTLER: I'm looking through the AASB and AUASB annual report. I noticed that, at around the same time as ASIC was publishing its report in respect of auditing standards last year, where I think it's quite concerning to see that we've gone from under one in five to one in four cases where the auditors did not obtain reasonable assurance that the financial report as a whole was free of material misstatements—you'd have to say that's not a cheerful report for the Australian auditing profession—AASB was undertaking a major restructure, as was the AUASB, with eight redundancies in AASB and two redundancies in AUASB, at a cost $1,172,799 for the former and a bit over 400 grand for the latter. Do you think that there are any issues around confidence that might arise from the fact that you are having these major restructures at the same time as there might be some questions in respect of the profession? That question is for everyone on the panel.

Mr Price : I might lead off. At least in my mind, the most common issues we tend to see, or that we saw in the 93 files we inspected, didn't really relate to any ambiguity around the standards.

Ms BUTLER: It was conduct rather than standards?

Mr Price : For example, with audit it's very important that there's an appropriate documentation trail—lack of documentation, lack of professional scepticism, work around the audit of asset values or around impairment wasn't satisfactory or work around the audit of revenue wasn't satisfactory. Those sorts of issues that we found in those 93 files really didn't go so much to any problem with the standard. It was more around compliance with the standard. So I think it's important to bear that in mind. That's not to say that the standards are absolutely perfect. There are some cases. We're in regular communication with the standard setters where there are things at the edges that we think could be improved. But really, at the core of this, we think there is an overall need to improve audit quality. We know that the largest audit firms share our desire to do that. Really, we just need to go ahead and get it done. That's what we really need to do.

Ms BUTLER: Perhaps I could ask the boards what motivated the restructure.

Ms Peach : The reason for the restructure was to enable the boards to more appropriately focus exactly on what you're asking for, which is the development of the standards themselves. It had been a number before there had been any sort of restructure of the boards, so it was basically trying to get the focus back on the end users and making sure that we were focused completely on stakeholders but also making sure that we were able to get the international standards reflected appropriately in Australia. One of the key things when you're a domestic standard setter is that you need to be able to influence internationally. So, again, part of the restructure was to make sure the focus was on having the right technical people and that they were really focused on making sure we influence internationally to get the right standards in the first place.

Prof. Simnett : I'll support that statement. I came in after the restructure was done—I've only taken on the chair in the last 10 months. It was done to improve the efficiency and effectiveness. There were no problems with the work program or anything else that was observed. There was oversight of the process by FRC in those particular regards to make sure it was done, but we're always looking at continuous improvement in the process, and sometimes continuous improvement requires us to make some decisions to ensure that we can do it. But there is no evidence that there were any problems arising from the restructure.

Ms BUTLER: Will there be a net decrease in the number of positions? In other words, will you replace all 10?

Ms Peach : There has been a reduction in the number of staff, but there has been also a change to what I would call a new model to make sure that when we are developing standards we have the ability to draw in resources that are specialist resources for particular areas. Rather than having a very, very large core group with general expertise across a number of standards, we now try to make sure that we are drawing in the right expertise at the right time. Most of the reduction in staff has been in the administrative area rather than in the technical areas.

Ms BUTLER: On this question of getting in expertise, is that why consultancy costs doubled compared with the previous year and administration costs doubled compared with the previous year?

Ms Peach : Yes. That has been part of the process of trying to get the right people into the right roles and making sure that we are focused on the technical output and programs that are important.

Ms BUTLER: I noticed that the balance sheet had some quite surprising and significant variances between budget and actuals—this is on page 83 of your annual report. The variance for net assets for the AASB was just over $1 million—$1,040,000 approximately—and the variance for the AUASB was about $350,000. That's a significant variance when the original budget was $2.5 million and $759,000 respectively. Does the restructure explain—does that go to why the balance sheet is so different? It was a bit of a surprise to see it. I don't know if you have it in front of you.

