Changes in The European Audit Services Market

Abstract

In-depth changes are now taking place in the audit services market in Europe. They are mainly caused by the implementation of new rules laid down in European regulations. However, Member States have relatively broad freedom in drafting detailed regulations. In light of the above, the main purpose of this article is to identify disparities between financial audit systems in different European countries and to assess them in the context of changes introduced in the EU as a whole. Particular attention is paid to aspects connected with the organisation and the structure of the audit services market. Rules applicable in 30 countries have been analysed and differences identified concerning the scope of Public Interest Entities, the obligatory audit firm rotation, the ban on providing selected non-audit services, and joint audits. Disparities were found in key aspects of statutory auditor activities which are still very controversial. The biggest ones concern the obligatory auditor rotation and the maximum duration of engagement by a given entity. This has a negative impact on the effectiveness of the whole market and its competitiveness.

Full text

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Cite this Article as: Malgorzata KUTERA “Changes in The European Audit Services Market” Proceedings of the
36th International Business Information Management Association (IBIMA), ISBN: 978-0-9998551-5-7, 4-5
November 2020, Granada, Spain.
Changes in The European Audit Services Market
Malgorzata KUTERA
Jagiellonian University, Cracow, Poland
malgorzata.kutera@uj.edu.pl
Abstract
In-depth changes are now taking place in the audit services market in Europe. They are mainly caused
by the implementation of new rules laid down in European regulations. However, Member States have
relatively broad freedom in drafting detailed regulations. In light of the above, the main purpose of this
article is to identify disparities between financial audit systems in different European countries and to
assess them in the context of changes introduced in the EU as a whole. Particular attention is paid to
aspects connected with the organisation and the structure of the audit services market. Rules applicable
in 30 countries have been analysed and differences identified concerning the scope of Public Interest
Entities, the obligatory audit firm rotation, the ban on providing selected non-audit services, and joint
audits. Disparities were found in key aspects of statutory auditor activities which are still very
controversial. The biggest ones concern the obligatory auditor rotation and the maximum duration of
engagement by a given entity. This has a negative impact on the effectiveness of the whole market and
its competitiveness.
Keywords:
Statutory Audit, EU Audit Reform, Audit Firm Rotation, Non-Audit Services
.
Introduction
A series of scandals stemming caused by falsifying corporate financial results has significantly
undermined trust in auditors globally. They started in 2001 with the collapse of Enron and the situation
deteriorated further during the last economic crisis. As a result, the last several years have seen a
process of in-depth changes to the financial audit system. In the European Union, this mainly entails
implementing new regulations which became binding in audits of 2017 financial statements. The above
regulations significantly impact formal aspects of practising the profession of a statutory auditor and
the operation of audit firms. They concern, among other things, precisely defining the role of the
statutory auditor, effectively preventing conflicts of interest in the provision of various services and
restricting market concentration. There have also been major changes to the supervision system of
statutory auditors and the rules of reporting audit results.
Directive 2014/56/EU and Regulation 537/2014 form the legal grounds for the most recent system
changes. The Directive lays down a number of guidelines concerning all obligatory audits in a given
country, while the Regulation introduces additional requirements for auditing the statements of Public
Interest Entities (PIEs). These new regulations apply within the European Union as well as in Iceland,
Liechtenstein and Norway, which are members of the European Economic Area (EEA). Even though
the UK has recently left the EU, it has also implemented them.
Still, it must be said that the above regulations leave a lot of leeway in setting national rules. Altogether,
they contain about 50 different options to choose from. Member States were happy to use these options
and have actually implemented highly varied rules, including those governing matters that are key for
the organisation of the audit services market. Significant discrepancies between national financial audit
systems hinder harmonising the market within Europe as a whole and definitely reduce its efficiency.
What is of fundamental importance in this context are, in particular, the regulations adopted on the
scope of Public Interest Entities (which have always been subject to more detailed and demanding rules
of auditing), the obligatory rotation of audit firms and the maximum duration of engagement by the
client, the ban on providing certain non-audit services and the rules of conducting joint audits.
