COMMISSION OF THE EUROPEAN COMMUNITIES 
Brussels, 24.07.1996 
COM(96) 338 final 
GREEN PAPER 
THE ROLE, THE POSITION AND THE LIABILITY OF THE 
STATUTORY AUDITOR WITHIN THE EUROPEAN UNION 
(presented by the Commission) 

CONTENTS Para. no. 
1. INTRODUCTION 1.1-1.15 
2. REGULATION OF STATUTORY AUDIT AT EU LEVEL 2.1 - 2.10 
AND NEED FOR EU ACTION 
3. THE ROLE OF THE STATUTORY AUDITOR 
A definition of statutory audit 3.1 - 3.7 
• The accuracy of financial statements 3.8-3.13 
• The going concern status/solvency of the company 3.14 - 3.21 
• The existence of fraud 3.22 - 3.29 
• The respect by the company of its legal obligations 3.30 - 3. 32 
• Responsible behaviour by the company with regard to 3.33 - 3.35 
environmental and societal matters 
• Priorities for action and possible methods 3.36 - 3.38 
The audit report 
• Contents of the audit report 3. 39 - 3.44 
• Priorities for action and possible methods 3.45 - 3.47 
4. THE POSITION OF THE STATUTORY AUDITOR 
The competence of the statutory auditor 
• Competence in the Eighth Directive 4.1 - 4.4 
• Priorities for action and possible methods 4.5 - 4.6 
The independence of the statutory auditor 
• Definition of independence 4.7-4.15 
• Priorities for action and possible methods 4.16-4.17 
The position of the statutory auditor within the company 
• The statutory audit and corporate governance 4.18 - 4.26 
• Priorities for action and possible methods 4.27 - 4.28 
The role of governmental and professional bodies 
• Quality control 4.29 - 4.33 
• Priorities for action and possible methods 4.34 - 4.36 
5. AUDITOR'S CIVIL LIABILITY 
Towards a limited liability ? 5.1 - 5.5 
Priorities for action and possible methods 5.6 - 5.7 
6. THE STATUTORY AUDIT IN SMALL COMPANIES 
The small company audit 6.1 - 6.6 
Priorities for action and possible methods 6.7 
7. GROUP AUDIT ARRANGEMENTS 
The statutory audit in groups of companies 7.1 - 7.3 
Priorities for action and possible methods 7.4 
8. THE FREEDOM OF ESTABLISHMENT AND THE 8.1 - 8.2 
FREEDOM TO PROVIDE SERVICES 
Freedom of establishment and freedom to provide services for 8.3 - 8.5 
individuals 
Freedom of establishment and freedom to provide services for audit 8.6 - 8.9 
firms 
Priorities for action and possible methods 8.10 - 8.13 
9. CONCLUSION 9.1-9.5 
Bibliography 
1. INTRODUCTION 
1.1 The requirement to have the annual and consolidated accounts of certain companies 
audited by a qualified professional, which was introduced for the Community as a 
whole by the Accounting Directives, is designed to protect the public interest. The 
assurance offered by audited accounts should enhance the confidence of all parties 
which are concerned with the affairs of companies. The increased transparency 
resulting from the harmonisation of the financial information published by 
companies together with the increased reliability of that information as a result of 
the audit by an independent and qualified professional were regarded as an 
important contribution to the completion of the Single Market. 
1.2 The role of the statutory auditor has recently been the subject of much debate world­
wide. As a result in particular of a number of important financial failures, questions 
have been raised concerning the function of the statutory audit and the independence 
of the auditor. At EU level, it has been difficult to respond to these questions 
because the regulatory framework which surrounds the statutory audit at EU level is 
incomplete. There is no common view at EU level on the role, the position and the 
liability of the statutory auditor. The absence of such a common view has a negative 
impact on audit quality and on the freedom of establishment and freedom to provide 
services in the audit field. 
1.3 Against this background and in response to requests from the auditing profession, 
the Commission considers it desirable to organise a wide-ranging reflection on the 
scope and need for further EU level action in this area. Since the European Council 
of Birmingham, the Green Paper has become one of the privileged instruments for 
the consultation of Member States and interested parties. The present Green Paper is 
intended to raise the awareness of all interested parties in the issues at stake and to 
elicit their comments. 
1.4 In drafting this document, the Commission took account of various studies which 
have been produced in this field at national and international level1. The 
Commission itself launched a study on the role, the position and the liability of the 
statutory auditor, which was carried out by the Maastricht Accounting and Auditing 
Research Center (MARC), in order to establish a clear picture of the way in which 
the statutory audit is dealt with in the legislation of Member States. It is intended to 
discuss some of the issues raised in this document and the comments received at a 
Conference which the Commission is organising on 5 and 6 December 1996 
concerning the role, the position and the liability of the statutory auditor. 
1 See bibliography annexed 
1.5 After a short description of the existing regulation of the statutory audit at EU level 
and the reasons why renewed action at EU level may be justified, the document 
discusses the main issues relating to the role and the position of the statutory 
auditor, his liability, the audit in small companies, group audit arrangements and 
freedom of establishment and freedom to provide services in the audit field. Each 
chapter concludes with a short section suggesting possible priorities for action and 
ways and means to tackle the issues at EU level. It is particularly on those points 
that comments from interested parties would be welcome. 
2. REGULATION OF STATUTORY AUDIT AT EU LEVEL AND NEED FOR 
EU ACTION 
2.1 In accordance with the Fourth Council Directive (78/660/EEC) of 25 July 1978 on 
the annual accounts of certain types of companies, all companies covered by the 
Directive must have their annual accounts audited by a qualified professional. The 
statutory auditor must also see to it that the annual report is consistent with the 
annual accounts for the same financial year. Member States may exempt small 
companies as defined in the Directive from the obligation to have their accounts 
audited. 
2.2 The Seventh Council Directive (83/349/EEC) of 13 June 1983 on consolidated 
accounts has extended the audit requirement to all entities which draw up 
consolidated accounts on the basis of the Directive. Similarly, the Council 
Directives 86/63 5/EEC of 18 December on the annual accounts and consolidated 
accounts of banks and other financial institutions and 91/674/EEC of 19 December 
1991 on the annual accounts and consolidated accounts of insurance undertakings 
have introduced a requirement for all entities covered by those Directives to have 
their annual accounts and consolidated accounts audited by a qualified professional. 
2.3 Member States may only approve as auditors the persons who satisfy the conditions 
of the Eighth Council Directive (84/253/EEC) of 10 April 1984 on the approval of 
persons responsible for carrying out the statutory audits of accounting documents. 
The conditions of approval concern professional qualifications on the one hand and 
personal integrity and independence on the other. 
2.4 While the Eighth Directive defines the minimum qualifications of the statutory 
auditor it does not contain any specific guidance concerning the independence 
requirement. At the time of adoption of the Directive, the Commission stated that 
this situation was not satisfactory and that they reserved the right to come back to 
this issue at a later stage. This has not yet been done. Similarly, the Proposed Fifth 
Directive concerning the structure of public limited companies and the powers and 
obligations of their organs, which contains provisions dealing with the appointment 
and dismissal of the statutory auditor, the audit fee, the audit report and the liability 
of the statutory auditor, remains on the Council table. Some of the issues concerned 
are regulated at national level or are the subject of self-regulation through the 
accountancy profession. There are however inevitable differences in the way they 
are dealt with and there is often no legislative backing. 
2.5 The justification for EU interest and action in this area rests in the Single Market. 
The audited financial statements of a company established in a Member State are 
used by third parties in other Member States, such as investors, creditors and 
employees. These third parties not unreasonably assume a certain level of assurance 
and a certain coverage of the audit. Just as there have been pressures to standardise 
these aspects of audits at a national level, partly in response to market forces, there 
is also demand for some standardisation of these aspects of the audit at a European 
level. It would of course be necessary to ensure that any standards which are 
developed can be kept up to date in the face of changes emanating from the 
development of the Information Society 
2.6 There are also arguments related to the free movement of services and freedom of 
establishment. Several studies launched by the Commission, notably on 
Competition in European Accounting completed in 1992 and on the Role, the 
Position and the Liability of the Statutory Auditor completed in 1996, have shown 
that there is not yet a European market in audit services and that important 
differences remain between the national laws and regulations of Member States 
which deal with the statutory audit. 
2.7 The 1992 study concludes that the need for the service provider to be located in the 
same place as the client, coupled with various legal and professional obstacles, rules 
out true cross-border trade. Measures taken towards harmonisation and mutual 
recognition have some way to go in order to bring about significant changes in this 
situation. The 1996 study concludes that if there is to be a European market for audit 
services, initiatives are needed at EU level in two areas : freedom of establishment 
notably of audit firms and freedom to provide services in the audit field on the one 
hand and audit quality on the other hand. The report also concludes that differences 
between the liability regimes in the Member States are likely to have a negative 
impact on intra-Union trade in audit services. 
2.8 Similar concerns were expressed in a position paper presented by the Fédération des 
experts-comptables européens (FEE) in February 1996. In this document the 
accountancy profession asks the Commission to look at a number of issues which 
are particularly relevant for them and on which they believe that action at EU level 
is necessary. These issues concern particularly the freedom of establishment of 
statutory auditors and the freedom to provide cross-border audit services, as well as 
professional liability. 
