Changes In Auditor Reporting

Changes In Auditor Reporting

Auditors' reports on firms that report on compliance with the UK Corporate Governance Code

Alongside strengthening its Governance Code for premium-listed companies in 2012, the FRC, in its role as regulator of external auditors, now requires them to provide an expanded audit report for those companies. This guidance note explains how AFM is incorporating the new standard for its members.

Summary of AFM position

  • AFM is keen for its members to institute the audit reporting aspect in keeping with its desire for members to stay closely aligned with good practice in reporting under the Code.
  • The AFM Board and Regulation and Governance Committee therefore confirm all AFM members should implement the new audit standard and commission the new style auditor's report as part of their 2013 report and accounts.

Background: FRC requirements for listed companies

From 30 September 2013 year-ends, the external auditors of FTSE companies are required to:

  • Describe the assessed risks of material misstatement they identified which had the greatest effect on the overall audit strategy and where their efforts were directed
  • Explain how they applied the concept of materiality in the audit and what threshold they used as being material to the financial statements, and
  • Explain how the audit addressed the assessed risks of material misstatement.

Those auditors are also required to report by exception any inconsistences they detect concerning whether the following requirements of the Code are adhered to, that:

  • the annual report and accounts taken as a whole gives a fair, balanced and understandable assessment of the company's position and prospects, and
  • the section describing the work of the audit committee appropriately addresses matters communicated by the auditor to the audit committee.

The intention is that there will be a fuller description of the work the auditor has undertaken giving more insight to investors, or other users of the accounts, than the existing binary pass/ fail model of published audit reports.

The auditors are expected to coordinate descriptions of overlapping topics addressed in the section of the annual report describing the work of the audit committee in discharging its responsibilities and to avoid duplication of reporting about them.

Whilst the auditor may already document and communicate its judgments in private reports to the board or audit committee, there will no doubt be more time and effort devoted going forward as to how the information should be published and as to the appropriate place in the annual report and accounts.

The FRC has published a new standard, as well as an example auditor's report on its website.

Why does this apply to members of AFM reporting under the Annotated Code?

FRC states that its new requirements apply to entities that choose voluntarily to report on how they have applied the UK Corporate Governance Code. We have tested this position with FRC and with a number of audit firms, as follows:

First, does "the Annotated Code" constitute "the Code" itself?

The AFM has an involved process for updating the Annotated Code in line with the Code, promoting adherence by members through the annual Questionnaire, collecting systematically "comply or explain" responses and reporting overall results to regulators. Members report in "comply or explain" terms on individual provisions of the Annotated Code in their annual report and accounts. This appears, in substance, as close to the Code as you can get, even if a legal argument could be mounted to the contrary.

Second, there has been a debate amongst auditors on the intended reach of the requirement beyond premium-listed companies.

The FRC noted in feedback on the proposals that some mutuals (Industrial and Provident Societies were cited) may not be as well equipped to deal with the demands and that they may not meet a cost-benefit test. They further noted that the proposals may deter voluntary compliance - which cannot be a desirable outcome. Elsewhere they state that the changes "may" apply to friendly societies in circumstances where the friendly society has voluntarily chosen to report on how it has applied the UK Corporate Governance Code.

The problem for mutuals and their auditors is that the requirement is in an Auditing Standard, ISA 700, and so there would not normally be a "comply or explain" choice in the matter. To limit the scope of an audit is not tenable. As FRC's view is that AFM members, as voluntary subscribers to the UK Corporate Governance Code, should adopt the standard, there appears little if any discretion.

This is reinforced by the views of ICAEW, which recently reported on firms that voluntarily apply the Code, citing AFM's approach and stating: 'If entities decide they have reported voluntary compliance then this will not only require their auditors to adopt the new ISA (UK&I) 700 reporting paragraphs but will also require the directors to include a statement that they consider the annual report is fair, balanced and understandable and state whether the annual report appropriately discloses those matters that the auditors communicated to the audit committee.' In short AFM members that subscribe to the Annotated Corporate Governance Code should apply the new audit standard in consultation with their auditor. Your external auditor should be aware of the nature of recent discussions with FRC, not withstanding the late confirmation of the application of the standard.


AFM members should therefore adopt the new standards now, taking account of the following likely impacts:

  • likely to increase audit fees by up to 5% a year;
  • intensifies the need for audit to look beyond the numbers;
  • gives more robustness to the governance regime- by requiring auditors to assess the report and accounts against the wider criteria of 'fair, balanced and understandable';
  • reinforces the higher profile of the audit committee within the Code, as well as its relations with (external) auditors.

In addition to the requirements introduced via the new audit standards, the most recent version of the Code, which comes into effect for 2013, includes some other new audit requirements, in particular, that the audit committee should include in its report within the annual report details of the significant issues that the committee considered in relation to the financial statements, and how these issues were addressed.

As an example of how listed companies are already adopting the standard, see pages 88 and 89 of the Vodafone 2013 annual report.

AFM would welcome feedback on any concerns from members on applying these new requirements.

Audit tendering

The Annotated Corporate Governance Code was updated in October 2012, and as well as reflecting the above, carries across the requirement from the FRC Code for FTSE 350 companies to put their audit out to tender every ten years. AFM anticipates its members will seek to adopt the same practice where practical and proportionate.

