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Chapter three

Review of annual reports of bodies established under Part 12 of the ASIC Act

Financial reporting framework

3.1        Part 12 of the Australian Securities and Investments Commission Act 2001 (the ASIC Act) establishes Australia's financial reporting system. As outlined in section 224 of the ASIC Act, the objects of the financial reporting system include:

• facilitating the Australian economy;
• maintaining investor confidence in the Australian economy;
• developing accounting standards that require the provision of information that is relevant, reliable, easy to understand, allows investors to make and evaluate financial decisions, and assists directors to fulfil their statutory financial reporting obligations; and
• developing auditing and assurance standards that provide Australian auditors relevant and comprehensive guidance in determining whether financial reports comply with statutory requirements, and require auditors' reports to be reliable and capable of being readily understood by investors.[1]

3.2        Three agencies are established under Part 12 as the administrative arms of the financial reporting system; namely, the Financial Reporting Council (the FRC), the Australian Accounting Standards Board (AASB) and the Auditing and Assurance Standards Board (AUASB). All three bodies are to monitor their activities against the objects in section 224,[2] and to include in their annual reports an analysis of their achievements against the objects.[3]

3.3        While not established under Part 12 of the ASIC Act, the Australia Securities and Investments Commission (ASIC) is also integral to the administration of the financial reporting framework.[4] The Commission's contribution to the framework includes the enforcement of auditor independence and audit quality requirements.[5]

The Financial Reporting Council

3.4        The FRC was established by section 225 of the Australian Securities Commission Act 1989 (the ASC Act 1989)[6] and was re-established in 2001 by Part 12 of the ASIC Act.[7] As part of the financial reporting system, the FRC's role in the operation of Australia's corporations law is to:

• provide broad oversight of the processes for setting accounting standards and auditing standards in Australia;
• monitor the effectiveness of auditor independence requirements in Australia; and
• advise the Minister on these matters.[8]

3.5        The ASIC Act also confers on the FRC 'specific accounting standards functions', 'specific auditing standards functions', and 'specific auditor independence functions'. The FRC's specific auditor independence functions direct the FRC to monitor and advise the Minister about the effectiveness of Australia's auditor independence requirements. In undertaking this function, the FRC is to monitor international developments in auditor independence, assess the adequacy of the auditor independence requirements under the corporations legislation and professional codes of conduct. The FRC is also charged with assessing the overall adequacy of the investigation and disciplinary procedures of professional accounting bodies applying to Australian auditors.[9] The FRC's responsibilities do not extend to monitoring the disciplinary procedures of CALDB or the FRP.

3.6        The Council's specific accounting standards functions and the specific auditing standards functions recognise the position of Australia's financial system within the international economy. The functions also reflect the object in section 224 of 'facilitating the Australian economy by enabling Australian entities to compete effectively overseas'.[10] Accordingly, the FRC is required to:

• monitor developments in international accounting standards and auditing standards;
• further the development of a single set of accounting standards and auditing standards for world-wide use; and
• promote the continued adoption of international best practice accounting standards and auditing standards if doing so would be in the best interests of the private and public sectors of the Australian economy.[11]

3.7        As detailed in the 2010–11 annual report, the FRC's view of its purpose and functions reflects its statutory responsibilities:

The Financial Reporting Council (FRC) is the peak body responsible for overseeing the effectiveness of the financial reporting framework in Australia.

Its key functions include the oversight of the accounting and auditing standards setting processes for the public and private sectors, monitoring the effectiveness of the auditor independence regime, and advising the Minister on these matters.[12]

The Australian Accounting Standards Board

3.8        The AASB was established by section 226 of the ASC Act 1989,[13] and was re-established by Subdivision B, Division 1, Part 12 of the ASIC Act.[14] The AASB was established to raise the standards of accounting statements through developing accounting standards and 'a conceptual framework, not having the force of an accounting standard, for the purpose of evaluating proposed accounting standards and international standards.'[15] Reflecting the object of promoting Australian entities in the international market,[16] the AASB is also tasked with contributing to the development of 'a single set of accounting standards for world-wide use'.[17] The ASIC Act also establishes the Office of the AASB, to provide the AASB administrative and technical support.[18]

