12 June 2002

"Restoring Confidence in the Australian Auditing Industry" - Keynote Address to the Conference on New Directions in Australian Auditing and Accounting Standards, Sydney Hilton

At the outset I should say two things: firstly, my belief that there exists an overwhelmingly strong confidence in the quality of auditing in Australia; secondly, it is also my belief that we can improve on the structural framework around financial reporting quality.

Nevertheless, the present level of scrutiny of the accounting profession is pervasive, global, and at the forefront of public policy attention.

Corporate failures here and in the United States have led to widespread questioning whether disclosure practices are working and whether the supporting regulatory frameworks are sufficiently robust.

They have prompted scrutiny of the regulation of the accounting profession, a renewed focus on auditor independence issues, and an examination of the responsibilities of senior management, boards of directors, audit committees, analysts, ratings agencies and financial institutions.

But corporate failures nearly always reflect poor business judgements rather than poor auditing and accounting practices. Not everything laid at the door of the profession properly belongs there. But professional reputation is everything.

The profession would be wrong to conclude that the problems are only ones of perception. Even problems of perception need to be addressed if the profession is to enjoy the full confidence it needs to do its job effectively, and if it is to continue to attract and retain the right people.

There is a real opportunity at present for the profession to step forward and show leadership:

  • To contribute ideas on audit reform;
  • To recognise the international character of the debate and the need for national solutions to take into account what is happening in key capital markets.Given that Australia accounts for only around 2┬áper cent of international capital flows, we cannot afford to set our regulatory hurdles either too high or too low if Australian companies are not to be disadvantaged in relation to their international competitors;
  • Thirdly, to debate internally ways the profession can safeguard its strong ethical tradition and also ways it can help address the audit expectations gap by better educating market participants about the meaning of audit reports, risk/return trade offs and the role of auditors.

I would also urge the profession and its clients to contemplate why the market for audit and non-audit services had become so concentrated even before the demise of Andersens - and why the second tier firms have so far been unable to bridge the gap.

For its part, the Government is committed to ensuring that Australia has an effective regulatory and disclosure framework that is at the forefront of defining world's best practice.This includes strong auditing and accounting standards, and a robust supporting framework.

The Government is concerned to ensure that the structures and incentives are in place for a properly informed market, but it will not impose additional legislative requirements unless there is a clear failure of market mechanisms to produce appropriate outcomes.

Legislation is appropriate however where it delineates broad parameters for the conduct of business, removes uncertainty in the operation of the law and clarifies the rights, duties and responsibilities of stakeholders.

Australia has already achieved significant regulatory change in the accounting standard setting area, through the Corporate Law Economic Reform Program and I believe the Australian Accounting Standards Board and its oversight body, the Financial Reporting Council, are operating effectively under these new arrangements.

The focus of much of the Australian debate on audit reform has been the Ramsay report on auditor independence.

However, the Government's reform agenda goes well beyond auditor independence to include an examination of the financial reporting framework as a whole.

The Government recognises that a full consideration of audit quality must include:

  • the market for audit and non-audit services, particularly as it affects pricing and therefore quality of the audit;
  • the framework for setting auditing standards, whether they should have the force of law, and the international harmonisation of audit standards;
  • the rules and practices governing the audit engagement including the respective roles of management and the board;
  • auditor independence issues;
  • the structures for oversight of the profession, including disciplinary procedures, ethical rules, external quality assurance, educational requirements, professional development, competency standards etc;
  • liability issues ; and
  • corporate disclosure generally.

The Government's consideration of the financial reporting framework also includes pursuit of its commitment to international convergence to a single set of high quality accounting standards. This is a process the Commonwealth Government aggressively committed itself to with the CLERP reforms.

One of my core objectives is to have Australia at the forefront of building a strong international commitment and consensus of the need to adopt a single set of internationally accepted accounting standards by no later than 2005.

There is a lot of hard work to be done to achieve this, particularly converging US GAAP with IAS. On my recent visit to the United States the overwhelming message I received was "Yes, we agree we need international standards but we have to deal with Enron first."

My strong belief is that a set of high quality, internationally-agreed standards is a vital part of the solution to Enron and HIH.

The real issue, of course, is the quality of disclosure to the public - shareholders and potential shareholders. Financial reporting is the foundation of all corporate disclosure.

The language of financial reporting must be clear. In a globalised economy, with an increasingly large percentage of people having more of the monetary value of their lifetime work tied up in securities, we cannot abide a system that allows something to "get lost in the translation."

So the commitment of our country to international accounting standards is a fundamental commitment to the quality of financial reporting and corporate governance.

I am, therefore, pleased to announce that I have today approved funding of an extra $2 million over the next two years to help Australia meet that goal.

This money will significantly boost Australia's financial contribution towards the setting of international accounting standards by the International Accounting Standards Board in London, which performs work on standards convergence for its stakeholders. The IASB has been working very closely for many years with the Australian Accounting Standards Board and other national standard-setters to develop a single set of high quality accounting standards for world-wide use. Australia has played a very significant role in that work, especially at a high quality technical level.