2.9 Finally, the lack of a harmonised view at EU level concerning the role, the position 
and the liability of the statutory auditor risks becoming a serious handicap in the 
negotiations which are taking place at international level with a view of improving 
the access of the European companies to the international capital market. Last year, 
the Commission presented a Communication to the Council and to the European 
Parliament on "Accounting Harmonisation : a new strategy vis-à-vis international 
harmonisation" (COM(95)508). In this Communication, the Commission announced 
a new strategy which would allow global players in Europe to obtain capital on the 
international capital market without having to comply with different requirements 
on financial reporting. The Commission announced its support for the international 
harmonisation process led by the International Accounting Standards Committee 
(IASC) together with the International Organisation of Securities Commissions 
(IOSCO), aiming at the establishment of a core set of accounting standards which 
will be accepted in capital markets world-wide. Steps are being taken in order to 
increase the influence of the EU in this international accounting harmonisation 
process. 
2.10 There is however a significant risk that the accounts and consolidated accounts 
prepared by European companies will not be accepted in international capital 
markets unless these accounts have been audited by an independent and qualified 
professional in accordance with auditing standards which are regarded as generally 
acceptable world-wide. The International Auditing Practices Committee of the 
International Federation of Accountants (IFAC) has developed a number of 
international auditing standards. The EU will have to decide whether it wants to 
support these standards and if so, how and on what basis the European influence in 
the development of international auditing standards can be increased. 
3. THE ROLE OF THE STATUTORY AUDITOR 
A definition of the statutory audit 
3.1 Although the Fourth and Seventh Directives require annual and consolidated 
accounts to be audited by a qualified professional, the Directives do not contain a 
definition of the statutory audit. Similarly, the Bank Accounts and Insurance 
Accounts Directives require a statutory audit without defining what this means. 
3.2 According to the definition adopted by the International Federation of Accountants 
(IFAC), the objective of an audit is to enable the auditor to express an opinion on 
whether the financial statements are prepared, in all material respects, in accordance 
with an identified financial reporting framework. 
3.3 Numerous studies have shown that there are considerable differences between what 
the public expects from an audit and what the auditing profession believes that the 
auditor should do. The expectation gap resulting from this is a major problem for 
auditors since the greater the gap in expectations, the lower is the credibility and 
prestige associated with their work. It is an issue for the public at large, because the 
proper functioning of a market economy depends heavily on confidence in audited 
financial statements. 
3.4 Any definition of the statutory audit should consider the needs and the expectations 
of users to the extent that they are reasonable, as well as the ability of the statutory 
auditor to respond to those needs and expectations. 
3.5 As far as the needs and expectations of users are concerned, they can be considered 
reasonable if : 
the tasks have been prescribed by law ; 
there are stakeholders who are willing to pay for the service ( i.e. there is an 
effective demand) ; 
there exists a statutory auditor who is willing to supply the service ( for a 
price which reflects notably his level of qualification, the difficulty of the 
task, the number of hours and the risk involved) and is competent to do so. 
3.6 What statutory auditors can supply will depend not only on what clients are willing 
to pay for, but also on the auditors' technical skills and attitude to risk. Some of the 
demands placed on auditors may be unreasonable in that auditors cannot be 
expected to possess the skills necessary to do the work. 
3.7 The public expects the statutory auditor to have a role in protecting the interests of 
shareholders, creditors (e.g. suppliers, banks and credit institutions), pensioners, 
employees and the public generally by providing them with reassurances concerning 
the accuracy of financial statements 
the going concern status / solvency of the company 
the existence of fraud 
the respect by the company of its legal obligations 
the responsible behaviour of the company with regard to environmental and 
societal matters. 
It is useful to examine briefly the reasonableness of these expectations. 
The accuracy of financial statements 
3.8 There seems to be a widely held view among users of financial statements, that an 
unqualified audit report guarantees the material accuracy of the financial statements. 
3.9 There are two misconceptions inherent in this expectation. The first is that it is 
possible to prepare financial statements that are "accurate" and the second is that the 
financial statements are the responsibility of the auditor. 
3.10 As to the first misconception, it is generally agreed among those who are well 
informed about accounting that financial statements cannot be "accurate" in the 
sense that there is only one set of figures that correctly expresses the results of a 
company's operations and its financial status. The choices available for the 
accounting treatment of complex business operations and the uncertainties implicit 
in management decision-making defeat any attempt to develop a set of financial 
statements that all informed observers would regard as "accurate". 
3.11 In the EU, legal recognition that no set of financial statements can be uniquely 
"right" is embodied in the requirement that the annual and consolidated accounts 
should give a true and fair view, which is incorporated in the Accounting Directives. 
The strength of the true and fair requirement, which is an overriding principle in the 
Accounting Directives, is that it allows for the inevitably judgmental nature of many 
accounting figures. 
10 
3.12 There has been considerable criticism of auditors for not taking a stronger line when 
dealing with financial statements that comply "creatively" with the rules. When, in 
the auditors' opinion, the financial statements are misleading as a result of the 
directors' accounting choices and disclosure practices, auditing guidelines require 
the auditor to issue a qualified opinion that states clearly all the factors giving rise to 
the disagreement, the implications for the financial statements and, whenever 
practicable, a quantification of the effect on the financial statements. Moreover, 
when the auditor considers that the effect of the disagreement is so material or 
pervasive that the financial statements as a whole are misleading, auditing 
guidelines require him to issue an adverse opinion. 
3.13 The second misconception is that it is the statutory auditor who prepares the 
financial statements and is responsible for them. On this issue there is no doubt that 
it is the Board of Directors and not the statutory auditor which has the responsibility 
to adopt financial statements (prepared by management) showing a true and fair 
view. It is the directors and not the statutory auditor which determine the accounting 
treatment and disclosure practices adopted in the financial statements. Directors are 
in the best position to know the affairs of their company, to maintain its records and 
to prepare its accounts. Auditors should be independent of and separate from the 
management and supervisory boards of their clients. Their duties would therefore 
seem quite distinct. They should state whether, in his view, the financial statements 
have been prepared in accordance with the law and whether they show a true and 
fair view. 
The going concern status / solvency of the company 
3.14 Several surveys have shown that there is an expectation on the part of a significant 
proportion of the general public that the statutory auditor's report guarantees the 
financial soundness of a company. 
3.15 Amiual accounts are prepared on the basis that the company will continue as a going 
concern. Directors are entitled to adopt this basis only if they are satisfied that this is 
indeed the case. (If it is not, different accounting rules apply.) Some countries are 
considering a requirement for directors to comment explicitly on the ability of the 
company to continue as a going concern and to take the necessary steps to ensure 
that such comment is well founded. 
3.16 Auditors have a duty to be alert to factors that may increase the company's financial 
strength or decrease its resources, thus allowing them to assess whether the going 
concern basis is appropriate. They should warn the directors or supervisory board as 
soon as they become aware of matters that may threaten the going concern basis. 
Acceptance of the going concern basis implies solvency, that is, that at the balance 
sheet date the company's position was such that it would have been able to meet its 
liabilities in full as they fell due. Users expect the audit report to contain the 
auditor's opinion on solvency where the going concern basis is accepted. 
11 
3.17 Requiring this of the auditor would not relieve directors of the responsibility placed 
on them by company law for determining whether or not a company is solvent, nor 
mitigate the seriousness of their offence were they to continue trading while it was 
insolvent2. Directors' responsibilities are a continuing one, while the auditors' 
opinion is based on the position as seen at a particular date. 
3.18 Auditors need to be cautious in the way they report publicly any concerns that they 
may have. Continuance of a company may depend upon the rest of the world not 
knowing that its status as a going concern is open to any doubt. If, for example, 
auditors report that a company will continue as a going concern only if the bank 
continues to roll over its loans and its suppliers continue to grant normal periods of 
credit, this may result in the bank insisting on immediate repayment and the 
suppliers insisting on cash on delivery. 
3.19 On the other hand, some companies might still be in existence and shareholders' and 
creditors' money saved if problems had been identified earlier. Moreover, there are 
examples of companies that are able to continue trading despite its being public 
knowledge that they suffer from liquidity problems and are subject to discussions 
about financial reconstruction. Indeed, certain studies have found, comparing a set 
of companies having a going concern qualification with a matched set having no 
qualification that the survival rates were indistinguishable. 
3.20 Some Member States have laid down specific procedures2 to be followed by 
directors and auditors when the going concern assumption is called into doubt 
Different reports on corporate governance focus on this issue and some propose that 
directors should provide auditors with a written statement confirming that, in their 
view, the company will remain a going concern for the twelve months from the date 
the directors approve the financial statements. The directors should provide the 
auditors with evidence to support that view. Auditors will have a responsibility to 
perform procedures specifically designed to test the directors' view that the company 
is a going concern. The Cadbury Report3 and the Vienot Report3 propose that 
directors should be required to satisfy themselves that the going concern assumption 
is reasonable and that they should report accordingly to shareholders. Auditors 
should have a responsibility to test the directors' view that the company is a going 
concern and to give their opinion on the matter. 