Ms Peach : No. I'm sorry, we'll have to take that question on notice.

Ms BUTLER: There's also in your annual report an indication of an updated MOU between the AASB and AUASB which is said to have caused additional costs for both entities. Could you tell us a bit about what that updated MOU is about.

Ms Peach : The updated MOU is just in connection with internal costs between the AASB and the AUASB. Overall, in terms of the net cost to the government, those things eliminate out. The purpose of the restructure was for the two entities to work more closely together and reduce the overall burden, rather than just looking at the individual aspects.

Ms BUTLER: It says in your annual report that costs have increased to the AASB due to the updated MOU and that the AASB has recovered part of that as a management charged to the AUASB. Is that the zeroing out that you're talking about? It's a net balance.

Ms Peach : Yes. It's an internal allocation of the total costs.

Ms BUTLER: You moved premises in 2016-17 as well, is that right?

Ms Peach : We moved premises in 2015-16.

Ms BUTLER: Before your time, then.

Prof. Simnett : It was before my time, but the overall aim is to try and reduce the administrative costs down to just our minimum required level to support the technical, to try and put more resources into the technical side. It is really working closer together. Several the overall am and objective is to work closer together. We will incur a little bit of pain financially in putting that process together, but we still have to realise the gains of those things going forward.

Ms BUTLER: What's been the industry reaction

Prof. Simnett : Very positive. You will see now, if you have a look at our website, that our strategies are much more aligned. There has been from our stakeholders a very positive response to the fact that we are working closer together and we are seen to be working closer together.

Ms BUTLER: Does anyone else have a view on this restructure and its efficacy?

Mr Edge : I would like to say something which will actually sweep in three questions, starting from yours, Chair, about audit firms charging fees and getting off. The FRC oversees the two boards and audit quality. Just recently, as I said in my opening address, we have liaised with the three accounting bodies, the big four firms and about 11 other stakeholders. To answer your initial question: there is confidence in our standards as being world's best practice, and the reorganisation was seen as an improvement to bring the two standard-setting worlds together. That was all very positively seen in the marketplace.

I'll come back to your question and what happened after Enron. Enron caused Arthur Andersen to go out of business as an organisation, so the auditor did not get off. In Australia—and I know John's taken this question on notice—you can lose your registration as a company auditor if you are found to be part of an error, a fault. That's a career for an individual, not for a firm—that individual's career might finish. Also, there are court cases where large settlements are paid which cost the accounting firm a large amount of money as well. I just wanted to cover that off, to say that it wasn't getting through. As an FRC, it's my responsibility to make sure that our standards are well regarded. Certainly I believe, on behalf of the FRC, they are world's best practice and the reorganisation is leading to efficiencies and effectiveness.

Ms BUTLER: I have an unrelated question if there is time.

CHAIR: Has anyone got a related question?

Senator KETTER: I've got an unrelated question as well.

CHAIR: Okay. Fire away.

Ms BUTLER: I just wanted to ask you to tell us a bit about the work you did with the Insurance Contracts Act. That was in your report, wasn't it?

Ms Peach : The new insurance standards?

Ms BUTLER: Yes, the new insurance standards. I think your report says that you have world-leading standards in relation to insurance accounting and that you're pleased that some of the other nations are starting to keep up.

Ms Peach : Yes. We just like to reiterate that statement. Australia has had high-quality insurance standards in place for at least 10 or 15 years. This last year was the year that the International Accounting Standards Board issued a standard on insurance that actually effectively catches up with where Australia has been. It introduces fair value notions and it provides much better evidence for users about what the financial position and results of an insurance company are.

Ms BUTLER: Do you think that the insurance industry has done a good job of translating the information that they have to create to comply with your standards to plain English for consumers? Do you think it's assisting consumers, ultimately?

