impact OUTSIDE THE EUROPEAN UNION

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EU impact OUTSIDE THE EUROPEAN UNION AUDIT REFORM On the 17 June 2016, 28 EU Member States, followed by Norway and Iceland implemented new regulation regarding statutory audits of Public Interest

Notwithstanding the Referendum on membership of the EU, held in the UK on 23 June 2016, the UK remains part of the EU.

1 EU impact OUTSIDE THE EUROPEAN UNION AUDIT REFORM On the 17 June 2016, 28 EU Member States, followed by Norway and Iceland implemented new regulation regarding statutory audits of Public Interest Entities (PIEs) and their annual and consolidated financial statements. The EU Audit Reform comprises EU Regulation EU/537/2014 and EU Directive 2014/56/EU. Notwithstanding the Referendum on membership of the EU, held in the UK on 23 June 2016, the UK remains part of the EU. This publication covers the general requirements set out in the EU Audit Reform and does not reflect in detail the Member State options: ÞÞ Prohibited Non-Audit Services (NAS) Who do the prohibitions on the provision of NAS apply to? Indirect provision of a service ÞÞ Mandatory firm rotation ÞÞ Audit committee s role and responsibility; and THE DEFINITION OF AN EU PIE ÞÞ Audit reporting requirements. THE KEY CHANGES FOR AN EU PIE EU MEMBER STATE OPTIONS THE IMPACT OF THE KEY CHANGES ON A NON-EU RELATED ENTITY OF AN EUPIE What this means and how this impacts a non-eu related entity of an EU PIE WHEN THE REGULATIONS COME INTO EFFECT If your company, or an entity in your group, meets the definition of an EU PIE (see next section), we recommend that you consult with your BDO adviser who can assist you with the specific requirements relating to the EU Audit Reform and the Member State options that are applicable to your company.

entity is incorporated in the EU and meets one of the 4 definitions above.

Are All Stock Exchanges in the EU Regulated Markets?

The European Securities and Market Authority (ESMA) maintain a searchable database of EU Regulated Markets, on their website

Credit Institutions and Insurance Undertakings There are databases available to identify credit institutions and insurance

2 what is the definition of an EU PIE? The EU Audit Reform does not apply to an entity listed outside the EU, for example the US, China and Australia unless the entity is incorporated in the EU and meets one of the 4 definitions above. However, the EU Audit Reform may affect the group where a group entity is an EU PIE. 1. Are All Stock Exchanges in the EU Regulated Markets? No, most entities incorporated in EU Member States can operate on a number of different markets. The European Securities and Market Authority (ESMA) maintain a searchable database of EU Regulated Markets, on their website where you can verify whether the exchange, where your entity is listed, is an EU Regulated Market. 2 & 3. Credit Institutions and Insurance Undertakings There are databases available to identify credit institutions and insurance undertakings authorised in the EU and would therefore be considered a PIE: Credit Institutions Insurance Undertakings 4. Entities designated by an EU Member State to be a PIE Member States have the option to designate entities as PIEs (over and above definitions 1-3 above) generally in respect to undertakings that are of significant public relevance because of the nature of their business, their size or the number of their employees. 2

what are the key changes PIE? for an EU The key changes resulting from EU Audit Reform that may be applicable to your company or group: a. Prohibitions on NAS b.

how does it impact a non-eu related entity of an EU PIE Most countries in Europe are Member States of the EU, which currently has 28 Member States.

