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A discussion paper issued by the Auditing Practices Board. Copies of the document are available from the APB web site at www.abp.org.uk

Executive Summary

• The Association of Chartered Certified Accountants (ACCA) welcomes the opportunity to comment on the matters in the discussion paper, The proposed ‘Independent Professional Review’ of the financial statements of small companies.
  
  
• We applaud the decision of the Auditing Practices Board (APB) to initiate an informed debate on this topic in advance of the introduction of legislation.
  
  
• In proposing the development of the Independent Professional Review (IPR), the Company Law Review Steering Group (CLRSG), stressed its potential for achieving cost savings for ‘small’ companies. While we accept that the IPR offers some prospects of cost savings, we believe that these will be minimal. They are likely to be outweighed by the cost, both to the company itself and to the wider business community, of the absence of an audit.
  
  
• It is clear to us that the IPR, as envisaged in the discussion paper, will provide little more than the assurance which users would derive from the simple involvement of a qualified accountant in the preparation of the financial statements. The consequence of this is that the IPR will not provide a meaningful level of assurance to shareholders and others and cannot become a credible alternative to the audit.
  

General Points

1. The discussion paper includes an illustrative Statement of Standards for Performing an Independent Professional Review (illustrative Statement). We note that the APB may, in due course, draft appropriate Standards and guidance to support either a voluntary or a statutory IPR regime. As we anticipate giving our detailed comments on the wording of such Standards and guidance in response to a future exposure draft, we have restricted our comments on the discussion paper to matters of principle.
   
   
2. In the ACCA comments to the CLRSG on the Consultative Document ‘Modern Company Law: Developing the Framework’ we expressed the view that: ‘. . . the small company audit should be retained unless the proposed Independent Professional Review can be framed in such a way as to offer a meaningful level of assurance to shareholders and others, thus becoming a credible alternative to the audit.’ In order that the IPR could fulfil this role we urged that ‘. . . its drafters must be allowed to devise a procedure that offers the prospect of a meaningful level of assurance and should not be constrained by a remit to keep costs to a bare minimum.’ We also stressed that ‘. . . the small company audit (should) be retained until such time as the proposed Independent Professional Review is developed into a procedure which is likely to enjoy the confidence of accountants, businesspeople and stakeholders alike.’
   
   
3. To have any recognisable value the IPR must be understood. The understanding of users will be enhanced if the IPR occupies an easily identifiable position within an accepted framework for assurance engagements. This is provided by the recent IAPC International Standard on Assurance Engagements (ISAE). IAPC concluded that, while in theory an infinite range of assurance was possible, it was necessary to restrict the reports which accountants issue to two levels in order to communicate the level of assurance in a clear and unambiguous manner. The two levels are high assurance (an audit) and moderate assurance (a review).
   
   
4. The CLRSG’s proposal that the IPR should be based on the form of review laid out in International Standard on Auditing 910 ‘Engagements to review financial statements’ (ISA 910) is consistent with this framework. It is apparent from the illustrative Statement that the APB has sought, however, to deviate from ISA 910. We are not convinced that there is sufficient justification to introduce such changes as this will remove one of the most important bases for understanding the IPR. Further details of these concerns are given below in our comments on the specific questions set out in the discussion paper.
   
   
5. Irrespective of the proposed modifications to the form of review as set out in ISA 910, it is clear that the IPR provides little more than the assurance which users would derive from the simple involvement of a qualified accountant in the preparation of the financial statements.
   
   
6. The consequence of this is that the IPR will not provide a meaningful level of assurance to shareholders and others and can not become a credible alternative to the audit. We see no obvious solution to the difficulty faced by the CLRSG in trying to find a ‘middle way’ until this problem is solved globally by the accountancy profession.
   
   
7. Our comments below are made on the assumption that, nevertheless, the Government will legislate to introduce the IPR as previously envisaged. This will give rise to a curious position whereby some users will understand the IPR and be unable to gain much comfort from it, while the majority of users will not understand it. In many jurisdictions, users have been found to assume a high level of assurance for any report issued with financial statements despite the efforts of the accountancy profession to distinguish between an audit and a review. This expectation gap is wider than any associated with the audit and potentially more damaging to the accountancy profession and society in general.
   

Comments on Specific Questions

Our comments on the specific questions set out in the discussion paper are given below:

Benefits of Introducing the Independent Professional Review

1.1 Do you believe that the limited assurance provided by an Independent Professional Review will be of value to the intended users of the review report such as bankers, creditors and the taxation authorities?

This question is best answered by the intended users of the review report, who will have to make their own judgments. The moderate level of assurance provided by a review may not be sufficiently high to be distinguished in the minds of users from the assurance that they would derive from the simple involvement of a qualified accountant in the preparation of the financial statements. Conversely, we suspect that many users will mistakenly assume that the IPR provides a high level of assurance. We believe, overall, that users seeking a level of assurance over and above that provided by the involvement of a qualified accountant would be better served by an audit.

