Time to Endorse the ISAs for European Use: The Emerging Markets' Perspective

By Metka Duhovnik
Source: Taylor & Francis: Accounting in Europe

The paper aims to support the endorsement of the International Standards on Auditing (ISAs) from the perspective of an emerging market economy. Pointing to the problems facing the Slovenian audit market as an example of a small market, the paper tries to demonstrate the advantages of endorsing the ISAs for both emerging market economies and the European market as a whole. At the same time, it stresses the importance of a unified audit approach for the overall quality of auditing in Europe, and of treating emerging market economies as an equal partner in international bodies that issue auditing and accounting standards as a necessary condition for those standards to also be applicable to a less developed market environment.

1. Introduction

Directive 2006/43/EC on statutory audits of annual accounts and consolidated accounts (the Directive) requires statutory auditors and auditing firms in the member states (MS) of the European Union (EU) to perform statutory audits on the basis of international auditing standards. The 2006 Directive presumed that such auditing standards would be adopted by the EU Commission in the near future and allowed MS to impose additional requirements relating to statutory audits of annual and consolidated accounts for a period expiring in June 2010. This period is now over and one would expect European endorsed auditing standards to be in place already, but unfortunately, this is not the case. In the paper, I try to analyse the possible reasons for and consequences of the situation from the perspective of the emerging Slovenian market economy.

2. Historical Background

Currently, the only high-quality set of international auditing standards is the set of International Standards on Auditing (ISAs) issued by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants (IFAC). Although in 1977 IFAC began operations with all the usual problems of an international body, by the 1990s it seemed to be having success, particularly in the auditing field. In 1991, the International Auditing Practice Committee (IAPC), today's IAASB, renamed its international auditing guidelines the International Standards on Auditing because the term standard better reflected IFAC's position and authority (Humphrey, 2007b). In 1994, IAPC issued an updated codified version of the ISAs (Humphrey, 2007a). This was an opportunity for less developed and/or smaller countries like Slovenia to adopt internationally acknowledged standards since they did not have enough human and financial resources to develop their own auditing standards. At that time, Slovenia (after having gained its independence) began its transformation from a planned to a market economy. For this reason, some important legislation was enacted in the 1991–94 period. On the basis of the first Slovenian Auditing Act in 1993, the first codified core set of ISAs became mandatory. After 1993, the ISAs were translated into the Slovenian language and are today mandatory in their current version. In the meantime, Slovenia also became an EU member in 2004 and has since been obliged to enact the European legislation.

As described in the Policy Statement (2009) of the Fédération des Experts Comptables Européens (FEE – European Federation of Accountants), in 2004 the IAASB launched a project designed to improve the clarity of its pronouncements. Upon the project's completion in March 2009, the final result was a package of 37 clarified standards, of which 19 ISAs and the International Standard on Quality Control (ISQC) 1 were changed predominantly in terms of their form (redrafted); 16 ISAs were changed in both form and substance (revised and redrafted), and one, addressing communication of deficiencies in internal control, was completely new. Thereby, revised requirements were introduced, regarding mainly:

  • clear differentiation between a ‘Fair Presentation Framework’ versus a ‘Compliance Framework’;
  • the auditor's written and oral communication with management and those charged with governance;
  • audit materiality – requiring professional judgement to be regulated in such a way as to enable the auditor's proper understanding of the concept;
  • auditing accounting estimates – providing a clear definition of the term ‘accounting estimate’ and its treatment in the audit procedures;
  • much better and clearer definition of related parties;
  • audits of group financial statements – offering much better and much more detailed support for the solutions indicated by the Directive (see IFAC, 2008, 2010a for details)

When examining the clarity project, one first notices that the clarified ISAs are better organised and more suitable in substance than the earlier ISAs. Besides, all apply to audits of financial statements for periods beginning on or after 15 December 2009. Irrespective of this, the European Commission (EC) is still holding its endorsement back, although it unofficially proposed that the translation process of the clarified ISAs be performed by professional institutions in the MS by the end of the first quarter of 2010 – but without technical and financial support. Such a proposal has put the MS in an unequal position in two different ways:

  • first, it differentiates EU English-speaking countries from EU non-English-speaking countries; and
  • second, taking into account that the translation work required is the same regardless of the size of the country, the relative translation costs are greater for smaller member states.

