What’S New From The International Federation Of Accountants (IFAC) (August 2017)

FINANCIAL REPORTING COUNCIL

MONTHLY UPDATES (September 2017) – What’s new from the International Federation of Accountants (IFAC)

The main topics for discussion at the IFAC in September 2017 were with respect to: 1. IESBA Proposes Revised Ethical Requirements Prohibiting Improper Inducements 2. Keeping the Audit Profession Attractive 3. The Professional Accountant’s Mindset and Tackling Corruption 4. Transforming Challenges into Opportunities: Fee Pressure 5. Making Sense of Materiality 6. An SMP Perspective on Proposed Changes to the IESBA Code of Ethics 7. Working with Good Governance in the Public Sector: Five Lessons and Two Wishes

1 Monthly Updates – September 2017

1. IESBA PROPOSES REVISED ETHICAL REQUIREMENTS PROHIBITING IMPROPER INDUCEMENTS

The International Ethics Standards Board for Accountants® (IESBA®) has on 8 September 2017 released for public comment in New York, the Exposure Draft, Proposed Revisions to the Code Pertaining to the Offering and Accepting of Inducements. The proposals strengthen the Code of Ethics for Professional Accountants (the Code) by clarifying the appropriate boundaries for the offering and accepting of inducements, and by prohibiting any inducements with intent to improperly influence behaviour.

The proposed comprehensive framework covers all forms of inducements and applies to both professional accountants in business and professional accountants in public practice. It also provides enhanced guidance on the offering and accepting of inducements by professional accountants’ immediate or close family members.

“Inducements with intent to improperly influence behaviour are a very major concern for the public interest, and they include the issues of bribery and corruption. Inducements made with improper intent are unacceptable and should be prohibited,” said IESBA Chairman Dr. Stavros Thomadakis.

Among other matters, the proposals also require professional accountants to address any threats to compliance with the fundamental ethical principles in accordance with the Code’s conceptual framework where there is no improper intent.

“The development of the proposals was informed by input from Transparency International UK based on their experience and insights in the area of bribery and corruption,” noted IESBA Technical Director Ken Siong. “When completed, the provisions will constitute the last piece of the substantively revised and restructured Code.”

The IESBA invites all stakeholders to comment on the Exposure Draft by visiting the Ethics Board’s website at www.ethicsboard.org.

Comments are requested by December 8, 2017.

2. KEEPING THE AUDIT PROFESSION ATTRACTIVE

Audit is a people business. While increased regulation and technology change the demands on auditors, audit quality remains at the forefront. Looking ahead, Accountancy Europe believes it is key for the audit profession to appeal to top talent, including professionals with different backgrounds.

Accountancy Europe gathered views on the audit profession’s attractiveness, as well as ideas on keeping it attractive, by interviewing 21 key stakeholders comprising of young auditors, regulators, investors, academics, and policy makers. The findings are summarised below:

Key Ideas

Most interviewees thought that the best way to keep the audit profession attractive is to promote the audit profession’s achievements and demonstrate what benefits it brings to society. “Make people aware of the benefits of the audit profession: you learn a lot from the 1st day, you meet a lot of interesting people, and you do a lot of interesting things” a young auditor from Austria said. At the same time, clients, investors, and society should perceive the positive value of the audit.

There is also the retention issue: students and young professionals must not only be attracted to join but also motivated to remain in the profession and audit firms to prevent the loss of knowledge and experience. High junior staff turnover rates in audit firms are a concern for the profession and should not be overlooked. Audit firms face the constant challenge of managing the outflow of staff, especially as today’s economic growth creates more opportunities available elsewhere in the job market. It’s not all negative, as new colleagues entering the profession bring fresh ideas to an audit firm. But the challenge for the firms is also about keeping the right people.

From the interviews, five main factors influencing the attractiveness of the audit profession were identified:

 The registration process: the process of becoming a registered auditor encompasses several phases and can be very lengthy. There is a need to find a balance between demanding requirements to join the profession and ensuring that the best professionals are not discouraged from becoming registered auditors.

 Tougher regulation: greater accountability and scrutiny reinforce the public interest dimension of the audit profession. Although auditors understand this is part of the job, they notice that the nature of their work gradually changes, focusing more on tasks related to oversight and quality assurance.

 The compliance mind-set: the very desirable intellectual challenge might be perceived as diminished as work becomes a tick-the-box exercise. Professional judgment and audit quality need to remain the central elements of our work. “Too much focus on the audit process instead of focus on the outcome—we need to find the right balance” was mentioned by a regulator in the United Kingdom.

