Changes to the Audit Regulations - Eligibility
On 1 October, revised Audit Regulations were published on ICAS.com. There have been several amendments made, and firms should ensure that the revised regulations are reviewed and adhered to going forward. This article covers the changes to the eligibility requirements.
Changes to the Audit Regulations
On 1 October, revised Audit Regulations were published on ICAS.com. There have been several amendments made, and firms should ensure that the revised regulations are reviewed and adhered to going forward. While there have been various changes made, revisions to the following three areas are considered to have the most significant effect on our audit firms:
- Audit eligibility;
- Maintaining competence / Continuing Professional Development; and
- Audit compliance review.
Changes to the Eligibility Requirements
When do the changes below take effect?
While the revised Audit Regulations are effective from 1 October 2024, given the potential impact on firm eligibility, the FRC has agreed that changes discussed here will be subject to a six-month transition period with the new eligibility requirements coming in to effect from 1 April 2025.
Summary of change
This is a change to the eligibility requirements to make it clear that where a firm’s constitution, however comprised, includes certain decisions that need more than a simple majority-vote for approval, that audit-qualified persons must be able to control any such ‘super-majorities’. Firms will have until 1 April 2025 to comply.
The eligibility change explained in more detail
Audit firms will be aware that the previous Audit Regulation 2.03 required individuals who have an appropriate qualification (which in practice equates to the Audit Qualification in the majority of cases), and Registered Auditors (e.g. another registered audit firm) to hold:
2.03b - at least a majority of the voting rights (or hold such rights under the firm’s constitution) as enable them to direct its overall policy or alter its constitution;
2.03c - at least a majority of the voting rights in the management board (or hold such rights under the firm’s constitution) as enable them to direct its overall policy or alter its constitution.
While the above elements of the regulations have not changed, the most recent revisions to the supporting guidance notes and definitions used in the Regulations have brought renewed focus on what constitutes authority/control, and in particular seeks to address situations where a firm’s constitution requires a ‘supermajority’ for some decision making. The updates included:
clarifications to the guidance given on what constitutes a ‘majority’, to more clearly reflect that the ‘majority’ of rights required to be held by individuals with the Audit Qualification will be whatever ‘majority’/’supermajority’ a firm’s constitution requires to amend the firm’s overall policy / allow alterations to the constitution; and
clarifications to the guidance given on ‘voting rights’ to more clearly apply to all matters that direct the firm’s overall policy / allow alterations to the constitution.
What is a ‘majority’?
A new definition of ‘majority’ has been added to the Regulations:
“In the context of regulation 2.03 ’majority' of the voting rights means more than 50% unless the firm's constitution specifies a higher percentage of these rights is required for decision making, in which case, ’majority’ shall be taken to mean that specified percentage or more.”
This clarifies that where a supermajority is required to affect changes to the firm’s overall policy / allow alterations to the constitution then rights sufficient to meet whatever that supermajority is must be held by individuals with the Audit Qualification (and/or Registered Auditors).
What are ‘voting rights’?
The definition of Voting Rights used in the Regulations has been changed:
FROM: “The rights to vote on all or substantially all matters at meetings of principals or shareholders of the body in question…”
TO: “The rights to vote at meetings of principals or shareholders of a firm on all matters that direct the firm’s overall policy or alter its constitution…”
This change removes the ‘substantially all’ terminology and focusses more clearly on the relevant areas for decision making. The guidance notes to Regulation 2.03 go on to clarify that while a ‘majority’ normally means greater than 50%, where a firm’s constitution requires a higher percentage of voting rights for decision-making, “majority” shall mean the specified higher percentage. It also clarifies that in this context ‘decision-making’ relates to all management or ownership decisions which direct the firm’s overall policy or alter its constitution.
When considering this matter, firms should be aware that a positive authority to affect change is required. In that context, a fallback power of veto over some decisions would not be expected to constitute sufficient ‘authority’, and the Audit Qualified individuals (and/or Registered Auditors) must hold the authority to pass a vote if one were ever to arise.