Ms Peach : That's a difficult question to answer. The feedback that the IASB received as part of its process of developing the new insurance standard would indicate that most of the disclosures that were already being provided by Australian entities were in fact appropriate disclosures. There will always, of course, be new things every time a new standard comes out. In terms of plain English, I think one of the things that all of the bodies at this table have been encouraging entities to do is what we call a streamlining exercise, to make sure the financial statements are actually providing the right information and not cluttering up with information that is not particularly helpful. The IASB also has a project, which we will be picking up and contributing to as well, which is designed to promote better, more effective communication with users.

CHAIR: Just on that: you're happy with the disclosures and the transparency for payments from insurance companies back to, say, superannuation funds and what they do with that?

Ms Peach : I'm not sure that that one is actually in my remit.

CHAIR: It's part of their accounting.

Ms Peach : I'm not quite sure of the background of what's—

CHAIR: The reason I'm asking is that we are running a life insurance inquiry, and one of the many things we've heard is that there isn't enough transparency and clarity with regard to payments that are made between super funds and insurance companies. If you're saying the accounting practices of insurance companies are up to standard, that's not what we are hearing from certain witnesses that we've heard. I'm just asking if you're happy with those standards.

Ms Peach : I would say that I have not heard that information directly, but I'm certainly very happy to take that on board and have a closer look at that to see if there's anything else that needs to be done.

CHAIR: Our report will be out soon, so you can have a look at that.

Senator KETTER: Going back to the auditing issue, the elephant in the room in the auditing world is the potential for long-term relationships to exist between auditors and the reporting entity and the extent to which that impacts on some of these areas that ASIC is going to be looking at into the future. Mr Entsch, I'll ask a question of you. You provide advice to government and provide broad oversight for setting accounting standards. Is this an issue that exercises your mind and what can you tell us about how you are addressing it?

Mr Edge : That has been an issue raised for many, many years. The fact that the auditor is paid by the client, the auditor can develop a relationship with a client and the auditor may in fact have a long-term relationship with the client is not a new issue. It is part of the way the legal framework is established. Over the last 20 years there has been a lot of increased regulation, particularly around independence of the auditor and limiting relationships and investments and so forth. As well as that, probably the strongest one is the rotation of the audit partner, which the legislation requires every five years, roughly. The only part missing in Australia that could be contemplated is the rotation of audit firms. That is happening almost by default, because companies re-tender relatively regularly, so you do see a turnover of audit firms relatively regularly. I don't have statistics to support that, but the re-tendering process is meeting that last remit about whether there should be something around rotation of auditors.

Senator KETTER: So audit firms are now re-tendering—

Mr Edge : It has been a process for many years, but it's increasing because globally there have been changes in regulations internationally which help trigger it along.

Senator KETTER: Is Australia lagging behind in this?

Mr Edge : No, I don't believe so. As I've said, the only area that you could raise in that is the rotation of audit firms. We do not have that, but I believe the re-tendering process and the open market process for the auditor is meeting that outcome.

Senator KETTER: Do you have a comment about that, Mr Price?

Mr Price : I agree with Mr Edge's comments. In respect of the actual market impact of audit firm rotation, many of the jurisdictions that have introduced this have only done so recently. I think it's very important to see the actual outcome of those reforms before Australia considers them—that's a personal view. There is an argument that familiarity with the business actually improves your ability to ask the right questions and get a head of issues, and, if there is audit firm rotation, I would querying whether it ends up in a reduction of audit quality rather than an improvement of audit quality.

Senator WHISH-WILSON: In relation to that, if an auditor detects an irregularity in a business that they're auditing, is there any anonymous process they can go through to contact the regulator to put them on, for example, your risk list, rather than risking their own relationship by publicly—

Mr Price : The short answer is yes, there is.

Senator WHISH-WILSON: And does it happen?