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In the light of the above, the main purpose of this article is to identify disparities between financial
audit systems in different European countries and to assess them in the context of systemic changes
made in the EU as a whole. Particular attention is paid to aspects connected with the organisation and
the structure of the audit services market. In the introduction, EU regulations are analysed in detail,
mainly to determine the degree of decision-making freedom during their transposition into national
law. Then, the rules adopted by individual countries are verified in depth and key differences between
them are identified.
The following research questions have been formulated:
1) What is the scope of Public Interest Entities implemented in EU countries?
2) How did individual countries approach the problem of market concentration when
implementing regulations on the obligatory rotation of audit firms and the maximum duration
of their engagement?
3) Which non-audit services were ultimately prohibited in the EU?
4) What solutions for joint audits have been adopted by Member States now?
In this context, there has always been a significant problem with the relatively high concentration of
the audit services market, which inhibits its competitiveness. This is why the final solutions adopted
by countries in this regard, including those concerning joint audits, are particularly interesting.
However, the starting point of an analysis of the situation is the definition of public interest entities, as
only for this group of entities is auditor firm rotation obligatory.
Theoretical Background
Serious changes to the financial audit system in Europe were initiated in 2006 as a result of very public
scandals involving the falsification of company results in the early 21
st
century. Directive 2006/43/EC
introduced a series of regulations governing the provision of statutory audits, the organisation of audit
firms, introducing public supervision of statutory auditor activities and the cooperation between
supervisory organisations in the EU, as well as the systematic and obligatory training of statutory
auditors. More stringent requirements for audits of public interest entities were also introduced, e.g. the
application of uniform standards during these audits (International Standards on Auditing) or the
greater liability of statutory auditors. However, these changes turned out to be insufficient, particularly
during the last financial crisis. There were widespread concerns about insufficient information in
auditors’ reports, lack of credibility of their contents (particularly with regard to financial accounts of
banks, financial institutions and listed companies), too cosy relationships between audit firms and
entities they audited, doubts as to the actual objectivity and independence of auditors, as well as the
high concentration of the audit services market increasing systemic risk. In response to these concerns,
another reform was carried out at the EU level, by adopting Directive 2014/56/EU and Regulation
537/2014.
The new audit regulations came into effect on 17 June 2016 and applied to the financial year starting
after this date. An exception was made for the obligatory audit firm rotation, the implementation period
of which was extended. However, the implementation of these regulations in individual countries
followed very different paths and has still not been completed. By June 2016, 12 EU Member States
had implemented the revised regulations, a year later the number was 25, and in June 2018 there were
27 such EU states. The last country in the EU to implement these regulations was Slovenia. As of July
2020, of all obligated states, the new rules had not been completely implemented yet by Norway.
Matters addressed by these new legal regulations have been the subject of many research projects over
many years. In the context of this article, the most important subject is the concentration of the audit
services market and the problem of auditor independence. The dominance of several audit firms
significantly limits the unbiased selection of an auditor and leads to systemic risk. It also directly drives
the prices of services provided by statutory auditors and the quality of their work. This is because an
excessively long engagement of an auditor by their client may also limit the objectivity and the
professional scepticism of the statutory auditor. This is why new EU regulations have introduced
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mandatory rotation of audit firms auditing the financial statements of key entities in every Member
State. Other new rules require joint audits, which force statutory auditors to cooperate, and ban the
provision of certain services to the audited economic operators.
The concentration of the audit services market concerns, in particular, the services provided to the
largest economic operators in each country (Simunic, 1980, pp. 161-190). The market is significantly
dominated by the Big 4 audit firms. It is worth remembering that significant mergers and acquisitions
occurred in the group of the largest global audit companies, which exacerbated this unfavourable
development further. This has been confirmed in the research of, among others, Minyard and Tabor
(1991, pp. 79-90), Wootton et al. (1994, pp. 58-74), Choi and Zéghal (1999, pp. 1-21) and Pong (1999,
pp. 451-475). Institutions responsible for the security of trading have been warning for years that this
high concentration may have a negative impact on price competition, the unbiased choice of an auditor
and the quality of statutory auditors’ work (FRC, 2006; Oxera, 2006, 2007; OECD, 2009). These
warnings were particularly resounding at the beginning of this century, right after a series of spectacular
company collapses initiated by the bankruptcy of Enron in 2001. However, the reforms made then in
the audit services market turned out to be ineffectual, and the very same problem reappeared during
the 2008 financial crisis. Analyses continued confirming the high concentration of the statutory auditor
market and linking it directly with the systemic risk of the financial sector (European Commission,
2010; Oxera, 2011; Treasury Committee, 2008). It is worth noting that in the literature, the
concentration of the audit services market was mainly studied from the perspective of various
competition factors. In particular, its impact on the price of financial statement audits and the quality
of statutory auditors’ work was analysed.
