Are auditors providing meaningful information in their resignation statements, and if not, why not? This article looks at the requirements and what stakeholders have been saying.
The requirements on auditor resignation are set out in sections 516-525 of the Companies Act 2006 (the Act). They are complex, and according to Sir Donald Brydon in his report of the Independent Review of the Quality and Effectiveness of Audit, not well understood, or if understood, consistently followed. In this respect his recommendations focused on public interest entities (PIEs) and their auditors, although he also noted the complexity of arrangements for non-PIEs.
What did Brydon say?
In his report, Brydon suggested that the vast majority of resignation statements say little of substance and that this information is not being shared in a timely manner. He recommended that amendments are made to the Act to clarify and strengthen the process by which auditors and companies inform shareholders and other stakeholders of an auditor’s resignation, dismissal or decision not to participate in a re-tender.
According to Brydon, the lack of clarity in the explanation required to be given for why the auditor has ceased to act contributes to the difficulty of improving audits. The belief is that this lack of clarity leads to boilerplate statements that are of little value to anyone.
Brydon recommended the introduction of a requirement for the auditor, as a minimum, to respond to the following questions in the case of a decision to resign or not to participate in a re-tender:
- Was the decision caused by a disagreement with the audit committee?
- Was the decision caused by the withholding of information by the company?
- Was the decision caused by the unwillingness of management to cooperate with the audit?
- Was the quality of the processes in the audited company such that the effort of auditing this company was greater than average and not reflected in the fees?
- Was there an issue of trust between auditor and either management or the board?
While these questions are helpful indicators of the matters that members and creditors might find useful, where they are connected to the auditor’s cessation of office, they cover areas of contention on which auditors might need legal advice before answering, which inevitably would impact the timeliness of information provided.
What is Government doing about this?
The Government, in its 2021 White Paper, Restoring Trust in Audit and Corporate Governance, agreed with the Brydon Review that the existing Companies Act provisions in this area are failing to provide meaningful information to shareholders and the regulator about the reasons for an auditor’s departure. It noted, however, possible concerns around auditor liability and that an unexpected departure of auditors may already be perceived by shareholders and others as a sign that a company has questions to answer about its financial reporting, regardless of whether the precise reasons are set out in the auditor’s departing statement. The Government is expected to reach a final view in the coming months on whether, and how, to implement the Brydon Review recommendations after taking account of responses to its consultation.
In our response to the BEIS White Paper, we recommended that there should be a requirement for auditors to always give a reason for resignation as a more effective solution to ensuring transparency and that there should also be greater opportunity for shareholders to question the directors about the reasons why an auditor has ceased to hold office.
As to the lack of useful information being a result of auditor concerns around liability, discussions with auditors suggest that this just isn’t the case and that there are much wider issues and challenges at play here.
Actions for auditors
Are there any actions auditors can take now? We think so, and take a look at these below.
Be clear on the requirements and timings
Firstly, when auditors cease to act for a company, they need to make sure they are absolutely clear about how the rules impact them, including whether (and by when) they need to make a section 519 statement of reasons for ceasing to hold office and who it needs to go to.
Remember, the rules vary depending on whether the company is a public interest company (PIC) or non-PIC, whether a non-PIC is a public or private company and when the auditor ceased to hold office. Auditors must also consider whether the reasons for resignation are ‘exempt reasons’, such as when the company is no longer required to have an audit. Both ICAEW and the FRC have developed guidance notes on the requirements, with flowcharts to help auditors (and companies) understand what they need to do and by when.
For private companies, it is also worth noting the exceptions in relation to deemed reappointment of auditors. ‘Deemed reappointment’ arises where no other auditor has been appointed by the end of the next period for appointing auditors and so, the auditor in office immediately before this time is deemed re-appointed. One of the most common exceptions is where the auditors have been appointed by the directors. In circumstances where the auditors are appointed by the directors, unless the auditors have been specifically reappointed, they will cease to hold office automatically at the end of the period for appointing auditors, and this is not, therefore, a resignation.
What matters connected to ceasing to hold office should auditors be bringing to the attention of members and creditors?
The Act does not provide guidance on the kinds of matters that should be brought to the attention of members and creditors. It is left to the auditor’s judgement.
Given the current requirements on audit firm rotation, we may see more resignation statements relating to situations where auditors choose not to participate in a tender for an entity that they have previously audited. A statement simply to this effect, ie, that the auditor has chosen not to participate in the tender, provides very little information to members and creditors about why they have made that decision. There may be specific matters that have had a direct impact on this such, as the firm reaching the end of the mandatory firm rotation period, a conflict of interest, the audit fee no longer reflecting the extent of work required, a breakdown in relationship between auditor and management, or concerns over the reporting of a company’s financial position or quality of its underlying processes.
Auditors may judge that these matters are of interest to members and creditors.
Lay the trail: communication and documentation are key
Auditors may be in for some difficult conversations with those charged with governance of a company about resignation statements, if their decision to resign comes out of the blue, without concerns or issues having previously been raised with them. Auditors should ensure that concerns are brought to the attention of those charged with governance as the audit progresses, and that these issues are clearly documented in their files. This will help to support auditors’ judgements as to what matters to bring to the attention of members and creditors.
Where auditors of non-PICs believe that there are no matters that they consider need to be brought to the attention of members and creditors, it is again worth ensuring that this is documented on file, including any discussion of the issues and judgements made – this is particularly relevant if an auditor would hesitate if asked whether they would be happy to take on this audit engagement again.
Make sure the statement is presented correctly
In preparing a statement under section 519 of the Act, the auditors are required to include:
- the auditor’s name and address;
- the number allocated to the auditor on being entered in the register of auditors kept under section 1239 of the Act; and
- the company’s name and registered number.
It would also be helpful to head up the section 519 statement with a clear reference to the requirement in the Act for such a statement.
A reminder for successor auditors
As successor auditors, there really is no excuse for failing to read the section 519 statements of predecessor auditors who have ceased to hold office – this information can help not only to inform client acceptance decisions but also the performance of the audit itself.
Quality management systems
With ISQM 1 on the horizon, audit firms should be in the process of designing and implementing their systems of quality management. This includes establishing quality objectives in relation to client acceptance and continuance, and identifying, assessing and responding to quality risks which might threaten the achievement of these objectives. Responses might include policies or procedures to enable auditors to escalate issues within audit firms, for review of resignation statements, and to ensure that the content of resignation statements is appropriately considered in acceptance decisions.
Share your views
We would be keen to hear from ICAEW members on this issue, especially on other actions that could be taken to enable the provision of more meaningful information in resignation statements. Please send your comments to louise.sharp@icaew.com
ICAEW guidance
External resources
Guidance on the circumstances in which the FRC is the appropriate audit authority, how the notification to the FRC should be made, and what it must cover is provided in the form of:
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