I am confident this $2 million contribution will prove to be a major step in reaching our objective of Australia having one set of international standards by 2005.

Key stakeholders broadly agree that adoption of IASB standards is very much in Australia's interest. It will bring significant benefits, such as lower capital and compliance costs and easy comparison of financial accounts of Australian and foreign-based companies. It will also be a considerable improvement on the existing cumbersome procedure whereby Australian standards are periodically updated to reflect IAS.

Adoption of the standards will also mean that audit certificates attached to financial statements will be able to be signed off as IAS consistent. This is expected to improve the opportunities of local companies to attract capital and issue debt instruments, particularly from overseas.

The $2 million will come from the National Guarantee Fund administered by the Australian Stock Exchange and will be in addition to the $2.8 million currently contributed each year to the work of the Australian Accounting Standards Board by other stateholders in standard-setting process - the federal, state and territory governments, the three accounting bodies and the ASX.

To help guide its approach about oversight arrangements for the accounting profession, the Government has before it:

  • The CPA proposal for an umbrella regulatory body. This would oversee the accounting and auditing standards used by professionals in undertaking the financial reporting function, and also be responsible for monitoring compliance with these standards and the enforcement of disciplinary matters.
  • We also have the Ramsay recommendation for an auditor independence supervisory board.
  • The Chairman of the Auditing and Assurance Standards Board, Mr Bill Edge, has recently stated that auditing standard setting was under-resourced.

    One option to address this issue - and to assist monitoring and oversight of auditing standards and the international harmonisation process - would be to bring a reconstituted auditing standard setting body under the broad oversight of the Financial Reporting Council.

In examining proposals for new structures affecting the profession, the Government will consider how they would assist in strengthening disclosure and the profession's contribution to this objective, how they might enhance the role of existing bodies such as the Australian Securities and Investments Commission, and efficiency and resourcing issues.

One of the biggest issues on the agenda is government's response to the Ramsay report. All of the submissions for which authors have granted public release permissions are now available on the Treasury website - www.treasury.gov.au.

Many of the Ramsay recommendations have received broad support from stakeholders. For example:

  • the general statement of principle in the Corporations Act requiring an auditor to be independent; and
  • the call for updating of the existing rules on employment, financial and business relationships between the auditor and audit client.

However, other recommendations have attracted mixed responses.

  • For example, in a recent speech the ASIC Chairman, David Knott, said that he favoured a ban on audit firms providing non-audit services to their audit clients.
  • Others argue that a blanket ban would reduce the audit firm's understanding of the client's business and hence the quality of the audit, while doing little to increase independence.

This is one of the issues I discussed with legislators and regulators in Washington recently Where the United States ends up is one of the issues Australia will need to watch closely.

    In considering this issue the Government will of course weigh all the arguments.

Last month the two main professional bodies announced the approval of a new professional standard for audit independence, based on the IFAC Code of Ethics.

  • Among other things, this new standard recommends:
    • seven year mandatory rotation of audit partners for listed entities;
    • a mandatory two year waiting period before a retired auditor, involved in the audit of a client, can become a director of that client; and
    • a ban on providing non-audit services - for example, material asset valuations - where, in also conducting the audit, a firm could be required to check its own work.

  • Adoption of the new standard is not mandatory until the end of 2003 so that contractual arrangements that may be inconsistent with the new rules can be unwound..

    However, I strongly support the bodies' call for their members to immediately adopt the new standard.

    This is,of course, without prejudice to measures the Government may wish to adopt that are dealt with in the standard.

I will be announcing shortly the Government's process for advancing Ramsay and wider audit reform. The delay in the final reporting date of the HIH Royal Commission has caused us to reconsider our schedule for Ramsay

Implementation will need to take account of overseas developments, including any additional reforms in the United States resulting from the Enron collapse, and also any relevant recommendations of the HIH Royal Commission.

It may therefore be necessary for the implementation phase to extend until after the Royal Commission has reported. However, that would not rule out earlier announcements and the earlier implementation of some measures.

I am encouraged that market participants have already introduced measures of their own to address auditor independence and related issues.-- for example, the ANZ and Pricewaterhouse Coopers. There is strong market pressure for corporate governance and therefore financial reporting quality improvement. This pressure is far preferable to the dead hand and blunt instrument of government regulation.

Transparency, accountability and disclosure are central to market fairness, efficiency and integrity. Investors must have ready access to day to day information affecting a company's share price and they must have confidence that published financial statements show a full and accurate picture of a company's financial performance.

Companies need to accept the disciplines of better financial disclosures and high quality audits, not only to exploit fully the benefits of cheaper international capital, but also to reduce the risks to reputations now clearly evident as a result of the Enron collapse.

The profession needs to show all the leadership it can to contribute positively to strong disclosure outcomes. This can only be in the profession's long term interest.

For its part, the Government is committed to ensuring the appropriate regulatory framework is in place - and working with all stakeholders in building confidence in financial reporting.