 Impact of technology: the millennial generation is proficient in the use of modern technology. Young professionals joining the profession should be encouraged to use their capabilities and share them with more senior staff. Also, as firms adopt technology to carry out certain procedures, there are opportunities for more interesting areas of work that may be more attractive.

 Work-life balance: the audit profession is known as very demanding in terms of work load with a high impact on personal life, especially in the peak season. Young professionals seem to increasingly value their personal and social achievements. This

imposes a new equilibrium on audit firms to achieve this balance, such as offering increased flexibility.

The auditor’s skillset and his or her interaction with other professionals are also looked into. The key idea regarding the skillset is the willingness to adapt to new situations. The skills needed for an audit will be increasingly driven by the context in which the audit is performed: new business models, technologies used, etc. These trends may make the auditor’s work more challenging but also more interesting.

There is also a growing demand for specialised professionals in the audit profession, ranging from data specialists to environmentalists, and for individuals without an audit or accounting background. This is due to three main factors: technology, increasing complexity in financial reporting, and new services provided by audit firms.

Technological developments impact the nature of the work of the auditor. Not only does the auditor have to further develop his own IT skills but audit firms are also including growing numbers of IT experts in the audit team in order to cope with changes in the business environment. “Every company is an IT company nowadays. What does that mean for audit firms?” asks an audit partner in the Netherlands.

Audit firms and Accountancy Europe’s members are taking action regarding the attractiveness of the audit profession. For example, members are increasing their interaction with universities and are setting up young professionals’ bodies.

Recommendations

From the interviews and reflections some conclusions have been reached and amongst other things, the following recommendations to stakeholders have been made:

 promote the achievements of the audit profession.  better inform students about the profession.  achieve a balance between demanding requirements to join the profession and ensuring that the best professionals are not discouraged to join.  work together to find the balance between demonstrating compliance and applying professional judgement.  be transparent and realistic on the use of technology in the audit procedures.

3. THE PROFESSIONAL ACCOUNTANT’S MINDSET AND TACKLING CORRUPTION

Over two-thirds (69%) of the 176 countries rated on the Transparency International’s Corruption Perceptions Index 2016 scored below 50 out of 100 (0 is perceived to be extremely corrupt and 100 is perceived to be completely clean).

Clearly, there is some way to go then in tackling global corruption.

Earlier this year, IFAC positioned the positive role of the accountancy profession in tackling corruption, identifying three vital areas of action: collaborative efforts across all sectors, transparent and accountable public financial management and, to support the public interest, greater public adoption of high-quality international standards on financial reporting auditing and ethics.

Ethics is core to the accountancy profession. It is widely recognised that in recent years there has been an increased focus on business ethics, driven in part by the many high-profile business scandals that have caught global attention. Incidents of fraud and corruption can impact organisations of every size and every sector globally. No finance professional can be complacent about the risk of either wrongdoing taking place somewhere within their organisation, or being targeted by external fraudsters, and need to be alert to apply their code of ethics. For professional accountants who have a duty to uphold integrity and objectivity, through their commitment to their code of ethics, there is a clear requirement to not knowingly misrepresent facts or subordinate their judgement to others and to be straightforward and honest in all professional and business relationships.

Management accountants, with their training in analysing and interpreting both financial and non-financial data, are in a position to challenge information that seems suspicious, and to be diligent in examining the supply chain, as well as interpreting where there most likely is high risk—be it in a market, product line or through partners or suppliers. They also have an important role to play in influencing the organisation to have the right systems in place, contributing to the ethical organisational culture and escalating identified issues promptly for resolution—all of which safeguard the organization. The recently introduced NOCLAR standard (Responding to Non-Compliance with Laws and Regulations) from the International Ethics Standards Board for Accountants offers further guidance in both addressing and escalating such issues. Professional accountancy organisations globally are taking steps to incorporate the standard into their Codes of ethics.

Fighting fraud and corruption continues to be a focus for G7 and G20 meetings as bribery and corruption are recognised as an impediment to economic growth. This was a theme prioritised by the 2016 London Anti-Corruption Summit, which brought together a group of world leaders from 43 countries who made a total of 648 anti-corruption pledges. In the last few years there has also been an increasing volume of legislative action and this momentum is set to build. For example, 2016 saw the biggest enforcement year in Foreign Corrupt Practices Act history with 27 companies paying approx. US$2.48 billion to resolve cases. 2016 also saw a focus on cases against individual executives and foreign officials.