1.2 If not what alternative to an audit do you believe might be of value to the intended users?

The needs of users are different. While, in restricted circumstances, some users might derive a useful level of assurance from certain agreed-upon procedures, it is not possible to say what, if any, alternative to the audit could generally provide a useful level of assurance.

2 Is an Independent Professional Review sufficiently distinguished from an audit to avoid unrealistic expectations as to the extent of assurance provided?

We do not believe that the IPR as proposed is sufficiently distinguished from an audit in the minds of potential users. Despite the efforts of the accountancy profession to distinguish between an audit and a review, the evidence in many jurisdictions is that users assume a high level of assurance for any report issued with financial statements.

3.1 Based on the procedures set out in the illustrative Statement do you believe that the Independent Professional Review will deliver cost savings as compared to an audit?

We agree that the IPR will enable some cost savings to be made. However, those cost savings arise only in relation to the company concerned and should be weighed against the cost to the wider business community of the absence of the audit. We believe that the value of the audit in this context far outweighs any direct cost savings.

3.2 If yes what do you estimate the saving to be?

We believe that direct cost savings will be minimal. Our experience of the audit exemption regime has been that exemption from audit does not result in significant cost savings because the bulk of the work on small business clients is concerned with accounts preparation. Similar considerations apply to the IPR.

Where the IPR regime extends to companies with multi-million pound turnovers and which prepare their own accounts, we believe that there will still be no significant savings in costs compared to an audit. This is due to the respective natures of the IPR and the audit: the former necessarily involves the use of senior staff, whereas the bulk of the verification work in an audit is carried out by junior staff at a low cost per hour.

3.3 If no why do you believe that cost savings will not be realised?

Please see our answer to question 3.1 above.

Requisite Skills and Ethical Matters

4.1 Do you think that the performance of reviews should be restricted to qualified accountants (i.e. members of the CCAB bodies) or should non-accountants be allowed to perform them?

The proper performance on an IPR will depend on the possession by the reviewer of appropriate assurance skills. We believe, therefore, that the ability to act as a reviewer should be restricted to Registered Auditors and CCAB members with practising certificates who could also demonstrate possession of appropriate skills. This could be demonstrated by accreditation following training or by some other form of professional scrutiny of their suitability to perform IPRs.

4.2 If their performance should be restricted to qualified accountants do you believe that practitioners should be licensed to perform reviews and be subject to professional monitoring?

Please see our answer to question 4.1 above. ACCA routinely monitors all of its members who hold practising certificates, not just those having Registered Auditor status. We strongly support, therefore, the view that professional monitoring should be required for reviewers.

4.3 If their performance is not restricted to qualified accountants what criteria would you establish to determine who should be able to carry out reviews?

Please see our answer to question 4.1 above.

5 Do you think that reviewers should be independent of the entities being reviewed? By independent we mean having no financial or other self interest conflict.

Using the definition of independence in the above question, we support the view that reviewers should be independent. We believe, however, that the ethical position of reviewers deserves more extensive consideration and foresee substantial difficulties if reviewers are not members of an appropriate professional body.

5.1 Should reviewers be allowed (or required) to compile the financial statements as well as perform an ‘Independent Professional Review’?

We believe that reviewers should be allowed to compile the financial statements but that this should not be required. The ethical codes governing UK auditors enforce separation between compilers and assurance providers only in respect of listed company audit engagements. Firms of Registered Auditors are permitted to provide both accounting and auditing services to SME clients if certain safeguards are met. We see no reason to treat IPR differently to audit in this regard.

We take the view that, if the preparation of accounts is planned properly and is undertaken in a way which is designed to provide useful assurance evidence, it can be very valuable for reviewers to be involved in accounts preparation. Any move to separate the two functions would, we believe, have a damaging effect on the SME community. This is because such a move would undoubtedly increase the overall financial burden on the companies concerned.

Our experience of the audit exemption regime leads us to believe that, because of business risk concerns, many firms will not accept IPR engagements unless they also prepare the accounts.

Need for a Sound Accounting Platform

6 A significant difference between the illustrative Statement and ISA 910 is that the Statement requires reviewers to perform limited procedures in order to assess whether the accounting records of the entity seem to provide a sound platform for the financial statements. Is the APB right to suggest this requirement?

We oppose the introduction of this requirement. There is no equivalent requirement in auditing standards and it is, therefore, incompatible with the need to have lesser standards for an assurance engagement which is only designed to provide moderate assurance.

There is insufficient reason advanced to deviate from the accepted position of ISA 910. This requirement appears to be an attempt to increase the assurance level of a review towards that provided by an audit. If the level of assurance provided by the review is insufficient, the answer is to favour the audit, not to seek to change the nature of the review. The recent IAPC International Standard on Assurance Engagements (ISAE) distinguishes between assurance engagements which are intended to provide either a high or a moderate level of assurance. In contrast to the high level of assurance of an audit, a moderate level of assurance is characterised by a report which provides negative assurance. IAPC concluded that, while there was, in theory, an infinite range of assurance possible, it was necessary to restrict the reports which accountants issue to two levels, so as to communicate the level of assurance in a clear and unambiguous manner. The introduction of the IPR to the UK must be facilitated by such clear messages backed by an international precedent. To introduce changes from ISA 910 without the most careful scrutiny would destroy that opportunity.