3 what are the key changes PIE? for an EU The key changes resulting from EU Audit Reform that may be applicable to your company or group: a. Prohibitions on NAS b. Mandatory rotation of audit firms and tendering provisions c. Audit committee s role and responsibility and d. Audit reporting requirements. Member State Options what does this mean? how does it impact a non-eu related entity of an EU PIE Most countries in Europe are Member States of the EU, which currently has 28 Member States. Within the EU Audit Reform, there are over 50 Member State options available to give the Member States flexibility to implement the rules how they feel best to protect their capital markets. In general, this flexibility allows for more stringent or softer rules than the rules in the EU Audit Reform. For example some Member States have included additional entities in their definition of PIE; additions to the list of prohibited NAS; the Regulation is mandatory rotation every ten years but Member State option to shorten (more stringent) or lengthen to up to 20/24 years if tender after year 10 (less stringent). The rules of the EU Member State where the EU PIE is incorporated, not where they are listed. what is the impact of the key changes? a. Prohibited Non-Audit Services (NAS) on a NON-EU related entity of an EU PIE There is a list of NAS that cannot be provided to EU PIEs. The full list of prohibited services is included in Appendix A. Though it is worth noting that some Member States (for example, France and the Netherlands) have prohibited ALL NAS, so the implementation of these regulations will have no effect in those Member States. The existing local rules will simply continue to apply. The definition of a PIE under the EU Audit Reform encompasses more entities than the IESBA Code, eg unlisted insurance undertakings and unlisted credit institutions. Therefore, the prohibitions are now applicable to more entities. A further change as a result of the EU Audit Reform is the consequence of providing a prohibited NAS. A breach of the EU Regulations by providing prohibited NAS will lead to the resignation of the statutory auditor. Who do the prohibitions on the provision of NAS apply to? The full list of prohibitions on the provision of NAS only applies to the: The European Contact Group (ECG) of which BDO is a member, is developing interpretations and guidance on the new EU Audit Reform rules. The ECG website provides the different Member States proposed or enacted options; and a host of information relating to the respective EU Member States laws. It also includes a summary document called the ECG Dashboard that provides a one page summary of how each Member State has or may implement some of the Member State options. Unless indirect services are provided which would flow through to the group (see section 4C). These are defined as EU PIE Restricted Entities. 3

What are the prohibitions that apply to non-eu related entity of an EU PIE There are 3 NAS that are prohibited to be provided by the auditor of an EU PIE or a network firm of the auditor to any

Bookkeeping and preparing accounting records and financial statements 3.

technology systems Note: the local and international independence rules and related prohibitions continue to apply.

that apply to any parent or controlled undertaking including those outside the EU. The full list of prohibitions is applicable only to the EU entities yellow highlighted boxes.

4 What are the prohibitions that apply to non-eu related entity of an EU PIE There are 3 NAS that are prohibited to be provided by the auditor of an EU PIE or a network firm of the auditor to any parent or controlled undertaking including those outside of the EU: 1. Services that involve playing any part in the management or decision-making of the audited entity 2. Bookkeeping and preparing accounting records and financial statements 3. Designing and implementing internal control or risk management procedures related to the preparation and/or control of financial information or designing and implementing financial information technology systems Note: the local and international independence rules and related prohibitions continue to apply. Example 1 If your company is the ultimate parent company listed in Canada or the non-listed controlled undertaking in India, the only prohibited services for your company would be the 3 listed above that apply to any parent or controlled undertaking including those outside the EU. The full list of prohibitions is applicable only to the EU entities yellow highlighted boxes. * the prohibitions do not apply to the 25% equity in the non-listed Dutch entity as it not a controlled undertaking. * Indirect provision of a service Although the prohibition on the provision of most NAS do not apply to entities incorporated outside the EU, some services provided to those entities could be prohibited if they are also to be provided directly or indirectly to an EU PIE Restricted Entity. For example, if a US parent company engages a BDO Network Firm to provide internal audit services across the group, including EU PIE Restricted Entities, this would be a breach of the EU Audit Reform rules, if a BDO Member Firm is the auditor of an EU PIE in the group. Similarly, an engagement to design and implement a risk management system and/or internal controls over the financial systems, which is to be rolled out across the group, for example to the EU PIE Restricted Entities, would be prohibited or if provided, would be a breach of the EU Audit Reform rules if a BDO Member Firm is the auditor of an EU PIE in the group. b. Mandatory rotation of audit firms The regulations require audit firm rotation after 10 years in office. There are transition provisions where the EU PIEs audit firm has already been in office in excess of 10 years. There is a member state option to: Extend the rotation period to 20 years if the audit has been put out to competitive tender within a 10 year period. Member states are not required to implement this option. The requirements of the competitive tendering process are described below. Extend the rotation period to 24 years, where joint auditors are used and if the audit has been put out to competitive tender within a 10 year period. Choose a rotation period less than 10 years, for example, Hungary are considering requiring audit firms to rotate every 8 years. Once an audit firm has rotated off, they and any member of their network cannot tender for the audit for the following 4 years (cooling-off period). Mandatory rotation applies to the auditor of the EU PIE only. However, many companies may decide they want the same auditor for all components within the group. As a result, your company, as a related entity of an EU PIE, may have to change auditors as a result of the mandatory firm rotation requirement and/or a more restrictive company decision. 4

