Audit Firm Governance Code Adopted in UK

A working group sponsored by the UK Financial Reporting Council has adopted a governance code for the auditors of listed company financial statements. The Audit Firm Governance Code will cover global audit firms that audit the accounts of 95 per cent of the companies listed on the London Stock Exchange. The code will be applicable to those firms that audit more than 20 listed companies, which essentially restricts it to the Big Four and other global audit networks. For these firms, the code sets a benchmark for good governance which other audit firms may wish to voluntarily adopt in full or in part. As with almost all European corporate governance codes, the Audit Firm Governance Code will operate on a comply or explain basis.

Drawing on aspects of the UK Corporate Governance Code, the audit firm code establishes a core principle that audit firms should appoint independent non-executives within their governance structure and deeply involve them in the governance of the audit firm. These independent non-executives will have a duty of care to the overall firm.

The code also embodies the idea that management at the audit firms should set a tone at the top that fosters quality audits, sound professional judgments, and the public interest. The firm should have a code of conduct and disclose the code on its website. Similarly, audit firms should publicly commit themselves to follow the governance code.

The code requires audit firms to maintain a sound system of internal control and risk management. Firms should annually evaluate the effectiveness of risk management and internal controls using a recognized internal control framework, such as the Turnbull Guidance.

The code sees the management of reputational risk as being quite important. The ability of a firm to continue to operate in the listed company audit market largely depends on its reputation of conducting high quality audits. The firm’s independent non-executives can be particularly useful in addressing reputational risks.

Another code principle is that firms should establish confidential whistleblower procedures enabling people to report concerns about the firm’s commitment to quality work and professional judgment. In addition, the code envisions that audit firms will publish audited financial statements in accordance with ISFR or GAAP. And, management should annually publish commentary on the firm’s financial performance and prospects.

Audit firms should also commit to a dialogue about the code with shareholders and audit committees at the companies whose financial statements they audit. This principle is based on the belief that an audit firm’s continued ability to maintain confidence in its audits depends on good two-way communication between the firm and shareholders and audit committees. Independent communication channels are likely to be most important when events occur posing a major threat to a firm’s reputation.

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