For a country like Slovenia with a population of 2 million and approximately 120 practising certified auditors, the EC's translation proposal was a substantial technical and financial burden. With the World Bank's support and due to the good cooperation of the Slovenski inštitut za revizijo (SIA – Slovenian Institute of Auditors) with IFAC and FEE, a high-quality translation of the clarified ISAs had been completed by the end of the first quarter of 2010 (compare IFAC News, 2010, p. 4).

3. The Clarified ISAs in the European Environment

In the absence of unified auditing standards within the EU, the question is how many different sets of auditing standards might be reflected in the auditors' reports of listed companies in the same regulated market in a MS. To be able to explain how far such differences can go it would be necessary to analyse not only the differences between auditing standards adopted in different MS but also their practical application and the effectiveness of quality control procedures. While at this historical moment it is difficult even to accept the ISAs, it is impossible to envisage standardised quality control procedures. For this reason, I will try to analyse how far away from the ISAs auditing standards in a MS might be.

The IFAC Member Body Compliance Program (IFAC, 2010b) identified eight European MS (Bulgaria, Cyprus, Estonia, Latvia, Malta, Romania, Slovakia and Slovenia) where national law or regulation requires the use of ISAs as issued by the IAASB in the auditing of general purpose financial statements. In five MS (Czech Republic, Hungary, Ireland, Luxembourg and the UK), a national standard-setter has adopted ISAs as the auditing standards to be used in the country, meaning that there are no separate local auditing standards. In nine MS (Denmark, Finland, France, Germany, Italy, Netherlands, Poland, Portugal and Sweden), ISAs have generally been adopted as the local standards but there may be some national modifications to them; changes, if any, are stated to be in line with the spirit of the IAASB Modifications Policy (IAASB, 2006). For another five MS (Austria, Belgium, Greece, Lithuania and Spain), the information available does not allow an evaluation of whether the local adoption process is reasonably up to date, or whether modifications to or other differences from the ISAs meet the requirements of the IAASB modification policy, or whether the declared convergence with ISAs is still an objective not yet achieved.

By comparing the IFAC results with somewhat earlier results of the FEE (2006), which tried to ascertain whether the national auditing standards were closely related to the ISAs (e.g. by translation or limited transformation), we find that for eight MS in the first group where law or regulation requires the use of ISAs, the results are the same, with the exception of Estonia's auditing standards, which the FEE study of 2006 declared were not closely related to the ISAs.

For five MS where, according to IFAC, a national standard-setter has adopted the ISAs, the results of the FEE study are similar and demonstrate a close relationship with the ISAs.

Nine MS from the IFAC Compliance Program that have made national modifications to the ISAs are mostly declared by the FEE study as having national auditing standards closely related to the ISAs. The exceptions are Poland and Portugal, which declared themselves in the FEE study as having auditing standards that are not closely related to the ISAs. In any event, it is likely that the national standards in these countries are gradually approaching the ISAs, which has become more evident in recent years.

In the last group of five MS, the results are unclear for Austria and Spain. While according to IFAC the information available is not adequate to evaluate the adoption process, for the purpose of the FEE study these two states declared themselves as having national standards closely related to the ISAs.

With regard to the current translation process, IFAC News (2010) suggests that the translations of the IAASB clarified ISAs have been approved for publication in several languages by the Directorate General for Translation (DGT) of the EC. In August 2010, finalised translations of 36 ISAs and ISQC 1 were available in seven official EU languages (English, which is the source language of the standards, Finnish, Lithuanian, Romanian, Slovakian, Slovenian and Swedish). The DGT has itself performed the translation into the Maltese language, although the translation has not yet been published.

However, not many MS had completed the translation processes and were thus not well prepared to use the clarified ISAs on the effective date. In spite of this, at least those countries where the ISAs are mandatory on a legal basis have to use them for statutory audits of financial statements for periods beginning on or after 15 December 2009. In the European capital market, these countries encounter others using a different set of auditing standards with different requirements and explanatory materials, also resulting in a different form of auditor's report.