4. TRANSFORMING CHALLENGES INTO OPPORTUNITIES: FEE PRESSURE

Pressure to Lower Fees

The third highest challenge small- and medium-sized practices face globally is pressure to lower fees. Practitioners are fully aware of the importance of providing quality services, but it is clear that some clients remain reluctant to pay for such services. Technological advances, globalization, and outsourcing to less-expensive offshore contractors may also prompt clients to keep up the heightened fee pressure.

The Guide to Practice Management for Small- and Medium-Sized Practices includes a section on coping with pricing pressures.

 Adopt new approaches to pricing. Instead of billing an hourly rate, set prices for services such as business advisory services based on perceived or estimated value to your client. Also, packaging more desirable services with services that are essential but less desirable allows for a broader range of services for a larger fee.

 Stress the value of services offered. Talk to clients regularly about the benefits of the services they receive. Communication is an important part of value pricing.

 Focus efforts on most valuable clients. Evaluate clients, group them, and offer different service levels to different groups, especially for non-audit services such as business advisory or tax. This technique, referred to as yield management, is used in the airline industry to price seats by the level of service in first class, business class, or economy sections. Some clients will appreciate, and pay for, first class service. Others will prefer the economy rate.

 Leverage technology. Maximize technology to improve processes and lower costs in the face of stagnant or declining fees. Cloud computing solutions deliver the same services, like payroll and bookkeeping, for less cost, email costs less than regular postal services, and Skype is less expensive than telephone or in-person meetings.

 Re-examine service offerings. Consider combining value with additional services for little extra cost, or provide the same for less cost. To set your practice apart in the marketplace, consider specializing in niche markets or services.

 Fee breakdown. Break invoices into smaller parts. For example, instead of charging a total amount for “Services Rendered,” an invoice can show separate services and each cost, such $X Tax Return, $X Annual Report, etc. This clearly demonstrates each individual service and makes it harder for clients to complain.

 Find less expensive sources of supply. Review your practice’s suppliers and look for competitors offering benefits that may warrant switching. Competitive pricing and choice of suppliers, from internet service providers to computer hardware vendors, may have improved considerably since your practice first chose its suppliers.

 Tackle overheads. Seek to minimize waste and make the most efficient use of human and environmental resources, including workspace, energy, and consumables. To optimize expensive office space, practices may encourage staff to perform work at clients’ premises or at home and pre-book a desk space when in the office. Similarly, practices could find staff efficiencies through improved workload distribution, adequate planning and supervision of engagements, and delegating work to the appropriate levels. Flexible working hours may avoid staff redundancies, which erode morale and make it difficult to recruit new staff. Shifting routine work to more junior staff can also help cut

costs, but staff assignments need to be managed carefully to maintain quality results and avoid damage to your practice’s brand.

5. MAKING SENSE OF MATERIALITY

The accounting concept of materiality means that only information that is important to investors needs to be included in the financial statements. Information about trivial matters can be excluded. Even though this sounds straightforward, applying the concept in practice is not always easy.

Companies often find it difficult to decide what is material. Consequently, rather than exercising judgement about what to include in financial statements, they use the requirements in the International Financial Reporting Standards (IFRS) as if they are a checklist. This results in financial statements that comply with the accounting requirements but do not communicate information effectively to investors.

The International Accounting Standards Board is working to make the communication of financial information more effective. Hence, helping companies to decide whether information is material is an important part of the Board’s Better Communication in Financial Reporting theme—our focus for the next few years.

Concept of Materiality

Whether information is material is a matter of judgement. The concept of materiality works as a filter through which management sifts information. Its purpose is to make sure that the financial information that could influence investors’ decisions is included in the financial statements. The concept of materiality is pervasive. It applies not only to the presentation and disclosure of information but also to decisions about recognition and measurement.

When making materiality judgements, companies need to consider a range of facts and circumstances, including both quantitative factors (for example, how big the amount involved is) and qualitative factors (for example, the specific circumstances of the company). When the concept of materiality is not applied appropriately, it may result in disclosure of too much information (sometimes called clutter) or too little information.

Practice Statement

In order to reinforce the role materiality plays in the preparation of financial statements and help companies exercise judgement, the IFRS Practice Statement 2, Making Materiality Judgements has been published. It provides companies with guidance on making materiality judgements when preparing financial statements in accordance with IFRS Standards.

This non-mandatory document gathers in one place all the IFRS requirements on materiality and adds practical guidance and examples a company may find helpful in deciding whether information is material.