Mr Niven : It does. I don't have the statistics to hand. It's a formal process under legislation—the Corporations Act. Auditors are required to report to us suspected contraventions of the Corporations Act, subject to a couple of exemptions, and we regularly receive those. I don't have stats, but it's certainly a volume every month. It relates to a whole range of provisions under the Corporations Act so there's that formal obligation and they are protected by a qualified privilege under the Corporations Act as well. I think you're talking more broadly, because it could be beyond the Corporations Act provisions. It's hard for me to talk about other legislation. I know there are provisions, for example, in the superannuation industry supervision legislation for reporting matters to APRA in certain cases, so it's hard to talk about those legislative provisions. In addition, there's an ethical standard issued by the Accounting Professional and Ethical Standards Board about noncompliance with laws and regulations which talks about the obligations of professionals to report matters that they identify as well. Certainly, we're not just receptive to receiving formal reports under the legislation; it's open to anyone, even anonymously, to report matters to us as well.

Senator KETTER: I want to touch on another chestnut, and this goes to the issue of general-purpose financial statements versus special-purpose. Ms Peach, we've discussed this matter before. Perhaps I will ask you, Mr Edge. There's been some public interest in, particularly, multinational tax avoidance and the extent to which some large multinationals are utilising special-purpose financial reporting, and that results in less disclosure of relevant information. Is this something that you're looking at the moment?

Mr Edge : It's not something specifically the FRC is looking at, but it is something the AASB is certainly looking at. I don't know whether you want to answer that question, but we are well aware of that issue and we are quite confident in the work that the AASB is doing.

Senator KETTER: Ms Peach, I should have asked you.

Ms Peach : We currently have two projects which are looking at this issue of general-purpose versus special-purpose financial statements. The first is an overarching program which we are also doing with the auditing standards board, which is to work with other regulators to go back and reset legislation to really identify who should be preparing and publicly lodging financial statements, with the outcome of that being that it should be a general-purpose financial statement. What I can report is that we have issued a consultation paper in conjunction with outreach with the Australian charities commission—so that's dealing more with the not-for-profit private sector. We are about to issue a research paper on what's happening internationally in terms of who prepares and lodges financial statements, as part of that overarching framework, and starting to move that into the for-profit sector, so the corporate sector.

In addition to that, we have another consultation paper which we are about to issue which is a result of the International Accounting Standards Board issuing a new conceptual framework which uses a reporting entity concept in a different way to the way that we use it in Australia. The reporting entity concept is what creates the difference between general-purpose and special-purpose reports in Australia. We will be using this avenue to suggest that there is another shorter term way of moving special-purpose financial statements. That will obviously need to go through some appropriate consultation and due process, but that will be out within the next two months.

Senator KETTER: How does that change actually occur in the standards? What's the process?

Ms Peach : If there were support for one of the proposed options which we have, what we would need to do is then come back with a formal exposure draft identifying the changes to the standards that would be required. But effectively, if that proposal were accepted, what would happen is we would remove part of our existing conceptual framework in Australia. That would actually remove the reporting entity concept, and then we would need to make some changes to the application of the standards. But the end result would be that, if you were required by legislation to prepare financial reports in accordance with accounting standards, our accounting standards would identify that if you have public accountability—which is effectively if you're a listed entity or a disclosing entity, a bank or an insurance company that has fiduciary obligations—then we would have to do complete and full general-purpose financial statements. That would be full recognition, measurement and disclosure. If you didn't meet those criteria, you would end up doing a second level of general-purpose financial statements. That's the question mark at the moment as to what that would look like, but obviously we have a significant consultation process that we would need to go through as part of that process.

Mr Price : I just want to add one thing that's current now. In December 2015, amendments were made to the tax legislation to require certain foreign owned entities that are part of globally significant groups to lodge general-purpose financial reports with either the ATO or ASIC. That has now commenced.

Senator WHISH-WILSON: I remember the legislation well. We had a very heated debate.

Mr Price : The ATO first started downloading those financial reports to us in January this year. So, at least for that subset, people will be able to access general-purpose financial reports.