4. Emerging Markets' Perspective

We can agree that auditing standards in almost all EU countries are closely related to the ISAs. At the same time, we do not know the exact definition of ‘close relationship’. However, without a detailed analysis it is unreasonable to judge which EU countries did abide by the original date at which the clarified ISAs should have come into operation. On the other hand, the analysis is almost impossible because quite a few EU countries are waiting for the action of the EC. Here we can presume, with a high level of certainty, that the clarified ISAs were used (at least formally) for audits of 2010 financial statements in EU countries identified by the IFAC Compliance Program as countries where law or regulation requires the use of ISAs as issued by the IAASB (Bulgaria, Cyprus, Estonia, Latvia, Malta, Romania, Slovakia and Slovenia). These countries belong to a special group inside the EU with several similarities. Most of them entered the EU in 2004, with the exception of Bulgaria and Romania that entered in 2007. The populations involved (except in Romania) are small, as is the number of statutory auditors (see Table 1 for details). 



Population (milion)

Number of statutory auditors

EU entry 2004



450, registered with ICPA




376 natural person auditors




150 certified auditors




690 holders of Practising Certificate




818 licensed auditors




184 certified auditors

EU entry 2007



570, registered with ICPA




1536 individual auditors

Further, not all statutory auditors are necessarily practising auditors. In Slovenia, some work, for example, at universities, at the Court of Auditors, in business or as internal auditors.

Otherwise, all countries on the list are emerging market economies with a short tradition in the area of commercial auditing, and with a similar political background (compare Cassar and Ittner, 2009, p. 337). The origin of auditing in these countries was very similar to what has been described for Russia (Mennicken, 2010, p. 356).

However, while the literature has included extensive discussions about whether the issuers of international accounting and auditing standards were more strongly influenced by the ‘Anglo-American’ approach to financial reporting or the Continental European approach (see, for example, Flower, 1998; Cairns, 1998; Nobes, 1998), there has been no discussion of the influence of this third group of countries on the international standard-setting processes. Besides, these countries are very poorly represented in international accounting and auditing bodies, even though they face serious problems in connection with the use of the International Financial Reporting Standards (IFRSs) and ISAs.

5. Potential Difficulties Arising from Not Accepting ISAs across Europe

Of course, translation is only the first step in implementing ISAs. In Slovenia, parallel to the translation process, the SIA started education activities relating to the clarified ISAs, but it was impossible to do so in much detail before the translation process was completed, in spring 2010. At that time, two other expected questions arose:

  • How is compliance with the clarified ISAs addressed in the existing audit methodology?
  • Where can one obtain auditing software that is compliant with the clarified ISAs?

Slovenia has no audit software providers. Expecting that the ISAs would be endorsed inside the EU, Slovenia was hoping to be able to choose from audit software providers inside the European market. Now the endorsement has been postponed, the hope of finding a useful tool to support audit procedures in small Slovenian auditing firms on the competitive European market has vanished. The question is whether small emerging market economies like Slovenia that make the use of ISAs mandatory will be able to realise the advantages of the clarified ISAs without the appropriate technical and professional support. We must be aware that in a country like Slovenia there are much fewer users of audit software and audit methodology than users of ISAs. Since big international network firms (Deloitte, Ernst & Young, KPMG and PWC (‘the Big Four’)) cover around 60% of the auditing market, the interested audit software users are small Slovenian auditing firms with on average approximately 80 statutory auditors. Regarding ISA-compliant audit methodology and audit software, these small Slovenian auditing firms cannot rely on the help of international networks as is the case with the education process. On the other hand, the development of audit software with integrated audit methodology would require a relatively well-organised and expensive project with a huge amount of auditing and technical knowledge. This problem also existed in the past and has been getting bigger year by year and has reached its peak with the implementation of the clarified ISAs.

However, audit methodology and audit software would solve only part of the problems, since they provide more technical than substantial support in the auditing process. Their advantage is that they leave the auditor no choice but to go through all the necessary steps of audit procedures and to support his or her opinion with sufficient and appropriate audit evidence. The disadvantage is that they provide no guidance as to what constitutes appropriate professional judgement and how this is to be exercised by the auditor during the auditing process.