3.9        As detailed in the 2010–11 annual report, the AASB's mission statement captures the Board's statutory responsibilities and role in Australia's financial reporting framework:

The mission of the AASB is to:

• develop and maintain high-quality financial reporting standards for all sectors of the Australian economy; and
• contribute, through leadership and talent, to the development of global financial reporting standards and to be recognised as facilitating the inclusion of the Australian community in global standard setting.[19]

The Auditing and Assurance Standards Board

3.10      The AUASB is established under Subdivision C, Division 1, Part 12 of the ASIC Act. Chief among the AUASB's responsibilities is the task of facilitating the objective of an Australian financial reporting system that provides clear guidance to auditors about auditing standards and requirements.[20] The AUASB formulates auditing standards, in the form of legislative instruments, that operate under the Corporations Act 2001 (the Corporations Act).[21] Consistent with the object in section 224 to 'enable Australian entities to compete effectively overseas', the AUASB is also tasked with contributing to the 'development of a single set of auditing standards for world-wide use.'[22]

3.11      The ASIC Act also establishes the Office of the AUASB, which provides technical services and administrative support to the AUASB.[23] The Board's 2010–11 annual report provides further details of the functions of the Office of the AUASB:

The Office of the AUASB is structured to meet one outcome: the formulation and making of auditing and assurance standards and guidance that are used by auditors of Australian entity financial reports or for other auditing and assurance engagements.[24]

3.12      The AUASB's statutory responsibilities are reflected in the Board's mission statement as contained in the 2010–11 annual report:

The mission of the AUASB is to develop, in the public interest, high–quality auditing and assurance standards and related guidance, as a means to enhance the relevance, reliability and timeliness of information provided to users of audit and assurance services...

The AUASB contributes to public confidence in the financial reporting and corporate governance frameworks by issuing auditing standards, which are legally enforceable for audits and reviews of financial reports required under the Corporations Act 2001, other auditing and assurance pronouncements and related guidance.

The role of the AUASB also extends to liaison with other national standard setters and participating in standard setting initiatives of the IAASB [the International Auditing and Assurance Standards Board] to develop a single set of auditing standards for worldwide use. Such involvement seeks to contribute ultimately to the quality of AUASB pronouncements.[25]

Coordination between the FRC, the AASB and the AUASB

3.13      The ASIC Act also requires significant coordination between the three bodies charged under Part 12 of the ASIC Act with the administration of the financial reporting framework. Accordingly, FRC's specific accounting standards functions and specific auditing standards functions also include oversight of certain activities of the AASB and the AUASB. The FRC is to:

• appoint members of the AASB and the AUASB, other than the Chair;
• determine the Boards' broad strategic direction;
• advise the AASB and the AUASB on the Boards' priorities, business plans and procedures;
• monitor the effectiveness of the Boards' consultative arrangements; and
• advise the Office of the AASB and the Office of the AUASB on the Offices' budgets and staffing arrangements.[26]

3.14      The ASIC Act requires the AASB and the AUASB to have regard to the FRC's advice concerning the bodies' priorities, business plans, procedures and strategic direction.[27]

3.15      However, as acknowledged in the FRC's annual report, in conducting its oversight duties the FRC is not permitted to undermine the independence of the AASB or the AUASB:

The ASIC Act expressly limits the FRC’s ability to become involved in the technical deliberations of the AASB and AUASB. In particular, it provides that the FRC does not have power to direct the AASB or AUASB in relation to the development, or making, of a particular standard, or to veto a standard formulated or recommended by the AASB or AUASB. This provision is designed to ensure the independence of the standard setters.[28]