These procedures go beyond what is presently required by virtue of Article 17 § 1 of the 2nd Council 
Directive (77/91/EEC) of 13/12/1976 which states that in case of a serious loss of the subscribed 
capital, a general meeting of shareholders must be called to consider whether the company should be 
wound up or any other measures taken. 
See Bibliography annexed. 
12 v 
3.21 Although neither the directors nor the statutory auditors can guarantee the 
continuing financial soundness of a company, it seems reasonable to expect the 
directors to state publicly whether in their judgement, given the trading environment 
in which the company is operating and expects to operate, adequate financial 
resources are available to enable it to remain a going concern for at least twelve 
months from the day the directors adopt the financial statements. It seems equally 
reasonable to expect the auditors to carry out procedures aimed at testing the 
directors' stated judgement and to report publicly on the result of such tests. 
The existence of fraud 
3.22 Audits have traditionally been associated with the detection of fraud. A survey 
carried out in the UK in 1989 found that 75% of the general public, including the 
majority of financially knowledgeable people, think that it is the statutory auditor's 
responsibility to detect fraud of all kinds. The same survey found that 61% of the 
general public think that it is the responsibility of the auditor actively to search for 
fraud. 
3.23 Until recently the standard auditor response was to say that the auditors' prime role 
is not to prevent or detect fraud and that this is in any event impossible. It was not 
until the 1980s that in some Member States, legislation sought to make explicit 
reference to fraud reporting / detection as an audit objective. Since that period, 
governments have become particularly concerned with issues of law and order, 
white collar crime and investor protection following well-publicised affairs that 
made press headlines in several Member States. 
3.24 Regulatory bodies in a number of Member States have issued auditing guidelines 
related to the statutory auditor's responsibility in relation to fraud, other 
irregularities and errors. The guidelines specify the respective responsibilities of 
management and of the auditor. Management has primary responsibility for the 
detection of fraud, other irregularities and errors. This responsibility is seen as part 
of management's stewardship role. The auditor's responsibility is to plan, perform 
and evaluate his audit work so as to have a reasonable expectation of detecting 
material misstatements in the accounts, whether they are caused by fraud, other 
irregularities or errors. 
3.25 The guidelines recommend that if, during the course of the audit, the statutory 
auditor begins to suspect fraudulent activity, he has a responsibility to investigate 
until his suspicions are either allayed or confirmed. In some Member States it is 
recommended that the auditor promptly report to senior management all fraud 
detected during the audit, even if the effect of the fraud is not material in the context 
of the company's financial statements. The only circumstances in which auditors 
should not so report is when they suspect senior management is involved in the 
fraud. In these circumstances the auditor should report the matter to an appropriate 
authority. In some Member States, statutory auditors are required to report to the 
Ministry of Justice. 
13 
3.26 Auditing guidelines suggest that the auditor may need to take legal advice before 
making a decision on whether the matter should be reported to a proper authority in 
the public interest. The difficulty for auditors is that normally they will have to 
make a decision based on their suspicions of fraud rather than on proven facts. If 
they report their suspicions to a third party and are subsequently unable to establish 
firm evidence of fraud they may be liable to legal action. 
3.27 In the financial sector, auditors' responsibilities in this regard have been clarified, in 
most Member States, by legislation which releases auditors from their obligations of 
confidentiality to their client organisations and give them the right but not the 
obligation to report to a regulatory body. 
It is now specifically provided for in Article 5.1 of a Council Directive 95/26/EC 
adopted in June 1995 that the statutory auditor of a financial undertaking" shall have 
a duty to report promptly to the competent authorities any fact or decision 
concerning that undertaking of which he has become aware while carrying out that 
task which is liable to : 
- constitute a material breach of the laws, regulations or administrative provisions 
which lay down the conditions governing authorisation or which specifically govern 
pursuit of the activities of financial undertakings, or 
- affect the continuous functioning of the financial undertaking, or 
- lead to refusal to certify the accounts or to the expression of reservations ;..." 
This Directive also provides in its Article 5.2 that : " The disclosure in good faith to 
the competent authorities, by persons authorised within the meaning of Directive 
84/253/EEC (the statutory auditor), of any factor or decision referred to in paragraph 
1 shall not constitute a breach of any restriction on disclosure of information 
imposed by contract or by any legislative, regulatory or administrative provision and 
shall not involve such persons in liability of any kind". 
This Directive is to be implemented in all Member States by July 1996 
3.28 If the fraud is material, statutory auditors need to ensure that the financial statements 
reflect the effect of the fraud and that all necessary details are disclosed. Provided 
the auditors are then convinced that the financial statements give a true and fair 
view, it is not necessary to qualify the audit report. If the fraud is not material in the 
context of the financial statements, it is the responsibility of the directors to decide 
whether disclosure is necessary. However, since undetected material fraud will 
result in financial statements which do not present a true and fair view of the 
company's affairs, it would seem that auditors have a duty to employ the means 
which they think are necessary to detect material fraud if their opinion is to be valid. 
14 
3.29 The public expects the opportunities for fraud to be minimised. It seems reasonable 
to expect the Board of Directors to take responsibility for setting up and maintaining 
systems of internal control that, inter alia, minimise the opportunities for fraud and 
maximise the likelihood that any such fraud will be quickly detected. It seems also 
reasonable to expect statutory auditors to confirm in the audit report that such 
systems of internal control exist and to say whether or not they appear well designed 
to serve their purpose. In the same way, it would appear reasonable to expect 
auditors to support the directors in their attempts to prevent and detect fraud by 
reporting to the directors any weaknesses they may have identified in these systems 
of internal control and any suspicions they may have in regard to fraud. 
The respect by the company of its legal obligations 
3.30 It appears to be the general view that it is the auditor's duty to detect contravention 
of company law or of statutory regulations which specifically relate to company 
law. The auditor cannot however be reasonably expected to report on matters 
beyond his competence or expertise, especially in today's complex legal 
environment. 
3.31 The directors should take responsibility for setting up and maintaining systems of 
internal control that, inter alia, minimise the opportunities for committing illegal 
acts in the name of the company and that maximise the likelihood that any such 
illegal acts will be quickly detected. It would seem reasonable to expect the statutory 
auditor to confirm in his audit report that such systems of internal control exist and 
to say whether or not they appear well-designed to serve their purpose. 
3.32 In addition, as part of their responsibility to prepare financial statements which show 
a true and fair view, directors must ensure that the statements reflect the financial 
implications of illegal acts detected, if these implications are judged to be material. 
The statutory auditor, as part of his responsibility to express an opinion on whether 
the financial statements give a true and fair view, must confirm that the statements 
reflect the financial implications of any such illegal acts. 
Responsible behaviour by the company with regard to environmental and 
societal matters 
3.33 There have been demands over recent years for companies to be subject to an audit 
of their social behaviour, most notably in respect of the physical environment but 
also in terms of employment practices, safety of operations, trade sanctions, product 
development policies and other issues of concern to the general public and to 
particular interest groups. 
15 
3.34 Without entering into the merits of such an audit or audits, it might be asked 
whether the statutory auditor has appropriate qualifications and experience to carry 
out this work, or whether it should be a separate exercise from the statutory audit 
and be carried out by qualified experts in the area(s). 
3.35 Although it is unreasonable to expect the statutory auditor to make judgements on 
matters outside his competence and expertise, it can be argued that auditors should 
accept that their responsibilities will tend to increase in line with public 
expectations. The auditor can, given time and a sufficiently clear consensus on what 
is expected, avail himself of the necessary expertise in areas which go beyond strict 
financial audit. 
Priorities for action and possible methods 
3.36 The absence of a common definition of the statutory audit in the EU creates a 
damaging expectation gap. A common approach to the statutory audit, taking 
account of the latest developments at international level, seems desirable. If the 
audit is to add confidence to published financial statements, users need to know 
what the audit certificate means in terms of assurance. In this regard, particular 
attention should go to the role of the auditor in respect of the going concern status of 
the company and the action to be undertaken by the auditor in case of fraud and 
other illegal acts. 
3.37 Consideration should be given to what extent existing International Standards on 
Auditing could be the starting point of a common definition of the statutory audit. 
Full account would also need to be taken, however of any particularities which 
distinguish the European from the international environment. 
3.38 To be effective, the common definition would need to become part of the regulatory 
framework in all Member States. It is for consideration whether an EU Directive 
would be needed to achieve this result or whether a Recommendation would suffice. 
In either case, due attention would need to be paid to flexibility, so that any legal 
requirement can easily be adapted to the rapidly changing environment in which the 
auditor operates. 
16 
The audit report 
Contents of the audit report 
3.39 The audit report is the medium through which the statutory auditor communicates 
with shareholders, creditors, employees and with the public at large. It is the result 
of the audit process. Usually, a distinction is made between a "long form" audit 
report and a "short form" audit report. The "long form" report is addressed to 
management and is not normally made available to the public. 
3.40 Although the content of the audit report is not prescribed under the Accounting 
Directives, company law in most Member States has specified the matters which 
have to be included in the published audit report. Professional bodies in all Member 
States have established standard forms of published audit reports. However, only 
three Member States have made it a binding rule that those standard forms be used. 