For emerging market economies, professional judgement is especially crucial in auditing fair value accounting estimates because market conditions do not satisfy the fair value definition. The question is how the auditor can exercise professional judgement in the case of the Slovenian capital market that has proven itself to be inefficient, even in the weak form of the Efficient Markets Hypothesis (Mramor and Valentinčič, 2001, p. 79).

Due to their complexity, answers to questions regarding fair valuation in Slovenia have been dominated by auditors from the big international audit networks. While one cannot say that they are not in line with the ISAs, it can be argued that they were not always appropriate in the circumstances. For example, even though this would be allowed by the ISAs, it was rare for a statutory auditor to conclude that the estimation uncertainty associated with a fair value accounting estimate was so great that the recognition criteria in the IFRS were not met and a fair value estimate could not be made. The reason for this is probably the centrally organised education of auditors belonging to the international networks. These auditors largely rely on the circumstances in developed market economies. In any event, it has to be recognised that a huge amount of knowledge is concentrated inside of the international network firms who jointly explore problems and share solutions. However, small emerging market auditing firms and institutes or chambers are incapable of financing representatives in international bodies, and therefore cannot present their specific problems to a wider regulatory audience. The return effect is that audits in the emerging market economies, even those performed by ‘the Big Four’, are of a lower quality than they otherwise could have been. This does not mean that the IFRSs and ISAs are not useful in these countries but it certainly means they should have been employed in a different way.

Without the positive effect of the developed market environment, the auditing process performed in emerging market economies on the basis of mandatory clarified ISAs may become a process intended merely to satisfy the market for the auditor's information, regardless of the actual truth and fairness of the financial statements. To borrow Macintosh's philosophical classification of accountants for auditors, we can argue that this could lead to a large number of ‘bullshit’ auditors (BSers), who take the financial statements prepared on the basis of the prescribed financial reporting framework and perform audit procedures, keep the official conceptual framework in mind, closely follow the whole corpus of official audit pronouncements and dictums of institutions like public oversight bodies, security market agencies, central banks and insurance oversight agencies, and create a standard audit narrative about the financial statements. However, in essence they are ‘indifferent to the truth of the object they are representing’ (Macintosh, 2009, pp. 157–158). The BS nature of the auditor is multiplied in an environment where legislation is unclear and much power rests with civil servants who interpret the law (compare Sucher and Bychkova,2001).

6. Possible Solutions

Possible solutions and their realisation can be observed in three different fields:

  • audit software with an integrated audit methodology;
  • solutions contained in international standards and rules; and
  • education.

6.1. Audit Software with an Integrated Audit Methodology

Due to their limited size and financial resources, the only way for Slovenian and other small emerging market auditors to obtain better technical support is for them to cooperate through professional institutions on the international level and seek one or more software providers offering ISA-compliant software with an integrated audit methodology. In the framework of such international cooperation, emerging market auditors should become involved in the evaluation and later on the distribution of the appropriate audit software.

6.2. Solutions Contained in International Standards and Rules

Small emerging market economies undoubtedly need a stronger involvement in international accounting and auditing bodies to make the solutions feasible. The solutions prepared by developed countries are not always useful for small countries – with different risks and inactive markets – even if they have been prepared for them.

The problem faced by emerging market auditors, auditing firms and professional institutions is that they do not have enough human and financial resources to be represented on international bodies. The only way for them to break through in this sense is via ‘the Big Four’ networks. However, when they become part of these, they no longer represent the small domestic market but rather the policy of the international networks. For this reason, it would be very helpful if international institutions were to clearly define the objectives of their effectively directed financial support. Such objectives should be created on the basis of appropriate professional research. Asking ministries about the priorities without being aware of what the profession really needs is usually (at least partly) a waste of money. The objectives should be stated in advance so as to enable ministries in small emerging market economies to choose objectives relevant to professional development.

Financial support for professionals (not civil servants) to participate in international bodies would make those bodies' solutions acceptable not only to developed countries but also emerging market economies.