Senator KETTER: That's for globally significant entities?

Mr Price : That's correct.

Senator KETTER: Is there a loophole, though, in that process for some of those globally significant companies?

Mr Price : In what sense?

Senator KETTER: That's okay. Ms Peach, who are the gatekeepers in terms of this process of getting change with the standards down the track? What are the key decision points there?

Ms Peach : The key decision points will really be around what happens with some of the key stakeholders. That will include preparers, users, accounting firms, professional bodies et cetera but also the regulators themselves. It would be preferable to have legislative change to make sure everybody is being involved in the consultation process. Our preferred option is not to go down the route where we have to make changes in our standards without having other changes in the regulations themselves. So it really is just about the consultation process and making sure that regulators are fully on board with some of the changes that we are suggesting.

Senator KETTER: My understanding is that those multinational companies can provide a global general-purpose financial statement, not an Australian specific report.

Mr Price : I believe there is an existing ability—and Mr Niven will correct me if I get this wrong—for certain global companies to lodge their home account jurisdictions in Australia.

Mr Niven : Yes. There are a couple of parts to this. Foreign companies that operate in Australia, that carry on a business in Australia, already have an obligation under the Corporations Act to lodge financial reports with us. The part that you are referring to, I think, is in the interpretation of elements of tax legislation, where the ATO has given its interpretation on its website—and it may be that the question is best directed to the ATO. But I do understand—and from reading the legislation—that the interpretation that they have issued is that there is an obligation on an Australian entity to lodge financial reports. I won't go through the criteria. But it may be possible not to lodge a financial report for the Australian entity but, rather, to lodge a financial report for its global parent. That could be an entity in another country—the US or whatever—which presumably would consolidate the Australian operation but wouldn't report specifically on what's happening in Australia.

Senator KETTER: I guess that's where I'm saying that, if the objective was to have more transparency in what is going on in Australia, unfortunately that can be disguised by the global entity. Mr Edge, is that an issue that is being looked at?

Mr Edge : My first response is that that that is a tax issue, as distinct from a financial reporting issue. All the work we are trying to do is produce financial reports that promote investor confidence and are reliable for the users. The tax office is able to collect its own information to decide how much tax should be paid. The use of financial reports is a de facto way of trying to get information that they cannot otherwise obtain. That is a long way of saying we are trying our best to clarify the reporting framework so that all relevant users, of which the tax office is one, get the information they need.

Senator KETTER: Ms Peach, do you have a comment about what I call a 'loophole'? Is that something that you will be considering in your process?

Ms Peach : As Bill mentioned, I think part of the issue is going back to the complete framework project, because I think it's important in identifying who you think needs to be publicly watching and at what level that lodgement should happen. So I think that's more of a fundamental about how the legislation itself is actually set up rather than about the specific accounting standards themselves.

Senator KETTER: So there might be a need for legislative change to give effect to this.

Ms Peach : That could certainly be a possibility, yes.

CHAIR: We are due to finish, but Senator Whish-Wilson has some questions, so I'll hand over to the senator.

Senator WHISH-WILSON: In relation to Senator Ketter's question and Mr Edge's comment about the ATO crossover, in your chair's review, Ms Peach, you say, on, I think, page 12: 'The board also issued draft guidance on how to implement the Board of Taxation's voluntary tax transparency code.' Then you go on to say: 'The guidance promotes consistency and comparability of key information about entities' tax positions, in particular their effective tax rate.' How does that fit in to your comment, Mr Edge? How are you involved in the implementation of tax transparency?

Ms Peach : That's actually a separate project. The Board of Taxation issued the voluntary tax transparency code and they asked us to provide guidance. That guidance actually sits outside of the financial statements. The tax transparency code itself suggests to entities that they can choose either to put the disclosures within their financial statements or to put them outside. Whilst we haven't done a complete review, my observation would be that the majority of entities at this point are actually having that outside of the financial statements.