3.41 In general, the audit report concerning the annual accounts in Member States would 
normally contain the following information : 
whether the auditor has obtained all the information and explanations which, 
to the best of his knowledge and belief, are necessary for the purposes of his 
audit ; 
whether, in his opinion, proper books and records have been kept by the 
company ; 
whether the annual report is consistent with the annual accounts ; 
whether the annual accounts give a true and fair view of the company's assets, 
liabilities, financial position and profit or loss ; 
whether the annual accounts comply with the requirements of company law ; 
whether the audit was carried out in accordance with auditing standards. 
3.42 Looking at the audit reports of the largest listed companies in Member States, one 
could say that, in their present form, users can derive comfort only from the absence 
of a qualification to the financial statements. They give users no help in 
understanding what the auditors, who are appointed by shareholders and report to 
them, actually do in return for the audit fee paid to them. Without this information, 
it is difficult to see how investors and other users can form a conclusion with any 
degree of confidence on the weight they can place on the auditors' opinion. 
17 
3.43 There seems to be a general consensus that more information should be given about 
the scope and nature of the work on which the audit report is based. Users very often 
consider the audit report as an assurance or a certificate for their decision making. It 
is necessary that the audit report clearly states the auditor's responsibilities for 
reporting on the financial statements. 
3.44 The results of recent surveys have shown that harmonisation of the form and the 
wording of the audit report has increased in the EU over the last ten years. This is to 
a large extent the consequence of a more widespread and consistent adoption of the 
relevant International Standard on Auditing. Differences still exist however between 
Member States with regard to the wording and the coverage of the standard short 
form statutory audit report. These differences have a single market impact to the 
extent that they reduce the utility of reports issued in other Member States. In 
principle, where similar statutory audit work has been performed, this should be 
clearly communicated by way of similar wording in the audit report. 
Priorities for action and possible methods 
3.45 Once an agreement has been reached on the definition of the statutory audit, it 
should be easier to agree on the minimum content of the audit report. Because the 
audit report is the medium through which the statutory auditor communicates with 
shareholders, creditors, employees and with the public at large, it seems desirable 
that a similar wording in the audit report is used throughout the EU. 
3.46 In several Member States the wording of the audit report has been adapted to that 
developed by the International Federation of Accountants. It is for consideration to 
what extent this could also be the starting basis for a common definition at EU level. 
Proper attention would however need to be given to any particularities which 
distinguish the European from the international environment. In order to reduce the 
expectation gap, it would be necessary for the audit report to provide more 
information on what the auditor has actually done, which professional standards he 
has applied in carrying out his task and whether the financial information prepared 
by the company conforms with legal and other regulatory requirements. It would 
also be necessary for any reservations which the auditor might have to be clearly 
spelled out in his report. 
18 
3.47 As for the definition of the statutory audit, it seems necessary for the common 
definition of the audit report to have legislative backing in the Member States. It is 
for consideration whether this points to binding legislation ( i.e. a Directive) at the 
EU level, or whether a Commission Recommendation would be enough. Due 
attention must in any case be paid to flexibility, so that any legal requirement could 
be easily adapted to the rapidly changing environment in which the auditor operates, 
in particular developments related to the introduction of new information 
technologies. 
19 
4 THE POSITION OF THE STATUTORY AUDITOR 
The competence of the statutory auditor 
Competence in the Eighth Directive 
4.1 There can be no doubt that the demands put on the statutory auditor require this 
auditor to be a highly qualified professional. This is the reason why the Eighth 
Directive of 10 April 1984 on the approval of persons responsible for carrying out 
the statutory audits of accounting documents has put the competence of the statutory 
auditor at a very high level indeed. 
4.2 However, differences in the educational systems of the Member States cannot be 
ignored. These were a source of difficulties when attempts were made at the time of 
implementation of the Directive to compare national educational levels in the 
Member States. As a result, the accounting profession in Europe has stressed the 
need for professionals who want to offer cross-border services to acquire the host 
country professional title. 
4.3 Although the Eighth Directive has led to some harmonisation in this field, there are 
still important differences. There is at present no common understanding about the 
contents of the different courses which are listed in Article 6 of the Eighth Directive 
and which are part of the test of theoretical knowledge. The lack of a common 
understanding became clearly apparent when new Member States joined the EU and 
when Central and Eastern European countries asked for technical assistance for the 
establishment of training programmes for auditors. 
4.4 The development of information technology is likely to have important 
consequences for the audit function. It is sometimes seen as a threat to auditors, 
because of the diminishing importance of published financial statements to investors 
who may be able to obtain financial information on a permanent basis through 
different means. It can however also offer new opportunities, in terms of new attest 
functions associated with the new information flows, systems and types of 
information that reporting entities will provide to users as the information era moves 
forward. This is bound to have implications for the educational requirements which 
are presently included in the Eighth Directive and which were established taking 
account of the audit function in a different technological environment. For this and 
other reasons, it may be necessary to adapt or clarify Article 6 of the Eighth 
Directive. 
20 
Priorities for action and possible methods 
4.5 It is regrettable that neither the accounting profession, nor the academic community 
have taken any concrete steps to clarify the competence requirements listed in the 
Eighth Directive. It would appear that the definition of a curriculum for the 
education of auditors should be primarily a task for those who are directly involved 
in the educational process. More harmonisation in this field would certainly 
facilitate the application of the Mutual Recognition Directives ( see also section 8 ). 
In this context, it should be evident that the training process must prepare the 
auditors to operate in a Single Market. Such an initiative at European level could be 
undertaken for instance in the framework of the new Community programme 
SOCRATES and in particular Chapter I - ERASMUS, Action 1 .D on University co­
operation projects on subjects of mutual interest ("Thematic Networks"), which 
provide a reflection forum involving representatives of the socio-economic and 
professional world in specific subject study areas, including those of other countries 
participating in these programmes. 
4.6 Updating the list of courses included in Article 6 of the Eighth Directive will require 
an amendment to the Directive. If and when that is considered opportune, 
consideration should be given to the introduction of a procedure which will allow it 
to be further amended in future without passing through the full legislative 
procedure. 
The independence of the statutory auditor 
Definition of independence 
4.7 In accordance with the Eighth Directive, the statutory auditor must be independent. 
At the time of adoption of the Directive, it was impossible to agree on a common 
definition of independence. As a result, this subject has been dealt with differently 
by Member States. 
4.8 As pointed out by FEE4, independence is the main means by which the statutory 
auditor demonstrates that he can perform his task in an objective manner. In dealing 
with independence, it is necessary to address both independence of mind, i.e. the 
state of mind which has regard to all considerations relevant to the task in hand and 
independence in appearance, i.e. the avoidance of facts and circumstances which are 
so significant that an informed third party would question the statutory auditor's 
objectivity. 
See bibliography 
21 
4.9 In recent years, concern has been expressed about the threats which have developed 
to auditors' independence. Several surveys reported on the fact that companies were 
increasingly prepared to challenge auditors, to shop for opinions, to seek legal 
advice on auditors' views and to change auditors. Some reports concluded that, 
given the competitive pressures, it would be idealistic to assume that all auditors are 
at all times unmindful of the risk of losing business. Criticism has been voiced that 
the professionalism of the audit function has diminished in favour of a more 
"businesslike" attitude. 
4.10 Moreover, it has become, more common for the audit to be put out to tender. The 
principal objective in seeking competitive tenders is to obtain the services of the 
auditors as cheaply as possible. It is sometimes suggested that management resort to 
tendering in order to put pressure on the incumbent auditors, particularly when 
disputes have arisen. 
4.11 The growing intensity of competition for audit "business", and especially for the 
audit of large "prestige" companies, is also a cause of concern. There is no doubt 
that competition sometimes results in low-cost and perhaps even below-cost tenders. 
The procedure of calls for tenders which ensures transparency and competition, 
should not have as a consequence that auditors quote an audit fee which does not 
allow them to carry out their work in accordance with professional standards5. Some 
observers infer that the successful tenderers expect to recoup the balance of the full 
cost of the audit from non-audit consultancy services. This points to another concern 
which relates to the provision of non audit services. 
4.12 The question whether the auditor should provide other services to his audit client 
has been the subject of much debate. It has been advocated that the provision of 
other services to an audit client is likely to increase the auditor's understanding of 
the client's business and operations and therefore results in a better audit. Is has also 
been argued that there is no evidence that the volume of non-audit fees in relation to 
the level of audit fees is a threat to objectivity. Nevertheless, there is an equally 
strong belief that the provision of a broad range of non-audit services to an existing 
audit client can impair audit objectivity. Safeguards are necessary to respond to 
these concerns. 
In the case of public procurement, the Council has adopted a set of rules assuring transparency in 
competition for the award of public entities contracts. These rules also apply to audit services. See 
Directives 92/50/EEC and 93/38/EEC - Annex 1A - Category 9. 
22 
4.13 Such safeguards could consist in confining the provision of other services to those 
whose nature and quality are consistent with the auditor's professional image and 
which are unlikely to impair his objectivity, or in requiring the fee for both audit and 
non-audit services to be disclosed. A solution which would consist in preventing the 
auditor from providing any other service to his audit client would clearly solve the 
appearance problem. However, practice has shown that this solution is not a viable 
alternative, as it is too easy to circumvent by having the service provided by an 
affiliated or associated firm. 