6.3. Education

In emerging market economies it seems that we have reached a level at which it is possible to formally fulfil all requirements of the Directive, but without having an efficient education system in place. The problem starts with the basic education provided by universities whereby students are acquainted with the Anglo-American valuation models and techniques without being taught about their actual usefulness in the local circumstances. On the other hand, university programmes in the field of auditing are mostly occupied with auditing rules and do not teach students how to use different mathematical and statistical methods for audit purposes. It is a real challenge for university professors in emerging market economies to introduce the combined study of auditing and mathematical/statistical methods that are appropriate for the circumstances.

The second problem of late professional development is strongly connected with the absence of appropriate audit software with an integrated audit methodology to be available to current and future certified auditors. For this reason, professional institutions from emerging market economies are intensively looking for appropriate software in line with the clarified ISAs to demonstrate to practitioners how the audit process can be efficiently supported.

The third problem in the education field is how to foster education in the ‘Train the Trainers’ form, usually financed with international funds. Education is often organised in a pyramid system whereby trainers at the first level, coming from a well-developed market environment, are training second-level trainers with less knowledge. These second- or even third-level trainers are coming to emerging market economies to teach. In such a system, the original knowledge from the first level can rarely be transferred properly. Besides, the less developed the environment, the more knowledge is required to find the best solution.

In the ‘Train the Trainers’ approach it would be necessary for domestic professionals – whose knowledge should not be underestimated – to get in touch with the first-level specialists or, alternatively, to be taught as second-level trainers able to exchange information with the first-level trainers and transfer the knowledge in a way applicable to the circumstances of an emerging market economy. For example, it is not helpful for somebody from an American accounting background to train a ‘Big Four’ auditor who is originally from, say, a Polish accounting tradition, to teach Slovenians to use the ISAs. This is because the second-tier auditor is likely to be influenced by his or her own accounting tradition in the understanding of the international rules. Direct communication is necessary and at the same time is the only way to find the best solutions in a particular environment.

The ISAs' endorsement in Europe cannot itself solve the problems of emerging market economies. Yet it can bring about a unified European audit market with audit tools and products available to all European countries, and offer emerging market economies the basis for joining forces to influence decisions of international standard-setters, and develop educational programmes and solutions applicable to the circumstances of non-active markets.

7. The Benefits for the European Market as a Whole

Emerging market economies are only part of the European market. For this reason, the advantages of the clarified ISAs should have been demonstrated on the European level to stimulate their endorsement. Although empirical analysis is impossible without clarified ISAs in use, different authors (like Baker et al., 2001; Combarros, 2000; Van Der Plaats, 2000; Whittington, 2005) have offered quite a few arguments supporting the inclusion of the ISAs in European legislation.

The situation in Europe is well demonstrated by Jeppessen (2010, p. 191): ‘At present the international accounting profession seems to prefer to overcome resistance to auditing standard-setting by using two other forms of representation, observation and public oversight boards.’ The efficiency of these two instruments for audit quality can hardly be proved especially in emerging market economies where public oversight bodies are often state-owned agencies. Even in the USA, analyses of auditing firm supervision since the Public Company Accounting Oversight Board (PCAOB) began conducting its inspections shows that less is known about auditing firm quality under the new regulatory regime (Lennox and Pittman, 2010).

The problem often exposed in Europe – that is, whether one size of clarified ISAs fits all audit clients – is overestimated and is not a real problem even for small emerging market economies. It should be made clear that we are not talking about accounting but auditing standards, the use of which depends upon the size and complexity of the client. With the size of the client and the complexity of its operations, the problem of the ISAs' scalability in the audit procedure is resolved by itself.

8. Conclusion

Although the view of a specialist from an emerging market economy might be biased, the situation in the European market requires prompt action to maintain an appropriate level of audit quality in Europe as a whole. The fact is that at this moment in time the clarified ISAs are the best instrument available to unify the auditing approach in the European environment and to take the necessary second step after the endorsement of the IFRSs. If Europe waits for an alternative solution it may happen that, due to the time lag in its application, the overall quality of the European audit profession will be not on a par with the quality of audits in the rest of the world.

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