3.16      In addition to the oversight provided by the FRC, the interaction between the bodies is furthered by the administrative arrangements of the AASB and the AUASB. As is evident from the presentation and format of the agencies' annual reports, the AASB and AUASB share administrative resources. As detailed in the 2010–11 annual reports of both bodies, the AASB and the AUASB operate according to a shared service agreement under which seven of the AASB's eight administrative staff concurrently work for the AUASB.[29]

Review of the 2010–11 annual report of the Financial Reporting Council

3.17      The FRC noted in its 2010–11 annual report that it had introduced a strategic plan. The annual report records that following the appointment of FRC Chairman Ms Lynn Wood in March 2011, the Council adopted the Strategic Plan 2011–2014, which provides an action plan for the FRC against strategic issues relevant to the financial services sector.[30]

3.18      The plan includes a Strengths, Weaknesses, Opportunities and Threats (SWOT) analysis of Australia's financial reporting framework, which identified the following areas of weakness in, and threats to, Australia's financial reporting system.

Figure 3.1: Extract from FRC's SWOT analysis of the financial reporting framework[31]

SWOT analysis – Financial Reporting Framework
Weaknesses	Threats
Not all areas given equal attention and priority in developing international standards	Risk of fragmentation of the global IFRS [International Financial Reporting Standards] community
Exclusive focus on financial reporting, neglecting to some extent the wider context in which economic entities operate	Discussion of radical proposals to regulate audit practices, for example in the European Union
Complexity and length of annual reports	Failure of a big 4 accounting firm, potentially leading to a lack of competition in the audit market
Level of financial literacy among users, including company directors, leading to issues such as expectation gaps for audit reports	Plethora of narrow additional financial reporting burdens being advocated, for example as part of a Corporate Social Responsibility or Environmental, Social and Governance Agenda, without consideration as to their broader appropriateness
	Complexity caused by Australia's federal structure

3.19      The annual report also provides further information about the state of Australia's financial reporting system. Notably, the FRC has concluded that the 'independence framework in Australia continues to operate effectively'.[32] As the report elaborates:

[o]n the basis of its work during the period covered by this report, the FRC has not become aware of any evidence to suggest that the systems and processes used by audit firms to ensure compliance with auditor independence requirements are not working effectively.[33]

3.20      However, the annual report highlights two potential areas of concern with the auditor independence framework. First, the risk of duplication and regulatory overlap. The annual report indicates that in conducting its auditor-independence functions, the FRC places a high reliance on the activities of ASIC:

During 2010-11 the FRC continued to monitor the effectiveness of Australia's auditor independence requirements. The FRC performs this work primarily through the use of information obtained from the Australian Securities and Investments Commission (ASIC) and the other bodies with which it has a Memorandum of Understanding (MOU) and through periodic meetings with those bodies and other stakeholders such as auditing firms.[34]

3.21       The summary of the process by which the FRC conducts is auditor independence oversight functions is consistent with Treasury's findings outlined in its March 2010 consultation paper Audit quality in Australia: A strategic review. Treasury concluded that the 'FRC's annual Auditor Independence Report is largely based on the annual report that ASIC prepares on its Audit Inspection Program'.[35] Accordingly, Treasury has proposed that the option of transferring the FRC's auditor independence functions to ASIC should be explored.[36]

3.22      The second potential area of concern is the issue of whether the auditor independence framework is sufficient to deliver audit reports that meet the statutory objects of reliability, relevance and user-friendliness. The annual report also states that the FRC's key strategic issues include 'how to monitor the effectiveness of auditor independence and other audit quality drivers'.[37] The annual report notes that the veracity of audit reports is a topic of growing national and international interest:

A key international and local focus affecting auditing and assurance over the past year has been the debate on auditing related issues following the global financial crisis. These issues include audit quality, the role of the auditor and auditor reporting. There is also a considerably heightened focus on the independence of auditors and greater scrutiny over the scepticism and professional judgement exercised by auditors, and as a consequence, growing international pressure for greater regulation of auditors.^[38]