Statutory auditors’ independence is also the subject of many research projects. The important analyses
in this context concern the prohibition on providing non-audit services to the client whose financial
report the firm audits and the obligatory rotation of audit firms. However, the results are not clear cut.
Some studies demonstrate a negative relationship between non-audit services provided by a statutory
auditor and the quality of the annual audit of the financial statements of the entity (Sharma & Sidhu,
2001, p. 563-594; Kinney et al., 2004, p. 561-588; Khurana & Raman, 2006, p. 977-1016). On the
contrary, other studies show that providing non-audit services does not actually impair the accounts
auditing process (DeFond et al., 2002, p. 1247-1274, Knechel & Sharma, 2012, p. 60-81, Koh et al.,
2013, p. 1-33). For example, DeFond proved that there is no significant relationship between the fees
charged by auditors for non-audit services and their tendency to express other than positive opinions
on the audit of the annual financial statements of the same clients.
Another aspect connected with the independence of auditors is their obligatory rotation and the
maximum duration of their engagement by a given entity. In this context, both the change of the key
audit partner and the rotation of the entire audit firm are analysed. The obligatory change of the key
audit partner had already been introduced before. The current regulations govern the rotation of audit
firms. Most scientific research does not support the thesis that a longer duration of auditor engagement
by the audited company has a negative impact on the quality of services provided. On the contrary,
research more often indicates a positive relationship between these aspects (Johnson et al., 2002, p.
637-660; Myers et al., 2003, p. 779-799). For instance, Myers has proven that the longer the
engagement of the auditor by the company, the more sceptical the auditor is about risky decisions taken
by the board of the audited entity. There are also other studies demonstrating that in the early years,
the quality of financial statement audit is worse than later (Geiger & Raghunandan, 2002, p. 67-78).
The last element is the joint audit. Some analyses of this subject proved that the obvious increase of
the fee for this type of audit does not necessarily lead to better service quality (Guo et al., 2017, 1595-
1627). Other researchers have, for example, carried out a broad comparative analysis of joint audits in
France and single audits applicable in the United Kingdom. A clearly higher level of the total fee paid
in France was observed, but there was no significant improvement in the quality of the service provided
(Andre et al., 2016, p. 245-274). Similar conclusions are drawn from Deng’s research. He analysed the
results of work of individual pairs of audit firms involved in joint audits and demonstrated that the joint
work of a smaller firm and a Big4 firm does not necessarily improve the final audit quality (Deng et
al., 2014, p. 1029-1060).
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Methodology of Research
The main purpose of this article is to identify disparities between financial audit systems of individual
European countries, particularly with regards to the organisation of the market for audit services.
First, EU regulations are analysed, mainly to determine the degree of decision-making freedom during
their transposition into national law. The verification concerns mainly the provisions of Directive
2014/56/EU and Regulation 537/2014 which define a public interest entity, lay down rules of audit
firm rotations, the ban on non-audit services, and regulate joint audits. This is followed by an in-depth
analysis of legal texts governing the financial audit system in all obligated countries in which the reform
has already been completed. This research thus covers EU Member States, the UK, Island and
Liechtenstein, i.e. altogether 30 states. It excludes Norway, as the implementation in this country has
not yet finished.
Detailed rules of audit service provision in individual countries were also identified by analysing
secondary data, mainly form reports of the European Commission, of public authorities supervising
activities of statutory auditors and of global audit firms.
Research Results
One major aspect of the audit market reform was to define Public Interest Entities (PIEs). Principally,
the scope of PIEs in the new directive is not significantly different than in previous European
regulation. However, Member States were given the opportunity to broaden the set of such entities and
make it more precise. It should be noted that this is of key importance for the interpretation and adoption
of other regulations connected with the reform. This is because the second document adopted by the
EU– Regulation 537/2014 – contains important solutions envisaged specifically for the PIE group, so
delineating the scope of Public Interest Entities is a starting point for implementing further changes in
the audit market.
