The Development of International Standards on Auditing

By Robert S. Roussey

In Brief

The Convergence of International Auditing Standards

The explosive growth of investing and raising capital in the global markets has put new emphasis on the development of international accounting, auditing, and ethical standards. The worldwide accountancy profession, together with preparers, users, regulators, and other bodies, have been exerting great effort in the development of high-quality standards that can be implemented in the global as well as the domestic capital markets. The harmonization of these standards is receiving greater and greater attention by the participants in these markets.

International standards on auditing are promulgated by the International Auditing Practices Committee (IAPC) of the International Federation of Accountants. A codified core set of international standards on auditing were completed and released in 1994. The release of the core set has led to a growing acceptance of the standards by national standards setters and auditors involved in global reporting and cross-border financing transactions. In addition, the growth of assurance services has led to the development of a new framework and a new direction for the work of the IAPC.

The benefits for the use of common global accounting standards by preparers of financial statements and common auditing standards by auditors of those statements have been debated for a number of years. Although the debate continues, there is strong support for the creation of a common set of standards for use in capital markets around the world, particularly for cross-border financing transactions.

Two important sets of standards have emerged as candidates for widespread adoption: the accounting standards being developed by the International Accounting Standards Committee (IASC) and the auditing standards being developed by the International Auditing Practices Committee (IAPC) of the International Federation of Accountants (IFAC).

Many global 1000 companies headquartered outside the United States are preparing their financial statements in accordance with international accounting standards and are having them audited in accordance with the international standards on auditing. These financial statements are being sent around the world to be used by investors and other interested parties, and for capital formation.

With various developments under way in the move toward greater harmonization of these standards for global reporting, cross-border financing, and national use, there is no doubt that the number of companies using them will grow from hundreds to thousands.

International standards should be of interest to accounting professionals for a number of reasons, including the following:

* Americans invest in foreign companies that use these standards. At present, this ownership is more than $500 billion and growing.

* Subsidiaries of foreign companies in the United States are using these standards. Foreign companies who start to report on a global basis will ask local management and auditors in the United States, as well as in other countries, to prepare and audit the financial statements using international accounting and auditing standards.

International Standards on Auditing

The International Standards on Auditing (ISA) have come a long way since the start of their development in the late 1970s. They started as guidelines under the harmonization process of IFAC and its member bodies. The AICPA is one of the founding member bodies of IFAC and has participated in its activities since inception. IFAC's main focus is the enhancement and further development of the worldwide accountancy profession through its activities in ethics, education, the public sector, management accountancy, technology, and auditing. The IAPC has been charged with the responsibility to enhance and expand the worldwide use of auditing standards. Its objective is to improve the quality and uniformity of international practice by--

* issuing international standards on auditing;

* issuing guidance on the application of such standards;

* promoting the adoption of the committee's pronouncements as the primary source of national standards and as guidance in cross-border offerings;

* promoting the endorsement of the standards by legislators and securities exchanges; and

* promoting debate with practitioners, users, and regulators throughout the world to identify user needs for new standards and guidance.

The structure and membership of the IAPC is shown in Figure 1.

The IAPC receives public interest input through the Consultative Advisory Group (CAG), whose membership includes many of the leading international organizations of the world. CAG's purpose is to provide advice to the IAPC on its agenda; on issues of importance to the national, regional, and world communities; on new issues or revisions of existing material; on matters of public interest in the development of auditing standards; and on other practice guidance. Its membership is shown in Figure 2.

The IAPC issued 29 international auditing practice guidelines through 1990. At that time, it became clear that global capital markets needed auditing standards for cross-border financing. When the IFAC membership endorsed a change from guidelines to standards, the IAPC started on a lengthy comprehensive project to revise the guidelines and codify international auditing standards. In 1994, the IAPC issued a comprehensive, common body of international standards on auditing (ISAs), primarily focused on the audit of financial statements.

Growing Acceptance of the ISAs

Since their release, there has been a growing acceptance of ISAs, particularly adoption and use of the standards by--

* a number of the large international accounting firms as the basis for their worldwide auditing standards;

* global public companies reporting outside their national borders;

* companies involved in issuing securities in cross-border financing transactions;

* companies issuing securities in domestic financing transactions;

* regulatory bodies accepting financial statements audited using the ISAs for regulatory filings in their countries, or requiring the use of ISAs by including them in company law;

* global organizations, such as the Organization for Economic Cooperation and Development, that have endorsed ISAs for use in auditing financial statements in their jurisdictions; and

* national accountancy bodies that have used ISAs as the basis for their national auditing standards.

A 1998 survey of IFAC member bodies revealed some interesting information. First of all, of the 65 countries responding, the survey showed that eighteen (18) countries have completely adopted the ISAs as their national auditing standards. Of the remaining 47 countries, the survey showed that--

* 28 countries had no significant differences between the national standards and the ISAs;

* 9 countries had some significant differences, usually relating to reporting; and

* 10 countries had not identified whether there were any differences.