3.23      Treasury noted that concerns have been raised about the 'expectation gap' between public understanding of the nature of audit reports and the audit profession's view of their audit responsibilities.[39] These concerns have lead to recommendations for increased FRC activity. For example, the Australian National Centre for Audit and Assurance Research has recommended the FRC establish a taskforce to address the factors that may be contributing to the expectation gap.[40] While not directly referenced in the annual report, it appears that the FRC is responding to these concerns. As detailed in the annual report, as part of its strategic plan in 2010–11 the FRC introduced the  Audit Quality Task Force:

In 2011 the FRC decided that audit quality is a strategic issue for the FRC and the Audit Quality Task Force was established to focus on this issue. The Task Force identified recent key publications, reports and other initiatives in relation to audit quality in Australia, in other jurisdictions and at the international level for the purpose of formulating its work program for 2011-12.[41]

Committee view

3.24      The committee is satisfied with the annual report. The FRC's strategic plan appears broadly consistent with the role of the FRC as envisioned under the ASIC Act. The committee considers that future annual reports should evaluate the priority projects under the strategic plan against the objects in section 244 which underpin Australia's financial reporting system.

3.25      The committee draws to Parliament's attention the identified areas of weakness in, and threats to, Australia's financial reporting system. The committee will monitor developments in these areas with interest.

3.26      The committee notes Treasury's strategic review of audit quality in Australia and the proposal to transfer the FRC's audit independence functions to ASIC. The committee considers that the audit quality framework must promote auditor independence and require audit reports to be transparent, accurate and reliable. The committee is concerned that unnecessary duplication between the functions of ASIC and the FRC is avoided. The committee may seek the views of ASIC on this matter, as part of the committee's oversight of the Commission. It will also monitor the work of the FRC's Audit Quality Task Force and may seek the FRC's advice about the progress of the Task Force's work.

Review of the 2010-11 annual report of the Auditing and Assurance Standards Board

3.27      As the committee has previously noted, the 2009-10 financial year marked the introduction of the Clarity standards–43 revised auditing standards amended as part of a three-year review process.[42] The 2010-11 annual report notes that the AUASB 'monitored and facilitated' the introduction of the standards during the 2010–11 financial year.[43] However, the report does not contain an assessment of how the Clarity standards have measurably contributed to achieving a transparent and reliable financial reporting framework.

3.28      From the information obtained in the annual report, it is evident that Clarity responds to, and is consistent with, international developments in auditing standards following the global financial crisis. As noted in the annual report:

...a major focus of the International Auditing and Assurance Standards Board (IAASB) and the AUASB over the past three to four years has been the revision and re-issue of the Australian Auditing Standards (ASAs) in Clarity format. The IAASB issued its suite of Clarity auditing standards in 2009 effective for reporting periods beginning on or after 15 December 2009, and the AUASB released confirming Clarity accounting standards in 2009, operative for financial reporting periods that commenced on or after 1 January 2010. These revised auditing standards significantly increased the requirements on auditors in a number of areas of concern, including accounting estimates, using the work of experts, group audits and communication with audit committees. These standards, which are now applied by auditors, address many of the areas of concern raised during the crisis.[44]

3.29      While not referenced, the committee notes that this approach accords with the views of Treasury that 'global consistency is a critical goal that must always be borne in mind in considering any changes to the standard audit report'.[45] Treasury further concluded that 'it will be essential for the Auditing and Assurance Standards Board (in accordance with the FRC's strategic direction) to continue to base the Australian Auditing Standards on the standards issued by the International Auditing and Assurance Board'.[46] The committee also notes that Ms Merran H Kelsall, Chairman, AUASB, was appointed a member of the IAASB, and the IAASB task force, from 1 January 2011.[47]

3.30      The AUASB did not report any concerns with the FRC's activities in setting the Board's strategic direction, procedures and priorities. The annual report does not provide an evaluation of the merit of the interaction between the FRC and the AUASB as contemplated under Part 12 of the ASIC Act. The annual report did, however, note that the FRC is integrated within the AUASB's broad organisational structure:

Figure 3.2: AUASB organisational structure[48]

3.31      The annual report also comments that during the 2010–11 financial year, there were no parliamentary committee reports relating to the Board's activities.

