The implications of the new Auditors Act for your company
Independence and impartiality. That is the purpose of the forthcoming amendments to the Danish Auditors Act, which will come into force on 17 June 2016 at the latest.
We see growing demands from politicians and the general public for transparency in the financial statements of companies. At the EU level, various rules have therefore been adopted to protect companies against conflicts of interest among consultants.
If you are a business manager, it means that you now need to consider how to organise and compose the external advisory services and decide who should provide them.
In addition to increased transparency, the new rules have been adopted to make sure companies obtain the best possible advice. In this context, corporate managements should take a close look at their panels of consultants in relation to the assignments that are solved externally by consultancies and business partners in the fields of bookkeeping, accounting, HR and payroll, coupled with legal assistance and audit services.
385 PIEs will be affected – initially
The draft Bill proposes that the so-called PIEs (Public-Interest Entities) should ensure independent audits by drawing a sharp line between the preparation of financial statements and the subsequent auditing process. The affected undertakings include, among others, listed companies, banks, insurance companies and mortgage credit institutions.
- MUST rotate auditors every seven years;
- ARE NOT ALLOWED to buy consultancy and audit services from the same audit firm;
- MAY ONLY buy consultancy services from the appointed auditor for 70% of the total fees paid;
- MAY ONLY buy tax advisory services of a minor nature from their auditor.
Why these changes, and how should a PIE deal with them?
Besides public transparency, impartiality and independence are, as mentioned, the primary reasons for the new rules. The purpose is to avoid the situations where the auditor both provides consultancy and subsequently acts as a reviewing body in relation to the very same financial statements. By pursuing such a practice, companies risk that any poor advisory services that may be provided will never be disclosed to the public.
The limit imposed on the percentage of consultancy services purchased from the auditor may, offhand, seem to be contradictory since the Bill has already established rules prohibiting companies from obtaining advice from the auditor. In practice, however, an audit will always involve some degree of advice – and, accordingly, consultancy services –, and in respect of the public-interest entities, this has therefore been solved by imposing a limit of 70% of the total fees paid.
The obligation to rotate audit firms is another way of ensuring that a company's financial statements are once in a while audited by fresh, unbiased eyes, rather than being assessed by the same audit firm for the 25th consecutive year.
For a public-interest entity, it is therefore extremely important to consider whether the audit firm, according to the entity’s current practice, can be said to be independent – and maybe start identifying new possibilities of consultancy right away.
So far, only around 385 public-interest entities will be affected directly by the coming tightening in Danish legislation (source: Børsen).
What about the rest of us? What should we do?
It is true that legislation will primarily affect PIEs, but several experts predict that many other companies are going to follow although there is no statutory requirement at this point in time (source: Børsen). This means that the new Act could also have an impact on other forms of business entity, such as the public limited company (A/S) and the private limited company (ApS).
The new legislative amendments are in many ways a continuation and extension of the amendments to the Danish Auditors Act which came into force on 1 January 2013 and offered a wide range of relaxations of the rules governing public and private limited companies.
What is particularly interesting is the fact that, since 2013, reporting class B enterprises subject to an audit obligation have been able to opt for an ’extended review’ instead of an audit. As such an option has to be made at an annual general meeting and only applies as from the next following financial year, it is not until now that we are seeing the effects of this solution.
In an extended review, the auditor examines fewer items, and the solution may therefore be economically beneficial. The possibility of opting for an extended review is interesting for the businesses that do not require the additional security and “seal of approval” offered by an audit.
In common with outsourcing of functions in the administrative area, it is not only a professional, but also an attitudinal and strategic choice whether a business decides to opt for the review or the audit if the business belongs to the form of entity that has the option.
If you are subject to an audit obligation
If your business is subject to an audit obligation, but is not a PIE, you need not take any action at this point.
Nevertheless, if you would like to obtain independent consultancy services, you are free to make a distinction between audit services and consultancy services.
If your business is a reporting class B enterprise and meets certain criteria, you are entitled to opt for an extended review instead of an audit. The criteria that must be met are that the business is not allowed to exceed two of the following limits for two consecutive financial years:
- Revenue: DKK 89 million
- Balance sheet total: DKK 44 million
- Number of employees: 50
If you are not subject to an audit obligation
Small businesses still have the possibility of claiming exemption from the audit and extended review. To be eligible, these businesses are not allowed to exceed two of the following limits for two consecutive financial years:
- Revenue: DKK 8 million
- Balance sheet total: DKK 4 million
- Number of employees: 12
For many businesses, it is unnecessary to carry out the in-depth controls and inspections involved in an audit or extended review. For others, it is a good idea, especially if the business is planning a merger, acquisition or investment – or simply is going to take out a loan from the bank.
Whether the business should claim exemption from the audit and extended review is a decision to be taken by the board of directors and management, and here it is an advantage to seek advice from two or more sources.
If the business wants to exercise the possibility of audit exemption, it means that the business can choose to concentrate its purchases of financial reporting and consultancy services in one place and, thereby, avoid the cost of the extra work processes.
The draft Bill is based on various EU rules adopted by the European Parliament in April 2014. These are the rules that have to be implemented into Danish law by the coming summer.
Advice from Azets
At Azets, we provide advice in the fields of legal, HR and accounting services. We assist with legal challenges related to employment law, tax law and company law. We also provide advisory services and assistance with assignments related to VAT, company formation and other business changes.