Senator WHISH-WILSON: Because it's voluntary, will you be doing a review of how that's going at some stage?

Ms Peach : Yes. We're actually aiming to look at the use of the draft guidance that we put out, and we hope to have that guidance finalised by 30 June this year.

Senator WHISH-WILSON: I know we're over time, but I just want to ask a couple of specific questions to you, Ms Peach. You also talk about AASB 1058 and the work that you've done with the Australian Charities and Not-for-profits Commission, the ACNC, on providing education and implementation assistance on issues around reporting requirements. Have you been working on any other whole-of-government consultation around changes to reporting within the ACNC? The only reason I ask you this question is that in your opening statement you talked about auditability as being one of the things that you provide advice on. Are you involved with any of the changes around the ACNC and reporting requirements, potentially for foreign donations with the new legislation, and also around disclosure of advocacy versus other activities and the compliance on that?

Ms Peach : The answer to the last two questions is: no, we haven't been involved in any of those last two issues. We have worked with regulators other than the ACNC to look at the not-for-profit, private sector. We've been working with some state regulators to also try to improve financial reporting for incorporated associations et cetera. One of the things I think we will be doing with the ACNC is looking more broadly at what other reporting requirements there are. One area we have touched on but where we haven't yet completed a project is service performance reporting, which is actual outcomes—whether or not a charity has achieved what it said it was going to achieve with the money that has been provided. That has been more our area of focus than the specific issues that you mentioned.

Senator WHISH-WILSON: Just as a matter of interest, charities in this country are being asked to provide a breakdown of their activities—advocacy versus other activities. But, from the conversations I've had with them, they've got no idea how to do that, nor does anyone have any idea. If it's not your agency that's going to provide the government with advice on this legislation when it comes to the House or the Senate, who will? Given you've worked with these guys, who else would provide that advice around auditability or costs of compliance—the kinds of things you talked about in your opening statement?

Ms Peach : I do think we would be the right agency if there has to be specific disclosures around those areas; it's just that that hasn't been raised with us yet. As part of that, we would need to make sure there was some broad and widespread consultation to make sure that we'd really identified all of the issues that need to be considered before we come out and say: 'You mandatorily have to make these types of disclosures.' We have been in consultation with the ACNC around trying to improve how our standards work with what they call their National Standard Chart of Accounts, so I certainly think that there is some scope to improve the disclosures that charities are making and the level of disclosure that they need to make.

Senator WHISH-WILSON: So in terms of their compliance with that—their ability to comply with it and the costs of having to comply with it—you would be the right agency to provide advice?

Ms Peach : Yes, we would be.

Senator WHISH-WILSON: I find it fascinating that it's got this far down the track and you have not been brought into this process; in fact, I find that very disturbing. Sorry it's a political comment, but it's a very serious one.

Could I ask something more broadly—anybody could answer this question—in relation to the question Senator Ketter asked around the big consulting companies and auditing. Mr Price, you mentioned—I think these were your words—a 'lack of professional scepticism' within these firms. I suppose that points to a potential cultural issue. Do you want to expand a little more on that and what could be done? Is it that these guys get billable hours and they're competing with each other to get clients and don't want to lose that kind of business?

Mr Price : Yes. The reference to professional scepticism actually comes from some of our previous reports. When we looked at what we thought might be some of the core drivers, for the limited number of files that we look at, we came up with three key themes that were causing us some angst. One was around sufficiency and appropriateness of audit evidence obtained by the auditor. That's about making sure there's a document trail, which is quite important. The second was around the level of professional scepticism exercised by the auditors. And the last was about appropriate use of the work of experts and other auditors. The point about professional scepticism really is: while auditors might be retained by a corporate, and while they certainly will need to maintain a good working relationship with the corporate, they need not to accept material they're provided at face value. They need to exercise an inquiring mind and make sure they're asking the right questions.