Impact on ICAS audit firms
Firms will need to ensure that enough voting rights are held by qualified persons to meet any approval percentages stipulated in the firms’ governance documents. It is not enough that qualified persons can veto a decision; the qualified persons must be capable of passing the vote on all matters that direct the firm’s overall policy or alter its constitution.
It is not expected that these clarifications and amendments will have an impact on many ICAS audit firms, given the majority of our firm are small firms, or firms with simple governance structures. The changes are likely to impact larger firms and those which have more complex governance arrangements (e.g. where there are different voting arrangements for different policies/areas).
However, for the small number of firms that are affected these changes could impact those firms in a fundamental way with regards their audit registration and eligibility.
All firms must carefully consider their own specific circumstances to ensure the eligibility requirements are, and continue to be, met. Given the fundamental nature of Audit Regulation 2.03 with regards a firm’s eligibility for audit registration, any instances of non-compliance would be considered significant matters. Cases of non-compliance would be expected to result in reporting to the ICAS Authorisation Committee and consideration of regulatory action (such as a regulatory penalty accompanied by public notice).
Firms should be aware that considerations may well become more complex where there are multiple legal entries / registered firms within a group structure, and/or where legal entities (rather than natural persons) are principals in a firm (e.g. where corporate entities hold a director / LLP member role). If firms are in any doubt of whether principals and/or those with voting authority hold the Audit Qualification, they should look in to this as a matter of urgency – which may require contacting individuals’ membership bodies. Careful consideration should also take place when succession planning to ensure that individuals with the Audit Qualification, or Registered Auditors, always hold such rights under the firm’s constitution as enable them to direct its overall policy or alter its constitution.
Other relevant regulations: notification of changes in eligibility
The transition period to 1 April 2025 should allow firms time to make any governance changes required.
Firms should also be aware that Audit Regulation 2.11 requires audit registered firms to inform ICAS in writing, as soon as practicable, of any changes which might affect a firm's eligibility. Notification of such changes should be timely and not later than ten business days after the event.
It is recognised that some unforeseen or unavoidable circumstances may result in a firm ceasing to meet the eligibility requirements. Under Audit Regulation 2.17 a firm must notify the Authorisation Committee if it ceases to meet one or more of the eligibility requirements. Notification must take place in writing within ten business days of the situation arising and should set out the circumstances and what action the Registered Auditor proposes to take. On considering such a notification, the Authorisation Committee has the power to grant dispensation from the eligibility requirements in cases where continued registration would not adversely affect an audit client or any other person. Dispensation would be temporary, to enable the firm to address any eligibility issues, and would not last for more than 90 days.
Audit monitoring visits
While breaches of eligibility are relatively rare (in 2023 this was identified in only 8% of visits), they are among the most significant issues identified on audit monitoring visits.
From the monitoring team’s experience, issues with eligibility most often arise where there have been changes in the structure of a firm, or where principals have changed, without sufficient notification being made to ICAS and / or consideration of the potential impact of the changes with regards to compliance with the Audit Regulations.
Firms should be aware that not all CAs have the Audit Qualification, so care should be taken to keep track of changes in Audit Qualified principals and voting rights. Partnerships are reminded that all members / partners of such practices will be considered to have equal voting rights unless there is a formal agreement setting out otherwise.
There have also been a small number of other issues relating to eligibility noted in recent years, which are shared here again for reference:
- Non-qualified principals in an audit firm not completing the required Audit Affiliate application. Firms are reminded that under Audit Regulation 2.03a, any principal that is not a member of ICAS, ICAEW, ICAI, or ACCA will likely require an Audit Affiliate application to be submitted.
- Audit firms constituted as a corporate practice (i.e. a limited company), which have not sufficiently tailored their Articles of Association. Audit Regulation 2.03d sets out various requirements that must be met in such a firm’s articles of association. These include a requirement for shareholders to notify the firm of any changes in shareholding, and a requirement that the firm’s directors must approve any transfer of shares resulting in a shareholder holding more than 3% of the firm’s share capital.
- A case where an Audit Compliance Principal (ACP) was not a principal in the firm. In such cases, the regulations require the ACP to be a member of a management board which administers or manages the firm, but this was not the case.
