FRC Proposes Strengthening Auditor Reporting Requirements on Legal and Regulatory Breaches

The Financial Reporting Council (FRC) is taking steps to reinforce auditor reporting standards concerning the detection and disclosure of material misstatements resulting from non-compliance with laws and regulations. The initiative aims to clarify when auditors should report such breaches and other significant matters to relevant regulatory bodies, thereby enhancing the audit's utility and informativeness.

By implementing these changes, the FRC intends to provide increased assurance to users of financial statements that potential material misstatements have been adequately evaluated by auditors. This important move seeks to align auditing practices more closely with the evolving landscape of legal and regulatory compliance.

The FRC's consultation focuses on enhancing both ISA (UK) 250 Section A and ISA (UK) 250 Section B. Let's delve into the specifics of these sections:

ISA (UK) 250 Section A—Compliance with Laws and Regulations:

• The auditors' primary responsibility is to ensure that financial statements are free from material misstatements, whether they result from fraud, errors, or non-compliance with laws and regulations.
• Recognizing that auditors cannot be expected to assess every law and regulation applicable to an entity, the FRC is proposing a more robust risk assessment process. This mechanism will assist auditors in identifying laws and regulations that could materially affect financial statements.
• Ultimately, this change seeks to establish an effective system for auditors to scrutinize and identify instances of non-compliance, helping them fulfill their obligations efficiently.

ISA (UK) 250 Section B—Auditor Reporting to Regulators:

• ISA (UK) 250B builds on the existing framework that mandates auditors of public interest entities to report to regulators when they encounter significant matters relevant to regulatory bodies.
• The FRC is proposing to introduce a more principles-based approach that would require auditors to report information of significant importance to regulators, even when specific laws or regulations don't explicitly demand such reporting.
• This change is designed to ensure that essential information is communicated to the relevant authorities, especially when it could have a profound impact on the audited entities and the broader financial sector.

Mark Babington, the FRC's Executive Director of Regulatory Standards, emphasized the role of auditors in assessing risks arising from non-compliance with legal and regulatory obligations. He stated, "Enhancing auditor requirements in this area will provide users of financial reports and accounts with improved confidence that risks which could have an impact on a company are being appropriately managed and reported."

To implement these proposed changes, the FRC suggests an effective date for audits of financial statements for periods commencing on or after December 15, 2024. The consultation period for these enhancements is open until January 12, 2024, as the FRC seeks valuable input from various stakeholders.

These proposed changes reflect the FRC's commitment to enhancing transparency and accountability in the auditing process, ensuring that legal and regulatory breaches do not go unnoticed, and their potential impact is effectively managed.