According to the definition form the directive, all the following should be treated as Public Interest
Entities (Directive 2014/56/EU, article 2):
- entities governed by the law of a Member State and listed on regulated markets in the European
Union;
- credit institutions operating within the EU, regardless of whether they are listed on a regulated market;
- insurance undertakings operating in a Member State, also regardless of whether they are listed on a
regulated market and of their business line (i.e. type of insurance);
- other entities included in this group by individual Member States due to their significant public
relevance (because of the nature of their business, their size, or the number of their employees).
The last item of the aforementioned provision offers complete freedom to expand the scope of PIEs.
The majority of EU Member States took advantage of this opportunity, which led to significant
differences between the criteria adopted. Consequently, attention must be paid to the definition adopted
in a given country, particularly when considering the activities of multinational corporations. The
conditions defined for PIEs apply to every individual company domiciled in a selected Member State
regardless of where its mother company conducts its business and whether the latter is also treated as
a PIE.
Of all the countries obligated to reform the system, 19 have extended the scope of Public Interest
Entities while 11 adopted the definition from the EU directive. The relevant details are presented in
table 1.
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Table 1: Scope of Public Interest Entities
PIE defined according to the EU directive Extended scope of PIEs
1. Ireland
2. United Kingdom
3. Netherlands
4. Germany
5. Denmark
6. Finland
7. Estonia
8. Greece
9. Cyprus
10. Liechtenstein
11. Luxembourg
1. Portugal
2. Spain
3. France
4. Malta
5. Slovenia
6. Italy
7. Croatia
8. Austria
9. Czech Republic
10. Hungary
11. Poland
12. Bulgaria
13. Romania
14. Slovakia
15. Latvia
16. Lithuania
17. Belgium
18. Sweden
19.
Iceland
Another important but controversial aspect of the reform of the financial audit system in Europe is the
obligatory rotation of audit firms. It applies only to services provided to Public Interest Entities.
Consequently, the change of the audit firm is not obligatory for other entities, even if they are subject
to the statutory duty of having their financial statements audited. The basic rule of the EU law stipulates
that after 10 years of service, the audit firm must be obligatorily changed (Regulation 537/2014, article
17). The key audit partner representing a given audit firm and auditing the statements must be changed
after the maximum 7 years. If a company wants to bring back its former audit company, it must wait at
least 4 years before doing so.
However, the regulations have given Member States many additional possibilities of modifying this
obligation, particularly during the interim period of implementing the new regulations. Namely, it its
legislation, every country can:
- extend this basic duration once by another 10 years under the condition that the audited entity carries
out an independent tendering procedure (so the maximum duration of engagement will amount to 20
years);
- extend this period once by another 14 years if the engagement is based on a joint audit;
- shorten the period of obligatory rotation to below 10 years.
It should also be added that authorities supervising the financial audit system in a given state may, in
exceptional cases, permit the 10 year duration of engagement of the audit firm by the audited company
to be prolonged by another 2 years (upon a request of the audited entity). This can, for example, occur
when the entity underwent some complex restructuring processes or there were serious problems with
the tendering procedure conducted.
An analysis of rules finally adopted by individual Member States shows major discrepancies between
them. Limits concerning the obligatory auditor rotation are summarised in Table 2.
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Table 2: Rules of audit firm rotation (in years)
Country Minimum
engagement
duration
Maximum
engagement
duration
Possible
engagement
extension
(by tendering)
Possible
engagement
extension
(by joint audit)
Austria
1
10
Not possible***
Not possible***
Belgium
3
9
9
15
Bulgaria
1
7
Not possible
Not possible
Croatia
1
10
10
10
Cyprus
1
10*
10*
14**
Czech Rep.