At the time the codification was released, a number of standards setting bodies and other organizations around the world indicated that they would take substantial steps to harmonize with the ISAs, and to further consider the use of ISAs. Among these are the following:

The Netherlands. The Netherlands Auditing Standards Board decided to forgo the further development of national auditing standards and adopted the ISAs instead. Local requirements are presented at the end of each individual standard. Dutch auditing standards are published in both English and Dutch.

The United Kingdom. At the same time the IAPC was developing the codification of the ISAs, the auditing practices board of the United Kingdom was revising its national standards. The U.K. auditing practices board based its standards on the ISAs but used different wording and added local requirements. Each individual standard has a compliance statement at the end relating to whether compliance with the U.K. standard will also comply with the corresponding ISA.

South Africa. A project is in process to harmonize the South African Standards with the ISAs.

European Commission. The European Commission conducted a study that resulted in the publication of a green paper, "The Role, The Position, and the Liability of the Statutory Auditor within the European Union," in 1996. It was followed later in the year by a major conference on the topic. In a summary of the conference's conclusions, a spokesman indicated that there appears to be substantial use of ISAs in many member countries. The Commission decided to obtain more information on this use, with the intent of considering the ISAs as the standards for
use in the member countries. The Fédération des Expert Comptables Européens (FEE), the regional organization representing the accounting profession in EU, agreed to assist.

Fédération des Expert Comptables Européens. In the study and report by the FEE, "Setting the Standards: Statutory Audit in Europe," President David Darbyshire said that "FEE demonstrates the success of this process and the progress made in Europe in applying international standards on auditing. Convergence in country practice, as regards audit approach, is a reality." The executive summary stated that in part "Auditing standards in the countries of Europe are set at the national level by individual country standards setters ... The national standards setters in Europe all look towards ISAs in setting their local standards ... The study indicates a high degree of correlation between national standards and ISAs, either in terms of existing national standards or draft standards due for implementation nationally in the foreseeable future."

Other jurisdictions are also pursuing harmonization of accounting and auditing standards.

Canada. In a 1997 interim task force report on the development of strategies for the direction of standards setting, the Canadian Institute of Chartered Accountants (CICA) concluded as follows: "The ultimate goal is a body of auditing standards accepted internationally and by capital markets worldwide. Canada will play a significant role on a standard-setting body based either internationally or in North America." The final report, released August 27, 1998, recommended that "Canada should endorse the principle of the internationalization of standards setting for private sector accounting and auditing." The report went on to say, "CICA should continue to play a leadership role in setting auditing standards for the foreseeable future. ... This recommendation means that CICA should find the resources internally to reaffirm Canada's significant role in establishing international auditing standards, while maintaining its full responsibility for setting those standards in Canada."

The United States. The AICPA has started to increase its focus on international standards. The AICPA board established an International Strategy Special Committee, chaired by a former AICPA chair, Tom Rimerman, to develop a strategy, initiatives, and an action plan to elevate the AICPA's consideration of, and influence on, international processes in the areas of accounting, auditing, and ethics. The AICPA's Auditing Standards Board (ASB) considered these initiatives and established a number of action plans to implement key initiatives, as set forth in its report "Horizons for the Auditing Standards Board." Some of these action plans include establishing a standing subcommittee of the ASB on international auditing standards, promoting opportunities for joint projects, and initiating an effort for reporting on the credibility of information.

The International Organization of Securities Commissions (IOSCO) and the IAPC have opened discussions to consider the possible endorsement of the international standards on auditing.

Independence, Ethics and Enforcement at the National Level

The ultimate acceptance by users of financial statements for both the international standards on auditing and the international accounting standards will largely be attributable to the proper application of these standards by accountants and auditors.

In the same way that the IAPC changed from a guidelines committee to a standards setter, the International Federation of Accountants is also changing. In the past, IFAC has issued its code of ethics and related pronouncements with the understanding that the member bodies will make their best efforts to adopt them. IFAC is now considering the possibility of a new program to review its entire code of ethics with the aim of establishing a member body program of adoption of its ethics, independence, education, peer review, and enforcement pronouncements.

This program, if it can be implemented and adopted by the IFAC member bodies, would be a significant factor in providing additional credibility to the application of the international accounting and auditing standards.

The Growing Global Capital Markets

In addition to the very significant accounting and auditing harmonization developments, there are a number of other changes in the global marketplace that are having an important impact on the future direction of the work of the IAPC, most notably the astounding growth of the global capital markets. The increase in market value of all publicly traded companies and the notional value of derivative
securities are clear indicators of the emerging global economic and business environment.

In 1987, the global equity markets capitalization stood at U.S. $8 trillion; by June 30, 1999, it had almost quadrupled to U.S. $30.2 trillion. The use of derivative securities is also growing at an explosive pace--current estimates are in the area of $40 trillion.

The audit of financial statements is one of the key statutory requirements of regulators around the world. It is clear that the audit will remain vital for the stability and credibility of capital markets.

The IAPC has a responsibility to develop the best and most advanced set of auditing standards that meet the interests of the profession and the public. The IAPC is committed to the development of high quality auditing standards and supplemental guidance to achieve that end.