The reason advanced in the discussion paper for proposing this requirement is that reviewers face an increased risk where an appropriate level of accounting expertise has not been employed in preparing the financial statements. It is unrealistic to restrict measures aimed at reducing reviewer risk to one dealing with only the accounting system. A reviewer concerned about risk will consider all aspects of the company’s internal control structure, including the control environment and control procedures.

The introduction of the requirement suggested by APB (albeit relating only to one aspect of the internal control structure) will increase the cost of the IPR with no benefit to users of the review report. This is because it implicitly requires documentation of a process which will be unnecessary in the majority of cases where the reviewer also prepares the accounts.

Procedures Performed in a Review

7 Do you agree that Standards should specify the review procedures to be performed or do you believe that the procedures should be left to the reviewers’ judgment?

Standards should specify the types of procedures which will generally be applicable. Inevitably, the detail of the procedures must be left to the judgment of the reviewer.

9.1 Appendix 2 sets out illustrative review procedures, designed for the generality of reviews, in order to meet the requirements of the Statement. The procedures are not intended to be either a complete list or to be mandated by the Statement. This is because it is impossible, in devising such procedures, to deal with every circumstance that may arise with respect to a set of financial statements. Do you agree with this approach or should paragraph 35 of the illustrative Statement mandate the procedures set out in Appendix 2?

We agree with the use of illustrative procedures as set out in Appendix 2. These should not be mandated by paragraph 35.

9.2 If you do not believe that the procedures in Appendix 2 should be mandated does paragraph 35 specify the procedures in sufficient detail to ensure a consistent approach to Independent Professional Reviews?

Please see our response to question 7. Appendix 2 provides an appropriate level of detail in support of the procedures mandated by paragraph 35. We would also expect CCAB bodies to issue relevant guidance to members.

10 Do you agree that an Independent Professional Review should not encompass either performing procedures to identify whether fraud or illegal acts have occurred or considering the ability of the entity to continue as a going concern?

To include such procedures would go beyond that which is required in an audit. However, the issue of going concern is very important to creditors and providers of capital and if going concern is seen to be removed from the scope of the IPR there will be a large expectation gap to overcome. We are not, however, convinced that mention of such matters in the report will head off the adverse consequences for a reviewer of the failure of a client for which an IPR was carried out.

11 The illustrative statement does not contemplate reviewers obtaining corroborative evidence when they consider that further evidence is necessary in order to express an unqualified review conclusion. Do you agree with the APB’s approach which is intended to distinguish an Independent Professional Review from an audit?

Although the approach is markedly different to that in an audit, we doubt whether users of the financial statements would be aware of the implications. In practice, we would anticipate reviewers mitigating their business risk by obtaining further evidence.

Reporting Matters

12 Do you agree that the review conclusion should be expressed in the form of negative assurance?

There seems little alternative to this approach, which has the advantage of international acceptance and simplicity.

13 Do you agree that the review conclusion should be expressed in terms of conformity with the provisions of the Companies Act and the FRSSE and not be expressed in terms of the ‘true and fair’ view?

We reject the proposed wording, as it departs further from ISA 910 than would be strictly necessary to accommodate UK legislation. We refer you to the second paragraph of our answer to question 6 above.

We would prefer the review conclusion to reflect the need for the financial statements to give a true and fair view. We do not agree with the argument used in the discussion paper that ‘. . . the required procedures do not provide a sufficient basis for concluding in terms of the true and fair view.’ Sufficiency is not only dependent on the reliability and quantum of evidence but on its relevance to the purpose for which evidence is gathered. Sufficiency in relation to an IPR conclusion is qualitatively different from that for an audit opinion.

Neither do we believe that the omission of a reference to the true and fair view would succeed in reducing the expectation gap as claimed by the discussion paper (paragraph 24 of Notes on the development of the illustrative Statement). We think that users will not understand the subtlety in the APB wording.

We are also of the view that the meaning of the words ‘in conformity with’ is unclear.

The illustrative Statement should accommodate those circumstances where an IPR is required of accounts prepared in accordance with accounting standards, instead of the Financial Reporting Standard for Smaller Entities.

14 Do you agree that the Independent Professional Review report should be addressed to the entity rather than to the directors or the members?

In our view, the report should be addressed to the members, following the same logic as applies to auditors’ reports.

Standards

15 In the context of the audit exemption limit increasing to encompass companies with turnovers of up to £1 million do you think there is merit in APB developing and issuing Standards for a review engagement in advance of any decision as to whether an Independent Professional Review is to be required by legislation?

We suggest that APB should now develop Standards and guidance for IPRs. They could be used if companies exempt from audit wish to have a voluntary review. Their early preparation would also allow time for appropriate documentation and training to be put in place by reviewers and for professional bodies to prepare for monitoring of a statutory IPR regime.

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