Competitive tendering process The prescribed tendering process requires the audit committee of the EU PIE to be closely

There can be no constraints placed on the audit committee of the EU PIE, including no constraints placed on them by the

Their responsibility, when selecting a new auditor, will be to act in the interest of the PIE not the group as a whole.

Note: there is a small entity exemption where the Board assume the roles and responsibilities of an audit committee.

5 Competitive tendering process The prescribed tendering process requires the audit committee of the EU PIE to be closely involved in the appointment of the auditor and to select the auditors invited to tender. There can be no constraints placed on the audit committee of the EU PIE, including no constraints placed on them by the parent companies audit committee or Board. The EU PIE audit committee must be independent. Their responsibility, when selecting a new auditor, will be to act in the interest of the PIE not the group as a whole. c. Audit committee s role and responsibility Each EU PIE is required to have an audit aommittee. Note: there is a small entity exemption where the Board assume the roles and responsibilities of an audit committee. roles &! RESPONSIBILITIES As a related entity of an EU PIE, your company may be required to provide information to the EU PIE to assist the audit committee in meeting its roles and responsibilities. 5

d. Cap for non-audit services for statutory auditors In addition to the restrictions on the type of non-audit services that can be provided to PIEs by the statutory auditor (BDO), there is also a cap

Audit Reporting requirements The EU Regulations have introduced additional requirements in respect of auditor s reports issued.

6 d. Cap for non-audit services for statutory auditors In addition to the restrictions on the type of non-audit services that can be provided to PIEs by the statutory auditor (BDO), there is also a cap on the amount of nonaudit fees that can be generated by the statutory auditor from non-audit services in any given financial year, calculated as follows: e. Audit Reporting requirements The EU Regulations have introduced additional requirements in respect of auditor s reports issued. These changes are designed to enhance investors understanding of the audit process, including the critical judgements made. Average audit fees charged by the network for statutory audit work over the last three years Current year non audit fees billed by PIE Statutory Auditor (excludes fees for services that must be provided by the auditor by law) 70 % There is a Member States option to set a lower cap in relation to non-audit services and some Member States have set the cap at 30% and others at 50%. The cap will come into effect for accounting periods commencing on or after 17 June 2019, as the calculation relies on there being an average of three years statutory audit fees. Should the cap be breached, BDO will be prevented from accepting appointment for the financial period in question or signing the audit report if they had previously accepted reappointment. Some of the major changes include: Reporting on the Key Audit Matters arising in relation to the audit:» A description of the most significant risks of material misstatement, including fraud;» A summary of the auditor s response to those assessed risks; and» Where relevant, key observations arising with respect to those risks» Where relevant, a clear reference to the disclosures in the financial statements. Explanation as to how the audit was considered capable of detecting irregularities, including fraud; A declaration that prohibited non-audit services have not been provided by the statutory auditor or a network member firm and the audit firm remain independent; and Indicate any services, in addition to statutory audit services that have been provided to the entity and its controlled undertaking. See materials available on to support the changes brought about by the new approach to Auditor Reporting. The new and revised Auditor Reporting International Standards on Auditing (ISAs) are effective for audits of financial statements for periods ending on or after December 15,

what happens if the auditor cannot make?

inadvertent immaterial breach of the prohibition on the provision of NAS were discovered, the auditor would be required to resign from the audit engagement.