Recent IAPC Activities

The following are some of the recent standards and statements issued, under development, out for exposure, or that are presently on the IAPC project list:

* A Revised ISA on Going Concern. This standard will link to a new international accounting standard that sets up management assessment and disclosure requirements for going concern. This new accounting standard requires not only a specific management assessment of going concern, but also requires accounting disclosure when events and circumstances indicate a significant uncertainty that may affect on the going concern assumption. The new auditing standard builds on the accounting requirements, specifies the audit requirements with respect to them, and extends the other auditor requirements with respect to going concern.

* A Revised ISA on Fraud. The IAPC has studied the present environment with respect to financial statement fraud and has examined the research and new standards issued recently by other bodies on this topic. A revised ISA is under development.

* A New International Audit Practice Statement (IAPS) on Environmental Matters in an Audit. While the basic audit standards include requirements with respect to accruals and disclosures of matters affecting financial statements, the new IAPS will discuss the auditor considerations when applying the basic audit standards to environmental matters.

* A New ISA on Communications to Those Charged with Governance. Auditors have long been involved in various aspects of corporate governance. This new ISA prescribes the communication of audit matters of governance interest and describes the various matters that auditors should discuss with persons responsible for governance in an entity.

* A New IAPS on the Year 2000 Issue. An international audit risk alert on this topic was issued in December 1997, and an IAPS in July 1998.

The Growing Information Needs of Users

While there are many changes in this area, three are most important. They are the information needs arising from--

* the global information technology and communications revolution,

* the global expansion of business, and

* the global information and knowledge flow.

These three changes are not just increasing the need for information but also for its reliability. Most importantly, this information is not just financial in nature, but also relates to a broad range of other areas.

It is clear to the IAPC that the current financial statement audit model--the current basis of the ISAs--does not fit the new information needs of users. The solution was the development of a new framework described in a proposed international standard on "Assurance Engagements."

Part of the solution was to broaden the definition of information to include--

* nonfinancial information,

* process and performance information,

* qualitative information, and

* database information.

An illustration of the structure of the new framework is presented in Figure 3. The shaded boxes represent the standards in our present framework. All the other boxes represent new developments.

The framework includes a set of general principles for engagements meeting the criteria of an assurance services engagement. The general principles are intended to be used by auditing standards setters, such as the IAPC, in developing new assurance services standards, or by engagement personnel when a standard has not yet been developed for an assurance service.

New Services of the Accountancy Profession to Meet Those Needs

The accountancy profession does not stand still when it sees new market opportunities. What are the opportunities for new services for the accountancy profession, and what does the IAPC have to do in developing new standards to cover them? Some examples that relate to the new assurance services framework are as follows:

* Expanded reporting on financial information by directors and management, such as management's discussion and analysis (e.g., the U.S. SEC requirement for public companies);

* Reporting on nonfinancial information by directors, such as directors' reports to shareholders on corporate governance (e.g., the reports required by the London Stock Exchange);

* Reporting on the results of processes by directors and management, such as directors' reports on the adequacy of internal controls (e.g.,the reporting required by the banking industry in a number of countries);

* Reporting on compliance with laws and regulations (e.g., the oxygen content in gasoline required in the U.S.);

* Reporting on qualitative information by directors, such as ethical guidelines (e.g., the government contract industry guidelines on ethical conduct); and

* Reporting on database information, such as the reliability of data warehouse information (e.g., a company's customer information database).

In order to address these new information needs, the IAPC is refocusing its efforts to devote some of its resources to the development of standards and statements in areas such as--

* reporting on internal control,

* reporting on compliance with laws and regulations,

* reporting on statements of corporate governance, and

* prospective financial information (revision of a current ISA).

The Future

I believe that a number of additional steps must be taken by the worldwide accountancy profession and by the global business leaders. Foremost is a set of global independence, ethics, and enforcement requirements, and a set of global corporate governance rules. These ideas are presented in Figure 4.

IFAC can play an important part in this implementation by requiring each member body to take such action, rather than merely encouraging implementation. Such a set of rules will not only help to improve the implementation of auditing (and accounting) standards, but will also help to reduce the expectation gap in performing audits of financial statements.

I believe that global business leaders must implement a base set of corporate governance rules. These rules should apply, at a minimum, to any company involved in a cross-border financing transaction and to any company listing its securities on securities exchanges outside of its national borders. At the present time, these companies may only be subject to national corporate governance rules or specific rules set forth by certain listing agencies or securities commissions. A set of global corporate governance rules will not only help to improve the ethics of businesses but will also reduce the expectation gap in auditing financial statements prepared under those rules.

With these rules functioning on a global basis, with a strong set of globally acceptable and transparent international accounting and auditing standards, the accountancy profession can continue to play a key role in the global capital markets and the burgeoning assurance service markets. *

Robert S. Roussey, CPA, is chair of the International Auditing Practices Committee of the International Federation of Accountants and is a professor of accounting at the Leventhal School of Accounting, University of Southern California. He can be reached at

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