4.14 In all cases the auditor should ensure that he and his firm are not involved in the 
management or decision making of his client. The auditor should not be engaged in 
the preparation of the financial statements of his client, be involved in the valuation 
of assets or liabilities for purposes of recording them in the financial statements, act 
for the client in the resolution of litigation which may have a material impact on the 
financial statements, or perform services having a direct impact upon senior 
management such as their recruitment. 
4.15 Some commentators find cause for concern where a company retains the same 
auditors for a long period. It is argued that this can lead to too close and cosy a 
relationship with management, with the auditors becoming too responsive to 
management's wishes. The question whether the statutory audit should be made 
subject to a system of mandatory rotation has been the subject of considerable 
debate. The arguments in favour of such a system are not conclusive. In this context, 
it is important to note that one of the two Member States which had a system of 
mandatory rotation has recently abolished it. A solution which could enhance the 
perception of the auditor's objectivity, without causing the efficiency and quality 
drawbacks of firm rotation, could consist in setting up a rotation of audit partners 
within the same firm. 
Priorities for action and possible methods 
4.16 Independence is an important issue. Based on different traditions and experiences, 
this issue is dealt with differently in Member States. It is unlikely that it will be 
possible in the short term to agree at EU level on a common definition covering the 
various issues raised in relation with auditor independence. The adoption of a set of 
rules which regulate independence does not by itself bring about independence in 
practice. However, agreement on a common core of essential principles in all 
Member States would constitute an important step towards the establishment of an 
internal market for audit services. These principles could be developed by the 
profession at EU level. 
4.17 It is for consideration which instrument is most appropriate to ensure that an 
agreement reached at EU level is likely to be adhered to in practice. 
23 
The position of the statutory auditor within the company 
The statutory audit and corporate governance 
4.18 The statutory audit is an essential element of the system of corporate governance. In 
order to put the statutory audit in the right perspective, it is necessary to distinguish 
the role of the various organs of the company in the field of financial reporting. 
While the directors are responsible for the preparation of the financial statements, 
the role of the statutory auditor is to report to the shareholders on the financial 
statements presented to him by the directors. In doing so, the statutory auditor acts 
in the interests of the shareholders who have a financial stake in the company. In 
addition, his report lends credibility to the financial information used by third 
parties. 
4.19 Because the shareholders have the most direct interest in the outcome of the 
statutory audit, all Member States have given the right to appoint and to dismiss the 
auditor to the shareholders in the general meeting. However, for the shareholders of 
most listed companies, as a result of their large numbers and transient nature, there 
is no effective mechanism for them to do so. It is usually the directors who 
effectively appoint and dismiss the statutory auditor, with the decision merely being 
ratified by the shareholders at the annual general meeting. A consequence of this is 
that statutory auditors are criticised for not being independent of the directors. It is 
argued that, in disputes between the directors and the statutory auditor on issues 
such as accounting policy choices, the statutory auditor has an incentive to concede 
to the wishes of the directors. The statutory auditor may be put in a particularly 
difficult position in such disputes if the directors have gathered opinions from 
competing firms of auditors. 
4.20 It is argued that another result of the auditors being effectively appointed by the 
directors is that, due to cost pressures, both parties have reduced the role of the 
statutory audit to the minimum necessary to fulfil the legal requirements of 
company law as interpreted by the auditing firms themselves. It is argued that this 
has led to less attention being given by the statutory auditors to the assessment of 
the efficiency and effectiveness of companies' internal control systems, which could 
lead to an increased incidence of fraud and other illegal acts. 
4.21 The agreement of the statutory auditors' remuneration with the directors creates a 
further problem. The audit fee is normally agreed in advance and is based on the 
usually valid assumption that the auditors will not find any evidence of malpractice. 
However if, in the course of their work, the auditors become suspicious that there 
has been fraudulent activity that they feel should be subject to further investigation, 
they will have to agree with the directors a fee for this additional work. If the 
directors are involved in the malpractice, the statutory auditor finds himself in a very 
difficult situation. 
24 
4.22 In order to preserve the independence and objectivity of the statutory auditor, 
procedures giving greater assurance that the shareholders are able to make a real 
choice, for instance through a greater use of audit committees and/or reforms of 
board procedures or through the association of other parties, such as the workers 
council in the appointment and dismissal of the auditor, have been developed or are 
currently been examined in certain Member States. 
4.23 Both the Cadbury report in the United Kingdom and the Vienot report in France 
recommend that the board of directors in listed companies should establish an audit 
committee of at least three non-executive directors, chaired by one of their 
members. Since 1978, the New York Stock Exchange has required all listed 
companies to have audit committees composed solely of independent directors and 
the 1987 report of the American Treadway Commission6 concluded that audit 
committees had a critical role to play in ensuring the integrity of US companies 
financial reports. Experience in the United States has shown that, even where audit 
committees might have been set up mainly to meet listing requirements, they have 
proved their worth and developed into essential committees of the board of 
directors. 
4.24 However, it is likely that companies without a strong internal audit function will be 
unable to provide an audit committee with sufficient information to fulfil its 
responsibilities. The scope of the work of the statutory auditor and the timing of the 
statutory audit are unlikely to be adequate and appropriate for this purpose. 
Furthermore, the statutory audit is essentially a snapshot at a particular point in time 
whereas assessment of the effectiveness of a company's management information 
systems and systems of internal control should be undertaken on a continuous basis. 
Consequently, recommendations have been made for the appointment in major 
companies of a chief internal auditor to lead a strong internal audit team that is 
capable of providing the audit committee with sufficient information to fulfil its 
responsibilities on behalf of the board. As stated by the European Confederation of 
Institutes of Internal Auditing in their position paper on Internal Auditing in 
Europe7, the furnishing of objective and timely appraisals of the quality of an 
organisation's internal control and systems for managing business risk, would 
contribute significantly to strengthening management's control of the operations, 
thus contributing to sound corporate governance. In their view, it is necessary for 
the EU to introduce binding legislation for significant enterprises and sectors 
requiring the establishment of a professional internal auditing function and 
regulating qualifications and experience required, as well as the duties of the Board 
and Chief Executive in relation to internal audit conclusions and recommendations. 
6 See bibliography 
7 See bibliography 
25 
4.25 In Member States, the length of the statutory audit appointment varies from a fixed 
period of 1 year to 6 years to an indefinite period. In the Amended Proposal for a 
Fifth Council Directive it is proposed that the statutory auditor should be appointed 
for a specified period of not less than three financial years, and not more than six 
financial years. 
4.26 The 1996 study carried out for the Commission shows that the position of the 
statutory auditor within the company is not the same in all Member States. 
Differences range from an external adviser to an organ of the company. In some 
cases there even exists a dual audit requirement, which means that in addition to the 
statutory audit requirement following from the Accounting Directives, there is 
another audit imposed by the Stock Exchange Regulatory Authority. It is not clear 
that such a system offers any advantages in terms of improved control. On the other 
hand, it can lead to confusion concerning the relative status of the different auditors, 
especially if they come to different conclusions concerning the same company. 
Priorities for action and possible methods 
4.27 Recent debates about corporate governance have stressed the need to define more 
clearly the role of the board of directors in preparing the financial statements. The 
issue is however much more complicated and extends to defining the role of all 
parties involved in the financial reporting process (board of directors, supervisory 
board, general meeting of shareholders, auditor). In order to improve the system of 
checks and balances within the company, more attention should be paid to issues 
such as the creation of an audit committee and the establishment of a proper 
functioning system of internal control. 
4.28 It is difficult to deal at EU level with matters of corporate governance : past efforts 
to harmonise law on the structure of the company have not succeeded. In order to 
contribute to the debate at national level, it might be useful to consider a 
Recommendation at EU level on possible ways to improve the present system of 
corporate governance, especially in as far as it relates to financial reporting. It would 
then be up to Member States to initiate any necessary legislative action at national 
level. 
The role of governmental and professional bodies 
Quality control 
4.29 In accordance with the Eighth Directive, auditors must be approved by an authority 
designated by Member States. This authority must see to it that the persons 
approved as statutory auditors satisfy all the requirements imposed by the Directive 
and that they carry out audits in accordance with the principles of professional 
integrity and independence. 
26 
4.30 Most Member States have delegated the authority to approve the statutory auditor to 
one or more professional associations. In such cases, it is important that these 
associations also supervise the way in which their members conduct the audit. Most 
of these associations have developed professional rules describing the way in which 
the audit has to be carried out. These auditing standards are often inspired by the 
standards developed by IF AC. This is not, however, the case in all Member States 
and these auditing standards, where they are applied, are in most cases only a 
recommendation and not a legal requirement. There is at this stage therefore no 
guarantee that the statutory audits carried out by professionals approved on the basis 
of the Eighth Directive are of equivalent quality. 
4.31 Similarly, the way in which professional associations supervise their members is not 
the same. While some associations have organised peer review systems, whereby the 
work of an auditor is at regular intervals reviewed by another auditor, other 
associations have set up a special unit responsible for reviewing the way in which 
members carry out statutory audits. Here again, there is no guarantee that quality 
review systems in the various Member States are equivalent, or even adequate. 