1
10
10
Not possible
Denmark
1
10
10
14
Estonia
2
10
10
Not possible
Finland
1
10
10
14
France
6
10
6
14
Germany
1
10
10**
14
Greece
1
10*
10
Not possible
Hungary
1
10*
Not possible
Not possible
Iceland
1
10
10
14
Ireland
1
10
Not possible
Not possible
Italy
9
9
Not possible
Not possible
Latvia
1
10
10
Not possible
Liechtenstein
1
10
Not possible
Not possible
Lithuania
2
10
Not
possible
Not possible
Luxembourg
1
10
10
Not possible
Malta
1
10
10
Not possible
Netherlands
1
10
Not possible
Not possible
Poland
2
5
Not possible
Not possible
Portugal
2
8 or 9
1
-
2
Not possible
Romania
1
10
10
Not possible
Slovakia
2
10
10
Not
possible
Slovenia
3
10
Not possible
Not possible
Spain
3
10
Not possible
4
Sweden
1
10
10**
14**
UK
1
10
10
Not possible
* other rules for banks and financial institutions
** not possible for banks, insurance undertakings and pension funds
*** possible for contracts concluded in 2003-2014
The above data clearly shows that individual countries have made significant use of the scope of
freedom they were afforded when implementing EU legislation. With regards to the minimum duration
of audit firm engagement, most countries adopted 1 year (20 states). Only 10 countries adopted other
rules, with Italy and France choosing the most demanding ones. With regards to the maximum
engagement duration, the solution adopted in EU regulations is the most popular (10 years). However,
there are also clear restrictions: the shortest duration of engagement is effective in Poland, namely 5
years. There are much greater disparities in the rules allowing the possible extension of the engagement
duration of the audit firm. For normal audits, this possibility was generally not introduced in 11
countries, and for joint audits in 20. An overall analysis of data shows that Europe now has about 17
different solutions for the obligatory audit firm rotation adopted by the total of 30 countries. It should
be noted that these rules apply only to PIEs, but the definitions of a PIE differ in various states. This
brings about major disparities between national systems of financial audit.
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The third aspect of the reform of the audit services market concerns the prohibition of providing certain
types of services to entities whose financial statements are audited by the specific audit firm. This
prohibition applies only to selected non-audit services provided to Public Interest Entities and their
affiliates.
Under EU rules, the provision of the following additional services to the audited company is prohibited
(Regulation 537/2014, article 5):
a) within the scope of tax and tax compliance services:
- preparation of tax forms;
- payroll tax;
- customs duties;
- identification of public subsidies and tax incentives – unless the provision of this service by
the auditor is required by law;
- support and client representation during tax inspections by state authorities – apart from
exceptions defined by law in which representation by the auditor is obligatory;
- calculation of direct and indirect tax and deferred tax;
- tax advice;
b) valuation services;
c) accountancy, keeping books of accounts and executing financial reports;
d) payroll services;
e) designing and implementing internal control or risk management procedures related to
financial information or designing and implementing financial information technology
systems;
f) internal audit activities;
g) legal services:
- the provision of general counsel;
- negotiating on behalf of the client;
- acting in an advocacy role in the resolution of litigation;
h) promoting, dealing in, or under-writing shares in the audited company;
i) human resources management services with respect to:
- exerting significant influence over accounting or the preparation of financial statements (e.g.
searching for or recommending candidates for the financial department);
- structuring the organisation design;
- cost control;
j) other services:
- related to financing, capital structure and investment strategies of the client;
- involving the auditor in the client's management and decision-making processes.
It should be noted that the regulations have left certain freedom to Member States in fine-tuning their
regulations also in this area. In addition, every state may define other prohibited services and lay down
more restrictive rules of providing non-audit services. What is more, the state may permit the provision
of services related to tax law and asset valuation, on the condition that
- they have no direct or have immaterial effect on the audited financial statements;
- the estimation of the effect of these services on the financial statements is comprehensively
documented and explained in an additional report to the audit committee;
- the principles of auditor independence are fully complied with.
In every case, the audit committee is obliged to set additional, detailed conditions for the provision of
these services by the audit firm.
When analysing the rules adopted by individual Member States, it should be noted that they generally
followed two approaches: either only defining prohibited services in their legislature (“black list”), or
presenting a clear, exhaustive list of allowed services (“white list”). The second solution is obviously
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more restrictive, as it severely curtails the scope of non-audit services. However, it has been applied in
some cases. A full list of solutions applied in this area is given in Table 3.
Table 3: Implementation of rules on non-audit services
Country Restrictions in line with EU
regulations
Conditional provision of tax and
valuation services
Austria
Yes
Yes
Belgium
Yes
Yes
Bulgaria
Yes
Only tax services
Croatia
Yes
Yes
Cyprus
Yes
Yes
Czech Rep.