Regulators of some Member States may implement an exception that would enable the auditor to issue an auditor s report provided adequate disclosure was provided.

7 what happens if the auditor cannot make? a declaration that prohibited NAS have not been provided If the auditor is unable to make the declaration in the audit report that prohibited services have not been provided, for example if an inadvertent immaterial breach of the prohibition on the provision of NAS were discovered, the auditor would be required to resign from the audit engagement. Based on the current wording of the EU Audit Reform rules, there is no exception for inadvertent immaterial breaches. Regulators of some Member States may implement an exception that would enable the auditor to issue an auditor s report provided adequate disclosure was provided. However, it is not expected that the majority of Member States will do this. As a related entity of an EU PIE, your company can assist the EU PIE s audit committee by monitoring/ engaging the non-audit services provided to your company and ensuring that prohibited non-audit services are not provided. Otherwise, this would result in the EU PIE s audit committee as well as their auditor being in breach of the EU Audit Reform rules. when do the new regulations? come INTO EFFECT Those provisions that affect the audit engagement for example the prohibition of certain NAS, tendering and firm rotation come into effect for accounting periods commencing on or after 17 June 2016: Year end First date effective 30 June July September October December January March April 2017 The provisions that are not specific to the audit engagement, for example the establishment of the audit committee, came into effect on 17 June

8 APPENDIX 1 An audit firm of an EU PIE is prohibited from providing certain non-audit services, those services are: a. tax services relating to: preparation of tax forms;* payroll tax; customs duties; identification of public subsidies and tax incentives unless support from the statutory auditor or the audit firm in respect of such services is required by law;* support regarding tax inspections by tax authorities unless support from the statutory auditor or the audit firm in respect of such inspections is required by law;* calculation of direct and indirect tax and deferred tax;* provision of tax advice;* b. services that involve playing any part in the management or decision-making of the audited entity; c. bookkeeping and preparing accounting records and financial statements; d. payroll services; e. designing and implementing internal control or risk management procedures related to the preparation and/or control of financial information or designing and implementing financial information technology systems; f. valuation services, including valuations performed in connection with actuarial services or litigation support services;* g. legal services, with respect to: the provision of general counsel; negotiating on behalf of the audited entity; acting in an advocacy role in the resolution of litigation; h. services related to the audited entity s internal audit function; services related to the audited entity s internal audit function; i. services linked to the financing, capital structure and allocation, and investment strategy of the audited entity, except providing services linked to the financing, capital structure and allocation, and investment strategy of the audited entity, except providing assurance services in relation to the financial statements, such as the issuing of comfort letters in connection with prospectuses issued by the audited entity; j. promoting, dealing in, or underwriting shares in the audited entity; k. human resources services, with respect to: management in a position to exert significant influence over the preparation of the accounting records or financial statements which are the subject of the statutory audit, where such services involve:»» searching for or seeking out candidates for such position; or»» undertaking reference checks of candidates for such positions; structuring the organisation design; and cost control * Certain tax and valuation services are not prohibited, provided the member states have exercised the option, so long as: They do not have a direct or have a clearly immaterial effect, separately or in aggregate, on the financial statements; and The estimation of the effect on the audited financial statements is comprehensively documented and explained in the additional report to the audit committee. The overarching principles of independence are complied with; and The audit firm will not place significant reliance on the work performed by the firm in respect of these services.

EU Audit Reform - FAQ s

EU Audit Reform - FAQ s 17 June 2016 2 1. What is a Public Interest Entity ( PIE )? i. All entities that are both governed by the law of a Member State and listed on a regulated market (includes both equity