It also suggests a four-step process for companies to follow when preparing their financial statements. Applying that four-step process, a company:

 identifies information that has the potential to be material;  assesses whether the information identified is, in fact, material. In other words, whether an investor could reasonably be expected to be influenced by the information when making investment decisions;  organises the information so that it is communicated in a clear and concise manner; and  reviews the draft financial statements considering materiality from a wider perspective and as a whole.

In addition, the Practice Statement includes specific guidance on how to make materiality judgements on prior period information, errors, and covenants, and in the context of interim reporting.

Changing Behaviour

The Practice Statement is designed to promote positive changes in behaviour, encouraging companies to exercise judgement when deciding what information to include in their financial statements.

For behavioural change to take place, however, it is important that companies, auditors and regulators work together towards the common goal of providing better information to investors.

6. AN SMP PERSPECTIVE ON PROPOSED CHANGES TO THE IESBA CODE OF ETHICS

Contributing to international standards’ development and adoption are core elements of IFAC’s strategy for small- and medium-sized practices (SMPs) and, therefore, the IFAC SMP Committee’s annual work plan. To help ensure the stability, relevance and proportionality of standards to SMPs and their small- and medium-sized entity clients, IFAC and the committee dedicate significant resources to providing regular and timely input to both the International Auditing and Assurance Standards Board and the International Ethics Standards Board for Accountants (IESBA) (see previous Gateway article for more details on our input). The SMP Committee recently responded to three IESBA Exposure Drafts (EDs) on proposed changes to the Code of Ethics for Professional Accountants and application materials on the extension of Part C of the extant Code to professional accountants in public practice (PAPPs), further revisions on safeguards, and improving the structure of the Code. Extension of Part C to Accountants in Public Practice The IESBA believes it is possible for accountants in public practice to find themselves in ethically problematic circumstances that do not involve clients and, hence, face the same issues and ethical dilemmas as professional accountants in business. Accordingly, the IESBA

8 Monthly Updates – September 2017 seeks to clarify the circumstances in which the provisions in extant Part C should also apply to public practice. The SMP Committee generally supported the IESBA’s objectives and its holistic approach to clarify that the requirements and application material applies to those in public practice. Key points in the response included:

 Concern that accountants in public practice may continue to think that Part C of the Code is not applicable to them. In addition, the contention that the proposed approach would not impose an undue burden on accountants in public practice may not be accurate. The IESBA should consider an awareness campaign and develop communication messages to inform all professional accountants.

 The proposed requirement paragraphs R120.4 and R300.5 need to clarify that significance and possible frequency of occurrence may play a role in determining whether the threat to an individual accountant in public practice’s compliance with the fundamental principles had exceeded an acceptable level. The use of more examples in this respect would be helpful. Safeguards The Safeguards – Phase 2 ED continued the work from the first phase with the objective of enhancing a more robust conceptual framework with more explicit requirements and application material to explain how to identify, evaluate and address threats to compliance with the fundamental principles. This enhanced conceptual framework: a) Explicitly states that a professional accountant is required to address threats to compliance with the fundamental principles by eliminating them or reducing them to an acceptable level. b) Clarifies the safeguards in the extant Code and excludes others that the IESBA determined were inappropriate or ineffective. c) Includes some new requirements to assist professional accountants in evaluating and addressing threats. Specifically, in evaluating threats, professional accountants are required to consider new information or changes in facts and circumstances. Key comments from the SMP Committee included:

 Whilst the ED includes many requirements expressed more clearly, there are also instances where proposed revisions means that certain sections would become invariably longer with repetition introduced.

 The notion of independence as an enabler of objectivity as opposed to as an end in itself could have been given more thorough consideration from an SME audit/review perspective. The circumstances and, thus, public interest perspectives of many SMEs may differ considerably. What constitutes an appropriate degree of independence, and especially independence in mind, will also differ from one assignment to another.

 The IESBA should clarify what the requirement in R600.8 for the auditor to “ensure” is intended to mean in practical terms. The material detailing the personal attributes (skill, knowledge and experience) of a designated individual could be moved to application material instead.

