Comments on the Federal Auditing Law

Andrei Krikunov

On 7 August 2001, the Russian President signed the Federal Auditing Law No.119-FZ. Section 22 of this Federal Law stipulates that it shall come into effect within one month of its official publication (except for certain provisions). Since the federal Auditing Law was officially published in the Rossiyskaya Gazeta on 9 August 2001, it came into effect on 9 September 2001.

For seven years and a half, audit regulation had been governed by Interim Auditing Rules in the Russian Federation (hereinafter referred to as the Interim Rules) approved by the Presidential Decree No. 2263, dated 22 December 1993. P.2 of this Presidential Decree provided that the Interim Rules shall come into effect in the whole of Russia immediately after the Decree is published and shall remain effective until the Russian Federal Assembly adopts a Russian Federal Law that would govern auditing. Thus, it can be stated that the adoption of the Federal Auditing Law initiated a new stage in the audit development.

Auditing legislation had to be improved because the Interim Rules that were a crucial and timely segment of audit development in Russia did not meet current audit market requirement and lagged behind economic reality.

Lets review some provisions of the Federal Auditing Law (hereinafter referred to as the Law) and clarify new norms of audit framework in the Russian Federation introduced by the Law.

Section 1, Definition of Audit, states that audit (audit activities) is a business activity involving independent inspection of accounting records and financial statements of enterprises and sole entrepreneurs. This definition does not conceptually differ from the one given in the Interim Rules, which stated that audit (audit activities) is an business activity of auditors (audit firms) involving independent non-government inspection of financial statements, payment documentation, tax returns and other financial assets and liabilities of economic entities as well as other audit services.

However, there are significant differences in the way audit objectives are defined in the Interim Rules and this Section of the Law. For example, the Interim Rules provided that the main objective of an audit is to establish whether financial statements of economic entities are credible and whether financial and business transactions comply with Russian regulations. The Law provides that the objective of an audit is to express an opinion on whether financial statements of auditees are credible and whether accounting procedures comply with Russian legislation. We believe that such definition based on international practice provides a more accurate definition of the objective of an audit.

A detailed list of related services established in Section 1 of the Law is important because it provides a legal framework for assessing whether audit firms and individual auditors are entitled to provide such services. Given that related services account for a large percentage of auditors’ scope of work and fees, this norm (which was not specified in the Interim Rules) is extremely important. For the purpose of the Law, the following services shall be treated as related services:

1. setting up, recovering and maintaining accounting system, financial reporting and accounting advisory services;
2. tax advisory services;
3. financial analysis of enterprises and sole entrepreneurs, economic and financial consulting services;
4. management consulting, including the one related to business restructuring;
5. providing legal advice and acting for clients in tax and customs disputes with judicial and tax authorities;
6. computerization of accounting records and IT implementation;
7. appraisal of assets, business valuation and risk assessments;
8. development and analysis of investment projects; business-plan development;
9. marketing research;
10. research and development in audit related areas as well as dissemination of results in hard and electronic copies;
11. audit training in accordance with Russian legislation;
12. other audit related services.

The law stipulates that audit firms and individual auditors are not allowed to engage in any business activity other than auditing and related services, which is line with the earlier Interim Rules.

The law delineates audit legal framework. Section 2, Russian Federal Audit Legislation and Other Audit Regulations, states that audits shall be conducted in accordance with this Federal Law and other federal laws governing relationships arising in the course of audits. Russian federal audit norms in other federal laws must comply with this Law.

The Federal Law on Agricultural Co-operatives establishes specific features of the legal status of audit firms conducting audits of agricultural co-operative enterprises and unions.

Section 3, Auditor, defines an auditor as an individual who meets statutory qualification requirements as established by an authorized federal body and has an audit qualification certificate. This section does not introduce any new norms that are different from the Interim Rules.

However, there are certain differences between Section 4, Audit Firm, and the Interim Rules. The Section of the Law provides that at least 50 per cent of the staff of an audit firm shall be Russian citizens who are residents of the Russian Federation. In cases where an audit firm is run by a foreign citizen, Russian citizens shall account for at least 75 per cent. This section also establishes that an audit firm shall employ at least five auditors.