4.32 Some Member States have decided not to delegate the authority to approve auditors 
to a professional association but have this task carried out by a Ministry or by 
another body, such as a Chamber of Commerce. In this case too, appropriate 
arrangements need to be made to ensure that there is quality control and that actions 
are undertaken in cases where the auditors do not carry out their tasks in accordance 
with the principles of professional integrity and independence. 
4.33 In most Member States, special audit requirements apply to companies in the 
financial sector which are subject to prudential control by a competent authority. 
These additional requirements have been set up to ensure the protection of investors 
and policyholders. In addition, Member States may authorise exchanges of 
information under strict conditions and between the competent authorities of the 
.financial sector and the professional body of the statutory auditor, according to 
paragraphs 1 and 2 of Article 4 of Directive 95/26/EC. 
Priorities for action and possible methods 
4.34 The absence of a legal requirement at EU level that all statutory audits conducted on 
the basis of Community law must be carried out on the basis of an agreed set of 
auditing standards is a handicap for the Single Market and in the international 
context. It should be examined whether the standards on auditing developed by the 
International Auditing Practices Committee of the International Federation of 
Accountants and already applied to a certain extent in most Member States could 
provide a possible basis for agreed standards at EU level. As with international 
accounting standards, it would seem necessary to devise a mechanism to determine 
whether existing IF AC standards meet European requirements and to ensure 
increased European influence in the development of international auditing standards. 
27 
4.35 Such a mechanism at EU level could bring together all parties involved at national 
level in the definition of auditing standards and could discuss all relevant auditing 
matters. It would be important that an assurance be obtained that any auditing 
standards agreed upon at EU level were actually being followed in practice at 
national level. This might be difficult to achieve without giving those standards 
some kind of legal backing. 
4.36 Even if a code of principles on auditor independence and a core set of auditing 
standards can be agreed upon, the system will only be effective if the standards are 
enforced and if there is appropriate quality control. If a mechanism were set up at 
EU level, as suggested above, one of its tasks could also consist in examining the 
way in which quality control in the audit field is assured in the various Member 
States. Within the context of the Single Market, it is also important that the 
regulatory authorities in Member States communicate with each other. The rules of 
professional secrecy should not present any obstacle to this. 
28 
5. AUDITOR'S CIVIL LIABILITY 
Towards a limited liability ? 
5.1 Professional liability is an important issue for auditors. In some Member States, 
audit firms have been made responsible in a number of cases for amounts which 
were disproportionate with the audit fee and with the auditor's direct responsibility 
for the financial failure. The auditor usually disposes of professional indemnity 
insurance and there is a tendency to sue by preference the party whose professional 
liability has been insured. 
5.2 There are major differences as to the liability regime of the statutory auditor within 
the EU. In some Member States, there exists a legal civil liability cap, limiting the 
amount of damages that the statutory auditor might have to pay in the case of 
litigation. In other Member States, auditors can limit their liability by contract. 
Differences also exist regarding the possibility for the courts to limit the amount of 
damages in the case of litigation. 
5.3 Various suggestions have been made in order to arrive at a regime which could be 
regarded as more equitable to the auditor. These suggestions include the 
generalisation of a legal liability cap, the possibility for the auditor to limit his 
liability by contract, the incorporation of the audit firm into a limited liability 
company, the introduction of proportional liability and the introduction of 
mandatory professional insurance for auditors and for directors. 
5.4 The original proposal for a Fifth Company Law Directive provided for unlimited 
liability of the statutory auditor to third parties. The amended proposal contains no 
provision directly imposing upon the statutory auditor a liability to third parties, but 
provides for liability of the auditor only to the audited company, stating that these 
provisions do not in any way exclude an auditor's liability to shareholders and third 
parties under the general private law of the Member States. During the negotiation 
of this proposal in the Council of Ministers working group, the text was further 
clarified by stating that it is up to the Member States to regulate the civil liability of 
the persons responsible for the statutory audit so as to ensure that compensation is 
made for any damage sustained by the company, any shareholder or third party as a 
result of wrongful acts committed by the auditors in carrying out their duties. 
Member States could however allow the limitation by law or by contract of the civil 
liability to the audited company on the basis of negligence. Discussions on the Fifth 
Directive were however discontinued in 1991. 
29 
5.5 Meanwhile, it cannot be denied that the existence of different liability regimes in 
Member States has internal market consequences. As a result of an extensive 
liability regime, audit firms may avoid high-risk clients or even entire industries, 
calling into question the very rationale for a compulsory statutory audit. Costs of 
statutory audits to clients in highly litigious Member States may be higher than 
elsewhere. Insurance premiums throughout the EU might become more expensive as 
a result of litigation in some Member States. This might lead to a further 
concentration of the audit market in the hands of a limited number of audit firms. To 
the extent that there exists a legal or contractual liability cap only in some Member 
States, there might be a tendency to sue the auditor preferably in those Member 
States where there is no such liability cap. 
Priorities for action and possible methods 
5.6 There can be no doubt that the clarification of the role and the position of the 
statutory auditor would have a positive effect on the assessment of his liability in the 
case of an audit failure. Whilst there does not seem to be a reason to confine the 
liability of the auditor to the audited company - as the statutory audit has been 
required in the public interest - it would seem reasonable that the liability of the 
auditor should be limited to amounts which reflect his degree of negligence. 
5.7 Action at EU level in this field is likely to be difficult. The audit profession is not 
the only profession which is struggling with problems of liability. Furthermore, the 
legal traditions in Member States in the area of civil liability are quite different. It is 
for consideration whether the negative effects of a continuation of differences in the 
regulation of audit liability are significant enough to justify EU action, considering 
the difficulties which such action is likely to face and the possible discrimination 
which action specific to the audit profession might entail as regards other 
professions. 
30 
6. THE STATUTORY AUDIT IN SMALL COMPANIES 
The small company audit 
6.1 In accordance with Article 51 (2) of the Fourth Directive, Member States may relieve 
small companies, as defined in Article ll8, from the requirement to have their 
annual accounts audited by a qualified professional. Important reasons for this 
exemption were the wish not to create an additional burden for small companies but 
also the risks involved in a small company audit, where the auditor can rarely rely 
on appropriate internal control mechanisms. Where the exemption has been granted, 
Member States must introduce appropriate sanctions in order to ensure that the 
annual accounts and the annual report are prepared in conformity with the 
requirements of the Directive. 
6.2 On the basis of Article 51 (2), most Member States have exempted small companies 
from the audit requirement, although the criteria for defining a small company do 
not necessarily correspond with the thresholds included in the Directive. In 1989, 
the Commission proposed to require all Member States to abolish the audit 
requirement for small companies. This proposal was strongly resisted by a number 
of Member States. It was argued that published accounts which had not been subject 
to an audit by a qualified professional could be misleading. It was also argued that 
the audit is in the interest of the company itself because it provides the company 
with the expertise of a qualified professional. 
6.3 Considerations of independence play a lesser role in a small company where the 
auditor fulfils the role both of an adviser and of an external controller. It is not 
uncommon for the auditor in a small company to keep the books and records and to 
audit the financial statements. This certainly raises questions as to the independence 
of this professional and the usefulness of such an audit. This is the reason why some 
Member States forbid the auditor to be involved in the preparation of the financial 
statements of the company which he audits. In practical terms, this means that the 
company will have to pay for the services of two different experts, one expert who 
keeps the books and records and prepares the financial statements and another 
expert who carries out the statutory audit. 
According to article 53(2) of the Fourth Directive, the thresholds in Article 11 are reviewed every five 
years by the Council on a proposal of the Commission. The next revision of the thresholds is due to 
take place in 1999 and will take account of the Commission's Recommendation of 3 April 1996 
concerning the definition of small and medium size enterprises 96/280/EC. 
31 
6.4 Some Member States have recognised the different reality of a small company audit 
and have created different professions, one profession which is primarily engaged in 
advising and auditing small companies and another profession which concentrates 
on large companies. Other Member States have made a distinction between micro-
companies and small companies, whereby micro-companies are exempted from the 
audit requirement, while small companies are made subject to a so-called 
compilation report, which does not give the same assurance of a full audit but still 
gives some reassurance to users that the accounts have been properly kept. 
6.5 Medium-sized companies fall somewhere in between the two categories. The 
general feeling seems to be that these companies should still be required to have 
their accounts audited by a qualified professional. In that case, the same criteria 
should apply as in the case of large companies in terms of independence and audit 
quality. 
6.6 If one considers the question whether a statutory audit is useful in the case of small 
and medium-sized companies, it is important to keep in mind that there is a 
tendency to use the vehicle of limited liability companies which are not subject to an 
audit requirement as a means for money laundering. The question whether a 
company should be subject to an audit requirement can therefore not be seen 
exclusively in terms of deregulation. Arguments relating to public policy also need 
to be taken into account. 
Priorities for action and possible methods 
6.7 It is for consideration whether any change in the regulatory environment at EU level 
is desirable or necessary concerning the statutory audit in small and medium sized 
companies. At this stage, the Commission does not consider that convincing 
arguments have yet been advanced for changing the approach in the Fourth 
Directive whereby Member States can exempt small companies from the statutory 
audit. Moreover, it seems unlikely that Member States which require a statutory 
audit would be prepared to do away with it. Similarly the case has not been 
convincingly made for allowing or requiring the exemption of medium-sized 
companies from the audit requirement. 