It should be noted that there are transitional rules which apply to the FRC guidance; this may be important to members over the next 10 years in avoiding unnecessary cost: Corporate Governance Code

FRC has produced some helpful good practice notes on undertaking an audit tender.

Association of Financial Mutuals, October 2013

Back to listings



Corporate Governance Questionnaire Keyx



AFM Predecessors are Association of Mutual Insurers and Association of Friendly Societies

Annual election

Annual election of all board directors has become commonplace in PLCs, since it was incorporated into the Code in 2010. This was a reaction to governance failures and their contribution to the financial crisis. Annual elections give members an opportunity to react to the performance of the company and are also required for directors that have served for more than nine years.



Board includes committee of management.



The UK Corporate Governance Code (previously called The Combined Code), subject to the annotations made by AFM in the Annotated Corporate Governance Code (current version dated 2012).


Company means a mutual insurer and includes a friendly society.


Code Provision of the Code.



Diversity includes but is not limited to gender. Directors may differ in many important characteristics, such as educational and functional background, industry experience, social connectedness, insider status, gender, and race. The Davies report in 2011 put forward a voluntary target for gender diversity for the boards of listed companies of 25% by 2015.


Entrepreneurial leadership

The organising of a group of people to achieve a common goal using proactive entrepreneurial behavior by optimising risk, innovating to take advantage of opportunities, taking personal responsibility and managing change within a dynamic environment for the benefit of the organisation

Externally facilitated performance evaluation

An external facilitator brings rigour and struture to the performance evaluation of a board, as well as an independent and impartial perspective. Evaluation of the board of larger companies should be externally facilitated at least every three years. The external facilitator should be identified in the annual report and a statement made as to whether they have any other connection with the company.


Fair, balanced and understandable

This broad definition of the basis on which the annual accounts was prepared is intended to address the concern that the narrative report should reflect the board's considered view of the information that members and other users of the annual report and accounts needed, rather than being viewed as promotional in nature, and to ensure that the narrative and financial sections of the report were consistent.


Independent non-executive director

Member of the Board of Directors of an entity who is an outsider, meaning he or she is not an employee of or otherwise closely connected with that entity. An example is a broker sitting on the Board of a client company. Such directors are important because they bring unbiased opinions regarding the company's decisions and diverse experience to the company's decision-making process. In order not to have a conflict of interest, independent directors should not participate on the boards of directly competing businesses. Directors are typically compensated based on a standard fee for each board meeting, or on an annualised basis.



A Large Company is any mutual that does not meet the definition of a small mutual i.e. because it has gross premium income on average over the preceding three years of £20 million per annum or more and/or it has assets on average at the end of the last three financial years of £100 million or more.


Major shareholders

Although mutual insurers do not have shareholders, the principles underpinning the provisions of the Code are relevant and should be considered in relation to appropriate methods for facilitating direct member dialogue and involvement that may be in place (such as member forums or panels and/or delegate systems) and/or any members with significant membership rights. Also referred to as principal shareholders and significant shareholders in the Code.


Main Principle of the Code.


A recommendation from: "The Myners review of the governance of life mutuals published in December 2004"


Performance evaluation

Performance evaluation is a key means by which boards can recognise and correct corporate governance problems and add real value to their organisations. Boards who commit to a regular evaluation process find benefits in terms of improved leadership, greater clarity of roles and responsibilities, improved teamwork, greater accountability, better decision making, improved communication and more efficient board operations.


Senior independent director

The role of the Senior Independent Director includes the following:

  • Providing support for the Chair in the delivery of his or her objectives;
  • Ensuring the views of the other Directors are conveyed to the Chair;
  • Attending sufficient meetings with a range of members, perhaps in company with the Chair, to develop a balanced understanding of their issues and concerns;
  • Ensuring that the Chair is passing on the views of the members and especially that any concerns are conveyed to all Directors;
  • Ensuring that appropriate succession planning procedures are in place in relation to Board succession;
  • Carrying out the annual evaluation of the Chair in conjunction with other Non-Executive Directors while also taking account of the views of the Executive Directors; and
  • Taking responsibility for an orderly succession process for the Chair.


Small Company means a mutual with gross premium income of under £20 million per annum on average over the preceding three financial years and assets of less than £100 million on average at the end of the last three financial years.


Supporting Principle of the Code.

Statutory duties

The Companies Act 2006 codified certain common law and equitable duties of directors for the first time. The Act sets out seven general duties of directors which are:-

  • to act within powers in accordance with the company's constitution and to use those powers only for the purposes for which they were conferred
  • to promote the success of the company for the benefit of its members
  • to exercise independent judgement
  • to exercise reasonable care, skill and diligence
  • to avoid conflicts of interest
  • not to accept benefits from third parties
  • to declare any interest in a proposed transaction or arrangement.

The statutory duties do not apply to the directors of friendly societies, although they must comply with very similar duties under the common law.


Unfettered powers of decision

No one person should be able to make major decisions about the organisation on his or her own.

Unitary board

Unitary boards include both executive and non-executive directors and make decisions as a unified group. By comparison a two-tier board has a separate management and supervision board



"Year" means the financial year of the company in respect of which the questionnaire is being completed