The Law has Section 5, Rights and Obligations of Audit Firms and Individual Auditors, and Section 6, Rights and Obligations of Auditees and/or Individuals who Enter into Audit Engagement Agreements. Given more than eight year experience with the Interim Rules, these sections provide more detailed rights and obligations of both auditors and auditees.

The wording of Section 7, Statutory Audit, is materially different from the interpretation of this issue in the Interim Rules. For example, the Interim Rules stated that statutory audits should be performed in cases explicitly stated by Russian federal regulations. In addition, the Federal Accounting Law also provides that an audit opinion should be included in a set of financial statements of an enterprise if it is subject to statutory audits according to federal laws. However, prior to the adoption of the Federal Auditing Law most enterprises were subject to statutory audits in accordance with Russian Government resolutions rather than federal laws. Now the Law provides a list of criteria for enterprises subject to statutory audits.

This section also introduced a new provision establishing that only audit firms shall conduct statutory audits. This will improve the quality of statutory audits that are both economically and socially important.

In addition, Section 7, Statutory Audit, states that audit engagement contracts shall be entered into through an open bidding process in cases where the Russian federal or sub-federal government holds at least 25% interest in enterprises subject to statutory audits. The Russian Government shall approve open bidding procedures.

The confidentiality of information obtained during audits is crucial for both an auditor and its auditee. In our view, the Interim Rules did not properly address this matter. This gap, among other factors, gave rise to quite sensitive issues faced by auditors when dealing with law enforcement agencies. This serious issue is covered separately in Section 8, Audit Secret, of the Law. The concept of audit secret was introduced in Part I of the Russian Tax Code. This section provides detailed procedures for using information obtained during audits as well as quality assurance reviews of individual auditors and audit firms. The Law establishes responsibility for disclosing an audit secret.

The law provides the definition and scope of auditing rules (standards), which are an important tool for auditors. This matter was not covered in the Interim Rules. The Regulation on the Audit Commission under the Russian President approved by the Presidential Directive No. 54-rp on 4 February 1994 established that the Audit Commission should be entitled to develop standards on auditing and related services. During 1996 – 2000, the Audit Commission developed and approved 38 auditing rules (standards) and a glossary. However, their application and enforcement was difficult because auditors were not required to apply these rules (standards) and it was not possible to grant a proper legal status to these rules (standards) under the previous legal framework.

Now Section 9 of the Law, Auditing Rules (Standards), says that auditing rules are uniform requirements for conducting and executing audits and related services and assessing the quality thereof as well as for training auditors and evaluating qualifications thereof. Auditing rules (standards) are broken down into federal auditing rules (standards) and internal auditing rules (standards) of professional audit associations as well as rules (standards) of audit firms and individual auditors.

The Law establishes that federal auditing rules (standards) are approved by the Russian Government and shall be binding for audit firms, individual auditors and auditees except for provisions that are explicitly stated as optional.

Section 10, Auditor’s Report, says that an auditor’s report is an official document intended for users of financial statements of auditees. An auditor’s report is issued in accordance with federal auditing rules (standards) and contains a statutory expression of opinion of an audit firm or individual auditor on whether the financial statements of an auditee are credible and whether its accounting records comply with Russian legislation. Unlike the Interim Rules, this Section of the Law establishes that the form, content of and issuance procedures for an auditor’s report should be set forth by the federal auditing rules (standards).

The Law also contains Section 11, Deliberately False Auditor’s Report. The Interim Rules did not address this matter. This section is extremely important, given a dire need for higher quality of audits and responsibility of auditors for their work in good faith. Under this section, a deliberately false auditor’s report is an auditor’s report that is either issued without performing an audit or prepared after an audit in cases where it is in apparent conflict with documents provided and reviewed by an audit firm or individual auditor during the audit. An auditor’s report shall be declared as deliberately false only upon the court ruling.

This section establishes responsibility for issuing a deliberately false auditor’s report, which is the withdrawal of an audit license of an individual auditor or audit firm. An audit qualification certificate shall be canceled and criminal proceedings started against an individual who signs such an auditor’s report.