32 
7. GROUP AUDIT ARRANGEMENTS 
The statutory audit in groups of companies 
7.1 Consolidated financial statements portray the financial position and results of a 
group as if it were a single entity. The statutory audit of consolidated financial 
statements should be carried out with no impediments and obstacles greater than 
those encountered in the statutory audit of the financial statements of a single legal 
entity. With the increasing complexity of international business and the ease with 
which funds can be transferred from country to country, it is of increasing 
importance that the statutory auditor of a group has a total picture of the significant 
activities within a group. This can be difficult in the case of groups having 
operations in more than one jurisdiction. 
7.2 In practice, difficulties arise because there are no specific rules which offer guidance 
in the case of group audits. It is sometimes difficult for the group auditor to obtain 
information from the management and the auditors of the group companies which he 
does not audit. He may receive audited financial statements for the individual 
subsidiary undertakings, but he is not in a position to question the underlying 
rationale for the accounting treatment of transactions reflected in the financial 
statements. The group auditor may not have a total picture of the significant 
activities within the group. Difficulties may also arise due to the rules of 
professional secrecy. 
7.3 Possible solutions to these problems have been advanced : joint audit appointments, 
the development of a comprehensive and integrated standard on group audits, the 
granting of full access to all information necessary for the group auditor to carry out 
his tasks and the appointment of a single statutory auditor to all group companies. 
Priorities for action and possible methods 
7.4 The conduct of a statutory audit of consolidated financial statements could be 
further examined to see to what extent the issues can be dealt with without 
legislative action. The mechanism which might be set up at EU level in order to 
examine the question of auditing standards (see paragraph 4.35 above) might 
usefully look at this subject. In the absence of clear guidance at international level, 
an attempt might be made to develop at EU level a set of principles which could 
guide the group auditor in this matter. 
33 
8. THE FREEDOM OF ESTABLISHMENT AND THE FREEDOM TO 
PROVIDE SERVICES 
8.1 The Commission studies previously mentioned, have shown that there is at present 
no European market for audit services. National audit markets in the EU mainly 
function as separate markets, notwithstanding the fact that some forms of intra-
Union trade in audit services exist. Although the different laws and regulations may 
not constitute an absolute barrier to intra-Union trade in audit services, they do make 
establishment or services offered across borders more costly and / or less effective 
and therefore less likely. 
8.2 To the extent that an equivalent level of audit quality is established in all Member 
States and to the extent that proper arrangements can be found which ensure that the 
audit carried out in a particular Member State by a foreign individual or firm is 
surrounded with guarantees which are at least equivalent to those which surround an 
audit carried out by a local professional it should be possible to make progress in the 
direction of an internal market for audit services. 
Freedom of establishment and freedom to provide services for individuals 
8.3 The freedom of establishment of an individual statutory auditor in another Member 
State has been achieved, to a substantial extent, through Directive 89/48/EEC on the 
mutual recognition of professional qualifications. Auditors who wish to practice in 
another Member State, must acquire the qualification of this Member State but are 
exempted from following the complete educational programme. They can obtain 
this qualification, provided they pass an aptitude test. A possible alternative to 
establishment in most Member States is to delegate audit work in another Member 
State to an auditor established in that Member State. As this auditor would remain 
liable for the statutory audit, this solution is not in fact often practised. The Mutual 
Recognition Directive has only had a limited impact in the case of statutory auditors 
in that only a small number of auditors have been approved under this regime. 
8.4 Impediments to freedom of establishment come from the regulatory bodies of some 
Member States which stipulate that their auditing laws and regulations also apply to 
their auditors working in another Member State, even though these persons have 
been approved to perform audit work under the law of the host country. In order to 
be able to work simultaneously in each of the two countries, such persons must 
respect, at the same time, the rules of the regulatory bodies of both countries, which 
can sometimes be impossible. A possible solution would be the adoption by the 
profession and the authorities, of a code of conduct proposing rules in cases of 
conflict between the home Member State and the host Member State. 
34 
8.5 As far as the freedom to provide cross-border audit services is concerned, most 
Member States require individual professionals to have a professional establishment 
on their territory. This requirement results from the need to maintain an active 
monitoring of the professionals concerned so as to guarantee the quality of the 
services they provide. It has been argued that where a professional auditor possesses 
the title of the host Member State and respects the regulations of that country when 
practising there, the obligation to have a professional establishment on the territory 
of the country is an unnecessary burden. In this respect, the jurisprudence of the 
European Court of Justice in the Ramrath case supports the argument that a Member 
State can require a mere infrastructure and a certain effective presence of the 
statutory auditor. As the study carried out for the Commission in 1996 points out, in 
those Member States where there is no restriction on the delegation of audit work, 
the foreign auditor can work under the responsibility of a national auditor in the host 
country. 
Freedom of establishment and freedom to provide services for audit firms 
8.6 Freedom of establishment can first of all be exercised through the creation of a 
subsidiary in another Member State. The creation of a subsidiary by a foreign audit 
firm or for that matter the creation of an audit firm by foreign professionals is made 
difficult by the fact that national laws and regulations directly restrict the 
opportunities for foreign auditors to establish an audit firm. As the study carried out 
for the Commission in 1996 points out, almost all Member States require that (more 
than) the majority ownership and/ or (more than) the majority of management needs 
to be in the hands of national statutory auditors. In addition, in some Member 
States, other legal forms than partnerships and sole proprietorships are not allowed. 
This limits the possibility of the separation of ownership and management of audit 
firms. 
8.7 Compared to the provisions of the Eighth Directive, most Member States have 
established stricter laws and regulations on the ownership, management and control 
of audit firms. First, according to the Eighth Directive, audits may be carried out 
both by natural persons and firms of auditors which may be legal persons or other 
types of company, firms or partnership. Second, regarding ownership and 
management, the Eighth Directive only requires a majority to be in the hands of 
statutory auditors. In the case of management, the majority needs to be national 
auditors or auditors who have furnished proof of the legal knowledge required for 
purposes of the statutory auditing (Article 2(l)(b)(iii)). In the case of ownership, the 
majority may consist of statutory auditors from other Member States (Article 
2(l)(b)(ii)). A number of Member States require that the capital of an audit firm 
should be held entirely by natural or legal persons (individuals or firms) having the 
local statutory auditor title. In the same way, many Member States have interpreted 
Article 2 (l)(b)(ii) of the Eighth Directive in such a way that a majority of the voting 
rights in an audit firm must be held by natural persons or firms of auditors who are 
approved under the law of the host country. 
35 
8.8 Similar problems arise when an audit firm wants to create a branch in a host 
Member State. An additional problem in this context results from the fact that some 
Member States have limited the number of legal forms which an audit firm can take. 
This may have as a consequence that a foreign audit firm which has a legal form 
which is not allowed by the law of the host country cannot create a branch in that 
country. 
8.9 As far as the freedom to provide cross-border audit services is concerned, the same 
problems described above may arise when a foreign audit firm wishes to carry out a 
statutory audit in a host country where it does not possess an establishment. 
Priorities for action and possible methods 
8.10 Despite the public interest considerations involved in the statutory audit, there is no 
convincing reason why the Treaty provisions on freedom of establishment and 
freedom to provide services should not fully apply to the trade in audit services. 
8.11 Freedom of establishment (and to provide services) of individual statutory auditors 
is already dealt with through Directive 89/48/EEC. Some problems remain. For 
example, retaining the home country title after having obtained the host country 
title, and possible differences in the scope of activity between the Member State of 
origin and the host Member State. These problems could be further examined within 
the co-ordinators group set up by Directive 89/48/EEC, possibly in combination 
with the Contact Committee on the Accounting Directives, which is responsible for 
the Eighth Directive and in close co-operation with national professional 
associations of auditors. 
8.12 Freedom of establishment for professional firms through the creation of a subsidiary 
remains problematic because many Member States have established laws and 
regulations which are more restrictive than those in the Eighth Directive. Member 
States should be asked to remove those national requirements exceeding those of the 
Eighth Directive. In this context, there is a need to clarify the meaning of Article 2 
of the Eighth Directive in order to prevent it from being interpreted too narrowly. 
Such clarification should take place after consultation of the Contact Committee on 
the Accounting Directives. To the extent that Member States have adopted national 
dispositions which contain a discrimination on the grounds of nationality or non-
justified restrictions to the right of establishment, action will be promptly 
undertaken in order to ensure respect for the provisions of the Treaty. 
8.13 Without prejudice to the direct application of the relevant provisions of the Treaty, 
for the freedom of establishment for professional firms through the creation of a 
branch as well as for the freedom to provide cross-border audit services further 
initiatives may be needed. These could take the form of a specific Directive which 
complements Directive 89/48/EEC, as in discussion between the Commission and 
the profession. 
36 
9. CONCLUSION 
9.1 This paper cannot deal exhaustively with the many sometimes very complicated 
issues which surround the audit function. The matters dealt with are those which are 
considered particularly relevant in the context of the Single Market. 