Committee view

3.32      The committee is satisfied with the annual report of the AUASB. The committee expects that future annual reports will include an assessment of the achievements of the Clarity standards in promoting relevant and reliable auditor reports.

3.33      As the committee has noted, it is concerned with any divergence between auditors' statutory requirements and public expectations about auditors' role within Australia's financial services system. The committee will closely monitor developments in this area and may seek the AUASB's advice on the efficacy of Australia's auditing standards.

3.34      The committee draws the Board's attention to the reports on annual reports prepared by this committee and the Senate Economics Legislation Committee. It would be appropriate for these reports to be referred to in the discussion in the annual report regarding the external scrutiny of the AUASB.

Review of the 2010–11 annual report of the Australian Accounting Standards Board

3.35      As Treasury noted in its consultation paper Audit quality in Australia: A strategic review, the implications of the global financial crisis extend to accounting standards at the domestic level:

There have been a number of significant developments relating to accounting standards at the international level. The G-20 has requested that the two global accounting standard setters, the International Accounting Standards Board (IASB) based in London and the US Financial Accounting Standards Board (FASB), address a range of accounting issues that have arisen during the global financial crisis. These issues include fair value measurement, the simplification of the standard relating to financial instruments, the treatment of off-balance sheet exposures and enhanced disclosure of complex financial products. The G-20 has also urged the IASB and FASB to work towards a single set of global accounting standards.[49]

3.36      Consistent with the object of promoting Australian entities within international markets, the 2010–11 annual report notes that developments in domestic accounting standards have been shaped by events at the international level.[50] As documented in the annual report, the international community's response to the global financial crisis has influenced the responsibilities of the AASB in delivering accounting standards that promote transparent and reliable accounting reports:

Most of the revised Standards issued were to maintain conformity with International Financial Reporting Standards (IFRSs) issued by the International Accounting Standards Board (IASB). Many of these can be attributed to the IASB's ongoing response to the global financial crisis. Similarly, most of the AASB Exposure Drafts issued incorporated IASB proposals. During the year, the Board made submissions to proposals of both the IASB and the International Public Sector Accounting Standards Board (IPSASB). The AASB had regard to not–for–profit and public sector issues in the process of developing the new and revised Standards.[51]

3.37      The report does not evaluate the effect the revised standards, as the standards had not commenced as of 30 June 2011. As Mr Kevin Michael Stevenson, Chairman, reported:

Preparers and auditors can take some comfort from the fact that none of the major changes coming will have an early application date. There will be a number of years in which to make transitions.[52]

3.38      As the committee has previously noted, during the 2009–10 financial year the AASB revised the accounting reporting framework for 'non-public accountable entities'.[53] The annual report does not present an analysis of the impact of the new framework, known as the Tier 2 Australian Accounting Standards–Reduce Disclosure Requirements, as the standards are not due to commence until 2013.[54]

3.39      In detailing the AASB's management and accountability structures, the 2010—11 annual reports notes the statutory responsibilities of the FRC to appoint Board members and provide the Board strategic direction and advice. The annual report includes the following diagram showing the FRC's position within the Board's operational matrix:

Figure 3.3: AASB organisational structure[55]

3.40      The AASB did not report any concerns with the FRC's activities in setting the Board's strategic direction, procedures and priorities.

3.41      The annual report also comments that during the 2010-11 financial year there were no parliamentary committee reports regarding the Board's activities.

Committee view

3.42      The committee was satisfied with the annual report. The committee draws parliament's attention to the work of the AASB to improve accounting standards to take account of the issues raised by the global financial crisis. The committee expects that as these standards commence operation, future annual reports will include an assessment of the contribution that they have made to promoting reliable account and, ultimately, commercial certainty.

3.43      The committee draws the Board's attention to the reports on annual reports prepared by this committee and the Senate Economics Legislation Committee. It would be appropriate for these reports to be referred to in the discussion in the annual report regarding the external scrutiny of the AASB.

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