Yes
Yes
Denmark
Yes
Yes
Estonia
Yes
Yes
Finland
Yes
Yes
France
No (additional prohibitions)
No
Germany
Yes
Yes
Greece
Yes
Yes
Hungary
Yes
Yes
Iceland
Yes
Yes
Ireland
Yes
Yes
Italy
Yes
No
Latvia
Yes
Yes
Liechtenstein
Yes
Yes
Lithuania
Yes
Only tax services
Luxembourg
Yes
Yes
Malta
Yes
Yes
Netherlands
No (white list)
No
Poland
No (white list)
No
Portugal
Yes
No
Romania
Yes
Yes
Slovakia
Yes
Yes
Slovenia
Yes
No
Spain
Yes
Yes
Sweden
Yes
Yes
UK
No (additional
prohibitions)
Yes
The above table clearly shows that most countries adopted rules identical with EU solutions. Only four
countries decided to expand the scope of prohibited services, including two which created white lists.
With regard to the conditional provision of tax and valuation services it is clear that the majority of
countries decided to adopt a flexible solution in this regard. A definite ban on the provision of these
services was imposed by only 6 countries.
The last part of changes in the audit services market which significantly impacts its structure is the
explicit introduction of a joint audit, i.e. an audit of financial statements conducted independently by
two audit firms. This auditing model had been followed before and was particularly popular in France.
The new regulations emphasise its importance in the context of improving the credibility of auditors’
work. However, there is no obligation to introduce joint audits, even under engagements by Public
Interest Entities. Member States enjoy complete freedom in this regard. To date, joint audits have been
introduced as obligatory in three countries: France, Bulgaria and Croatia. In France, they are obligatory
for auditing financial statements of all PIEs, in Bulgaria – only for banks, insurance undertakings and
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pension funds, while in Croatia – for the largest PIEs (when conditions concerning employment or total
assets are met). In other countries joint audits are optional, but some are trying to promote this form of
cooperation between audit firms, e.g. by extending the time before the obligatory auditor rotation.
Conclusions
Research results presented above answer the key research questions asked in the introduction to this
article. Member States adopted different definitions of a Public Interest Entity. In 19 of them the scope
of PIEs is now definitely broader than proposed by the EU directive. Only 11 adopted a definition
identical as in European regulations. This ultimately means that in individual states, different groups
of economic operators are subject to more stringent rules of financial statement auditing. Even greater
disparities were identified between solutions concerning the obligatory rotation of audit firms. An
analysis of the minimum engagement duration shows that only 10 countries adopted a duration greater
than 1 year. In the majority, the auditor must be changed after 10 years, which is what was proposed in
the directive. However, there are also countries in which the change must occur earlier (e.g. after just
5 years in Poland). Significant discrepancies are also visible when one analyses the rules for extending
the auditor engagement. For normal audits, no such possibility is envisaged in 11 countries. On the
other hand, 19 countries introduced conditions for extending the engagement, but these are quite
diverse. In case of joint audits, longer engagement is impossible in 20 countries. Only 10 decided to
intentionally promote this form of financial statement auditing and introduced some criteria for
extending the auditor engagement in this regard. In most cases, the ban on providing selected non-audit
services is equivalent to the proposal from the directive. Four countries introduced more stringent
restrictions. There are greater discrepancies concerning the conditional provision of tax and valuation
services by an audit firm. A outright ban on their provision was adopted by 6 countries, while the
remaining ones allow it. The last research question related to the organisation of joint audits. In this
context, it is worth noting that this solution was not adopted generally as obligatory. Only 3 countries
chose it (France, Bulgaria and Croatia), and to very different extents. In the remaining countries joint
audits remain optional.
To summarise the results of this research, it should be said that European countries adopted solutions
for the financial audit system that differ quite a lot in many aspects. This also applies to key issues
related to the activities of statutory auditors, which have led to many controversies over the years.
Consequently, the audit services market in Europe cannot be called fully harmonised. The
discrepancies certainly limit its effectiveness and negatively impact the level of competition. However,
one should add that this this reform represents another good step in improving the transparency of audit
firms’ activities and the quality of services they provide.
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