In terms of your question about culture, we have been very pleased at what we've seen from the larger audit firms in terms of strong messages from the top about the importance of audit quality. But, like all things around culture, it's making sure those strong messages at the top actually translate through the rest of the organisation. I suppose it also includes things like coaching, robust review processes and effective accountability mechanisms when things go wrong. We think those things are there, by and large, but it's not an area where you rest on your laurels, and we certainly think that having that strong cultural commitment to audit quality is very important.

Senator WHISH-WILSON: Is it a matter of remuneration within these firms, that it's based on how much business they can bring in? Are there other ways that they could be remunerated based on benchmarks around that?

Mr Price : Mr Edge can probably comment.

Mr Edge : I would like to comment on your first point about familiarity with the client. Professional scepticism is often an issue around the complexity of the rules, the accounting standards and the auditing standards that need to be applied. It's not necessarily because of your familiarity with the client; it's more that you're so focused on the rules, the different calculations and the different disclosure modes that sometimes you're not taking a moment to sit back. That's how the accounting bodies in particular are trying to educate their members.

What was the second point of the question?

Mr Price : It was really around remuneration. The big firms, as I understand it—and Mr Edge will probably be closer to this—do use a balanced scorecard type approach at the moment.

Mr Edge : Absolutely.

Senator WHISH-WILSON: They do, do they?

Mr Price : Yes. Findings of poor audit quality have a very real remuneration impact on the partners involved; that's my understanding.

Mr Edge : Absolutely. If I was to say that there was one particular initiative in the last 10 years which has had a real impact, it is the impact on the partner's income if there are any deficiencies found in an ASIC review, in an accounting body review or in the firm's own internal processes.

Senator WHISH-WILSON: They have to cop the firm's fine, do they?

Mr Edge : Absolutely.

Senator WHISH-WILSON: A quick last question from me, Professor Simnett. Have you been asked to provide any advice on the implementation of a carbon accounting scheme? We've had lots of chats with regulators and other agencies about a future with carbon accounting, but have you been asked to do any work on that at all?

Prof. Simnett : Not from the Auditing and Assurance Standards Board's view. There is worldwide work being done, looking at some greenhouse gas type of work, but there's nothing specifically on our work agenda on carbon accounting. We would be on the assurance auditing and assurance side, and the accounting would have to be coming from an accounting framework approach.

Senator WHISH-WILSON: Are there any comments from anyone about whether they've had any input into that?

Ms Peach : It was a significant project that the ISB was looking at, but that was a number of years ago. So it really isn't a prominent project at this particular point in time. We do, however, keep a close eye out just in case we need to do something if Australia's carbon system does require an accounting standard.

CHAIR: Do you think we're closing the audit expectation gap?

Mr Price : I think about where we are in terms of audit quality. As I said publicly before, I'm very heartened that there is a commitment from all parties to try and deal with some of the issues we've seen around audit quality in the past. I'm not prepared to declare victory yet, and that's simply because when we do our risk targeted reviews on the ground we're not yet seeing that flow through. Whether that's because our risk targeting is particularly good and we're getting the hardest matters or whether that's because there's a bit of lag, in terms of improvement in audit quality, I'm not sure. But the commitment to solve the problem and the desire to work cooperatively to solve the problem is there, and I think they are two necessary things in order to take us forward.

Mr Edge : Can I just add to that. One of the things we've found with this recent process looking at audit quality is that we need to get more to audit committees and users to fully understand the complexities of the audit process. The audit expectation gap is reducing but it still exists. I think some people still see it as a commodity and pay the lowest audit fee they can and move on. We want to create for users a greater understanding of all these issues, which we've talked about this morning.

Mr Price : I'd wholly endorse those comments as well.

CHAIR: Thank you for coming this morning and giving evidence. If any of you have been asked to take questions on notice please provide them to the secretariat by 9 March 2018.

Proceedings suspended from 11:13 to 11:30