 There are significant concerns about the proposal to extend the provisions on recruitment services in the Code currently applicable to public interest entities to all audits. If the auditor is involved in the recruiting process (e.g., selecting various candidates) but not in making a management decision, the threat is not of the magnitude that the IESBA proposal implies. Structure The third ED was on the new structure of the revised Code, which mainly comprises the restructuring of the text of the remainder of the extant Code that was not included in the earlier Phase 1 (see previous article on the committee’s response to Phase 1 and to the initial consultation). The proposals included:

 Increased prominence of the requirement to comply with the fundamental principles and apply the conceptual framework;

 Increased clarity of responsibility—more clearly enabling identification, where relevant, of a firm’s responsibilities and, together with firms’ policies and procedures, professional accountants’ responsibilities; and

 Increased clarity in drafting—simpler and shorter sentences, simplifying complex grammatical structures, increased use of the active voice, and avoiding legalistic and archaic terms. Key comments from the SMP Committee included:

 Continued support for the IESBA’s approach and the general direction of the project.

 The Code should always prioritize attainment of ethical behaviour through the application of principles rather than mere prescription. For a global code, this will assist wider compliance rates as it allows the Code to work in conjunction with various national requirements.

 There are a number of areas that require further consideration by the IESBA, for instance, clarification of responsible party, repeated reference to the overall requirement, drafting inconsistencies, and delineation of requirements and application material.

 Concern that the proposed effective date may not provide SMPs with sufficient time to be able to review the new Code, understand the implications, and formulate policy changes at the firm level, as well as influence staff behaviour. In addition, there will be significant challenges for IFAC member organizations’ translators. IESBA should seriously consider a minimum time frame of 24 months for the effective date after approval instead of the proposed 18 months.

The needs of the SMP and SME communities will always be at the forefront as far as the SMP Committee is concerned. The SMP Committee looks forward to continued engagement with IESBA to deliver a global code that should be a pride of the profession. With the IESBA planning to issue the restructured Code by end of 2017 and a final adoption date in mid or late 2019, professional accountancy organisations and SMPs will need to start planning for adoption and implementation in the very near future. 7. WORKING WITH GOOD GOVERNANCE IN THE PUBLIC SECTOR: FIVE LESSONS AND TWO WISHES

Both in the public and private sector, auditors care about the governance arrangements of their auditees. In the public sector, where recommendations are a key audit output, it is argued to frame advice on the assumption that the client is rational, public-spirited and focused on achieving its objectives. This is how the IFAC/CIPFA International Framework, Good Governance in the Public Sector, defines the objective of good governance. So when the European Court of Auditors sought to assess the governance arrangements of the European Commission, the International Framework was the obvious tool to use. The conclusion and recommendations, plus insight into the approach, is covered in the 2016 Special report, Governance at the European Commission—Best Practice? The process also gave a chance to develop five lessons from working with the Framework, and a couple of wishes, that generated an interesting discussion at the CIPFA Annual Conference 2017 in July. The International Framework Is Consistent with Other Major Frameworks As IFAC and CIPFA told the world, the International Framework was developed after reviewing current literature. During the process, a check about whether the Framework is consistent with other key sources of guidance on the issues covered—if not, where the recommendations are expected to be challenged. The Framework passed with flying colours. The Role of the Audit Committee Is Central Having an audit committee with an independent membership and a wide-ranging mandate is essential. The arrangements of a number of international public sector bodies have been reviewed to see what can be achieved. There are some great examples of good practice out there. Getting the Structures Right Is Essential, But You Need People to Make the Structures Work A lively discussion on this at CIPFA’s conference was held. Two major thoughts emerged: To make the internal and external accountability mechanism work, where people are prepared to be asked tough questions—sometimes more than once. Ensuring all the right questions are asked is also crucial, and having a diverse group of people involved is a big advantage. External Reporting Feeds into Internal Accountability Setting the target of explaining the difficult issues to an external audience should mean that you debate them internally too. Best practice is to give those tough members on the audit

committee a chance to go through them. These days, reporting on non-financial issues often appears to be more of a challenge than reporting on finances. Applying an External Suite of Financial Reporting Standards Ensures You Have the Financial Information to Support Internal Questions The transformation of financial reporting by big international organisations should not be underestimated—and the European Commission is part of the group that has made a rapid advance. Applying a valid, independently-determined set of accruals standards (such as International Public Sector Accounting Standards) makes it harder to keep the bad news off the balance sheet. Now that is good for governance. And Two Small Wishes Putting together the International Framework was a tremendous achievement. Neither the CIPFA nor IFAC is expected to allow it to become outdated before reviewing the content. The guidance it contains is itself evolving, as is best practice in the public sector. And when a review takes place, someone is expected to take the material in the Supplement, which is believed to be excellent, as the basis for drawing up a self-assessment guide. This would be a valuable quick win.

For further information: http://www.ifac.org

Financial Reporting Council October 2017