As compared to the Interim Rules, Section 12, Independence of Auditors, Audit Firms and Individual Auditors, provides a more detailed description of individuals and legal entities that are not allowed to perform audit. This section also incorporated the experience of implementing the Interim Rules.

A brand new provision of audit regulation is a requirement to take out professional indemnity insurance in cases where an audit firm performs statutory audit engagements. This requirement is specified in Section 13, Indemnity Insurance for Statutory Audits.

As compared to the Interim Rules, Section 14, Quality Assurance of Audit Firms and Individual Auditors, provides a more detailed description of procedures for quality control, specifies the responsibility of auditors that evade external quality assurance reviews and regularly violate regulations and federal auditing rules (standards).

Section 15, Audit Certification, does not provide substantive changes to the way this issue was treated in the Interim Rules. Applicants for an audit qualification certificate must obtain a university degree in economics and/or law from Russian educational institutions accredited by the government and have at least three-year professional experience in economics and/or law.

An authorized federal body shall impose additional requirements on applicants for audit qualification certificate and set out audit certification procedures, a list of documents attached to the application for admission to certification, the number and types of certificates, qualification syllabuses and examination procedures.

This section provides that each qualified auditor must annually attend professional development training programs approved by the authorized federal body starting from the next year after he/she obtains a qualification certificate. The professional development training programs shall be conducted by individuals licensed to perform educational activities.

There is Section 16 of the Law, Reasons and Procedures for Canceling Audit Qualification Certificates. The Interim Rules did not address this issue in such detail.

This Section of the Law provides that an authorized federal body shall decide whether an audit qualification certificate should be canceled. The authorized federal body shall make a well-grounded decision on whether an audit qualification certificate should be canceled.

An individual whose qualification certificate is canceled shall be entitled to appeal the decision of an authorized federal body in court within three months of the receipt of the decision to cancel an audit qualification certificate.

In addition, this section establishes the duration of the period during which an individual whose audit qualification certificate is withdrawn cannot re-apply for another audit certificate again.

Given that the Federal Law on Licensing of Certain Activities governs the licensing of certain activities in the Russian Federation, Section 17, Licensing of Auditing, provides that audit licensing, including the issuance, suspension and cancellation of a license shall comply with the Russian licensing legislation. This section specifies the date when an audit firm or individual auditor obtains an audit license, which is the date when a relevant decision is made.

Under Section 18 of the Law, an authorized federal audit regulator will be responsible for audit regulation in Russia. Thus, the Audit Commission under the Russian President whose functions were specified in the Interim Rules (and terminated by the Presidential Decree No. 463, dated 25 April 2001) as well as Central Certification and Licensing Audit Commissions (TsALAKs) of the Russian MinFin and Central Bank will not continue in operation.

Section 18 provides that an authorized federal executive government body as determined by the Russian Government shall perform the functions of a federal audit regulator. The Russian Government shall approve a Regulation on the Federal Body.

An authorized federal body shall:

• issue regulations on auditing within its competence;
• arrange the development and submission of auditing rules (standards) to the Russian Government for approval;
• arrange the statutory certification, education and professional development of auditors in the Russian Federation as well as audit licensing;
• supervise the compliance of audit firms and individual auditors with licensing requirements and terms;
• enforce the compliance of audit firms and individual auditors with federal auditing rules (standards);
• define the scope of and develop procedures for accountability and financial reporting of audit firms and individual auditors to an authorized federal body;
• keep government registers of certified auditors, audit firms, individual auditors, professional audit associations and training centers in accordance with a regulation on register maintenance approved by an authorized federal body as well as provide information contained in registers to all interested parties;
• arrange the accreditation of professional audit associations.

As compared to the Interim Rules, Section 19 contains a new provision whereby the Audit Council is set up under an authorized federal body to take into account the views of professional auditors. The head of an authorized federal body shall approve a Regulation on the Audit Council.