9.2 In suggesting possible priorities for future action, particular attention has been given 
to the principles of subsidiarity and proportionality, as enshrined in the Maastricht 
Treaty. In conformity with the Communication on "Accounting Harmonisation : A 
new strategy vis-à-vis international harmonisation", preference is given to an 
approach which will allow a more coherent European view to be effectively 
expressed in the international debate. 
9.3 The underlying goal of this initiative is to contribute to a general raising of the level 
of auditing in the EU, which will ultimately benefit to all parties concerned with the 
life of companies. 
9.4 Please send comments to European Commission - DG XV - D/3 - Financial 
Information and Accounting Standards - 200, rue de la Loi - 1049 Brussels -
Belgium - ( Internet address d3@dgl5.cec.be) - before 20 December 1996. 
9.5 Comments received before 18 October 1996 will be taken into account in the 
preparation of the Conference to be held on 5/6 December 1996 in Brussels on this 
subject. 
37 
Bibliography 
Beijing, W., Maijoor, St., Meuwissen, R. and Van Witteloostuijn, A., The role, position 
and liability of the statutory auditor within the European Union, final report of the 
study, MARC, March 1996, Maastricht. 
Fédération des Experts Comptables Européens, The Role, Position and Liability of the 
Statutory Auditor in the European Union / Rôle, Statut et Responsabilité du 
Contrôleur Légal des Comptes dans LïUnion Européenne, Fédération des Experts 
Comptables Européens, January-Janvier 1996, Bruxelles. 
Fédération des Experts Comptables Européens, The Role, Position and Liability of the 
Statutory Auditor in the European Union. Appendices / Rôle, Statut et 
Responsabilité du Contrôleur Légal des Comptes dans L'Union Européenne. 
Annexes, Fédération des Experts Comptables Européens, January-Janvier 1996, 
Bruxelles. 
European Confederation of Institutes of Internal Auditing, Position Paper on Internal 
Auditing in Europe, April 1996. 
Common Law Team of the Law Commission, Feasibility Investigation of Joint and 
Several Liability (published for consultation), 1996, London: HMSO . 
CNPF AFEP, Le Conseil d'Administration des Sociétés Cotées (Rapport Vienot), 
Juillet 1995, Paris. 
Centre for European Policy Studies, Corporate Governance in Europe, Report of a 
CEPS Working Party, June 1995, Brussels. 
International Federation of Accountants, IFAC Handbook 1995. Technical 
Pronouncements, International Federation of Accountants, 1995, New York. 
Ebke, W. F. and Struckmeier, D., The Civil Liability of Corporate Auditors : an 
International Perspective, A discussion paper, International Bar Association, 
November 1994, London. 
The Institute of Chartered Accountants of Scotland, Auditor's Liability, 
Recommendations of a Working Party established by The Institute of Chartered 
Accountants of Scotland, November 1994, Edinburgh. 
Mclnnes, W.M..(ed.), Auditing Into the Twenty-first Century, A Discussion 
Document by the Research Committee of The Institute of Chartered Accountants of 
Scotland, The Institute of Chartered Accountants of Scotland, 1993, Edinburgh. 
38 
Report of the Committee on The Financial Aspects of Corporate Governance a Code 
of Best Practice (Cadbury report), Burgess Science Press, December 1992, London. 
Derek Ridyard, Jean de Bolle, Competition in European Accounting, National 
Economic Research Associates (NERA), Lafferty Publications 1992. 
The Financial Reporting Commission, Report of the Commission of Inquiry into the 
Expectations of Users of Published Financial Statements, The Institute of Chartered 
Accountants in Ireland, January 1992, Dublin. 
Archer, S., McLeay, St. and Dufour, J.B., Audit Reports on the Financial Statements 
of European Multinational Companies: a Comparative Study, The Institute of 
Chartered Accountants in England and Wales, June 1989, London. 
39 
FINANCIAL STATEMENT 
1 TITLE OF OPERATION 
Green Paper on the Role, the Position and the Liability of the Statutory Auditor 
in the European Union. 
2 BUDGET HEADING INVOLVED 
B5- 3000 : Actions relatives au fonctionnement du Marché Intérieur 
3 LEGAL BASIS 
4 DESCRIPTION OF OPERATION 
4.1 General objective 
The general objective of the Green Paper and the proposed conference 
on the Role, the Position, the Liability of the Statutory Auditor in the 
EU is to contribute to a wide-ranging debate with all interested parties 
on the issues surrounding the role, the position and the liability of the 
statutory auditor, which is sought by the Member States and bodies 
representing the profession. 
4.2 Period covered and arrangements for renewal 
The Green Paper is scheduled for adoption in July. The Conference is 
planned for 5 and 6 December 1996. The preparation work has already 
started and the follow-up to the Conference will continue into the first 
quarter of 1997. 
5CLASSIFICATION OF EXPENDITURE OR REVENUE 
5.1 Non-compulsory expenditure 
5.2 Non-differentiated appropriations 
5.3 Type of revenue involved 
Uo 
6TYPE OF EXPENDITURE OR REVENUE 
The expenditures involved concern the costs relating to the organisation of the 
Conference namely small utilities for the conference, printing costs for the 
programme of the conference and the report that will be issued after the 
Conference. 
100% subsidy NO 
Subsidy for joint financing with other sources in the 
public and/or private sector NO 
Interest subsidy NO 
Other NO 
Should the operation prove an economic success, is 
there provision for all or part of the Community 
contribution to be reimbursed? NO 
Will the proposed operation cause any change in the 
level of revenue? If so, what sort of change and what 
type of revenue is involved? NO 
7FINANCIAL IMPACT 
7.1 Method of calculating total cost of operation (relation between 
individual and total costs) 
hi 
7.2 Itemised breakdown of cost 
Commitment appropriations 
ECU million 
(at current prices) 
Breakdown 
Total yearn 
1 n + 1 
0,024 
0,024 n + 2 n + 3 n + 4 n + 5 
and 
subs, 
yrs Total 
0,024 
0,024 
7.3 Schedule of commitment and payment appropriations 
ECU million 
Commitment 
appropriations 
Payment 
appropriations 
yearn 
n + 1 
n + 2 
n + 3 
n + 4 
n + 5 
and subs, yrs 
Total yearn 
0,024 n + 1 n + 2 n + 3 n + 4 n + 5 
and 
subs, 
yrs Total 
0,024 
0,024 
0,024 0,024 
0,024 
8 FRAUD PREVENTION MEASURES 
Given the nature of the action, no specific fraud prevention measures are 
necessary. 
hi-
ELEMENTS OF COST-EFFECTIVENESS ANALYSIS 
9.1 Specific and quantified objectives; target population 
The objective is in particular to help the Commission to 
identify any areas or subjects where action at EU level 
may be needed, especially with a view to bringing about 
a single market for audit services and to continuing the 
improvement in the quality of financial reporting in the 
EU. 
The groups targetted are government departments in the 
Member States responsible for the regulation of 
companies, bodies representing the accounting 
profession and more specifically statutory auditors, 
organisations representing the preparers and users of 
accounts and those involved in standard-setting in this 
field. 
^ 
9.2 Grounds for the operation 
The statutory audit and the liability of the statutory 
auditor are already the subject of considerable debate in 
a number of Member States. The Commission has been 
pressed to participate. 
In 1995, DG XV launched an important study contract 
relating to the role, the position, the liability of the 
statutory auditor in the European Union. This study 
provides, for the first time, an overview of the different 
ways in which the profession of the statutory auditor is 
organised in the Member States. 
As a follow-up to this study, DG XV has prepared a 
draft Green Paper on the role, the position, the liability 
of the statutory auditor. This Green Paper raises a 
number of questions arising from the conclusions of the 
study. It is intended that the Green Paper will be 
adopted by the Commission in July 1996. 
The proposed Conference will mark the end of the 
consultation period on the Green Paper and will bring 
together an invited audience drawn from the groups 
referred to in the second paragraph of 9.1. above. 
9.3 Monitoring and evaluation of the operation 
An evaluation of the action will be made in 1997, based 
on a report prepared by the Commission on the 
Conference. 
hh 
10 ADMINISTRATIVE EXPENDITURE (SECTION m, PART A OF THE BUDGET) 
10.1 Effect on the number of posts 
Type of post 
Officials or 
temporary 
staff A 
B 
C 
Other resources 
Total Staff to be assigned to 
managing the operation 
posts 
1 
1 
2 Temporary 
posts 
1(END) 
1 Source 
Existing 
resources in 
the DG or 
department 
concerned 
1 
1 
1 
3 Additional 
resources Duration 
March 97 
March 97 
March 97 
10.2 Overall financial impact of additional human resources 
ECU 
Amounts Method of calculation 
Officials 
Temporary staff 
Other resources (indicate budget heading) 
Total 
10.3 Increase in other administrative expenditure as a result of the 
operation 
ECU 
Budget heading Amounts Method of calculation 
Total "~ 
^ 

ISSN 0254-1475 
COM(96) 338 final 
DOCUMENTS 
EN 06 
Catalogue number : CB-CO-96-414-EN-C 
ISBN 92-78-07854-9 
Office for Official Publications of the European Communities 
L-2985 Luxembourg