Members of the Audit Council are appointed by the head of an authorized federal body and nominated by accredited professional audit associations, federal executive government agencies, training organizations and universities. The Audit Council shall include representatives from federal executive government agencies that are responsible for the regulation of enterprises subject to statutory audit.

Representatives of accredited professional audit associations must account for at least 51% of the Council membership, which will enable the audit profession to participate in the decision-making process.

This section also sets out major functions of the Audit Council. In particular, the Council:

• participates in the preparation and preliminary review of major audit regulations and draft decisions of an authorized federal body;
• drafts federal auditing rules (standards), revises and submits them to an authorized federal body for consideration;
• considers applications and requests of accredited professional audit associations and submits relevant recommendations to an authorized federal body for consideration;
• performs other functions in accordance with a Regulation on the Audit Council.

In an attempt to meet current professional development requirements, the Law provides for accredited professional audit associations, which is crucial for more active involvement of professional audit associations in audit regulation and more efficient audit quality control. This issue is covered in Section 20, Accredited Professional Audit Associations.

This section establishes that an accredited professional audit association is a non-profit making association of auditors, individual auditors and audit firms with more than 1,000 certified auditors and/or more than 100 audit firms. An accredited professional audit association is set up under Russian legislation in order to support and protect interests of their members. It adopts binding rules (standards) of professional conduct and ethics and performs systematic control of its members’ compliance with these rules (standards). It must be accredited with an authorized federal body.

The reason why associations might seek the status of an accredited body is obvious. The government attests the professional level of an audit association and an authorized federal audit regulator delegates certain authority to this body. As a result, its reputation and publicity are improved in the audit and accounting community both in and outside Russia. This will also benefit other participants of the audit market. Audit practitioners and audit firms will be able to find a professional association that translates its words into action by taking care of its members, implementing best demonstrated practices and acting as an efficient audit SRO. References provided by a respectable professional association will enable clients of auditors and audit firms to be confident that qualified professionals will conduct an audit at a high level with due regard to auditors’ ethics. Future operations of an accredited professional association will demonstrate clearly its potential and capabilities. Based on the performance of accredited professional associations, it will be decided on a case-by-case basis whether additional authority should be delegated or existing powers canceled. The efficient operations of accredited associations will be a starting point for the delegation of further regulatory powers to professional audit associations.

The Law specifies that an authorized federal body should specify procedures for obtaining, refusing to grant and canceling accreditation as well as rights and obligations of accredited professional audit associations with due regard to this Law and recommendations of the Audit Council.

This section also provides that if an audit license is canceled, the audit firm or individual auditor shall be expelled from all accredited professional audit associations with no right to reapply for membership with accredited professional audit associations for a period established by an authorized federal body. However, this period should not exceed three years as from the day when an audit license is canceled.

Section 21 of the Law specifies responsibility for the violation of Russian federal legislation on auditing. In essence, this section is based on the Interim Rules. For example, the Law provides that if an audit firm or individual auditor engages in auditing without obtaining a proper license, it will be subject to a penalty fee ranging from 100 to 300 minimum wages as established by a federal law.

This section also provides that if an enterprise or sole entrepreneur subject to statutory audits is either evading or impeding a statutory audit, a penalty fee arises ranging from 500 to 1,000 minimum wages as established by the federal law.

This section also provides procedures for collecting penalty fees.

Section 22 specifies procedures for enacting the Federal Auditing Law. As was mentioned above, the Law came into effect within one month of its official publication (except for certain provisions). This section also specifies the duration of audit qualification certificates and licenses that were issued prior to the enactment of this Federal Law. It should be noted that, under p.4 of this section, audit firms must bring their articles of incorporation in compliance with the Section, Audit Firm, of this federal law within three months of the enactment of this Law, i.e. by 9 December 2001.

Following adoption of the Federal Auditing Law, Russian auditors are now subject to better legal framework. Implementing this Law will encourage audit in Russia and improve its image internationally. A success factor is constructive cooperation of auditors, professional audit associations and relevant government agencies aimed at audit development in Russia.

Mr. Andrei Krikunov is Head of the Department for Government Financial Control and Auditing, Russian Ministry of Finance.