The writer is a former member of the FRC’s Audit and Assurance Council
This year could be a critical one for corporate auditing. For the second time in this century, a series of scandals is forcing the Big Four accountancy firms to rethink their business models.
After the 2001 collapse of Enron, tighter US rules on selling other services to audit clients led KPMG, Deloitte, EY and PwC to sell or spin off their consultancy arms, but those businesses have regrown so robustly through sales to non-audit clients that audit revenues make up only a fifth of the Big Four’s total revenue.
Now a set of high-profile UK failures — Carillion, Thomas Cook and BHS — have reignited concerns about conflicts of interest and a new regulatory drive to split up the Big Four. This time the auditing profession should take advantage of the opportunity, pull away from consulting entirely and refocus on the users of corporate accounts and the public interest. There are several regulatory initiatives pending, including new international auditing standards requiring an increase in the disclosure of “key audit matters” — the most significant issues that came up in any company’s audit — and a UK proposal for audit to be operationally separated from other activities.
Stricter enforcement is already providing a stick to motivate change. The UK Financial Reporting Council levied almost three times more penalties on accounting firms in 2018-19 leading the Big Four to set aside £162m to pay future legal claims and fines. But where is the carrot? So far, audit fees have held up despite rules forcing companies to tender their audits more frequently. Investors may even be willing to pay higher bills for higher quality audits. After all, they — and their computerised stock screens — rely on the audited accounts in the investment process.
But this debate is about more than money. Donald Brydon’s review of UK auditing last month called for the creation of a new corporate auditing profession, separate from accountancy. Its ethical principles would go beyond integrity and independence to emphasise acting in the public interest and challenging management. Importantly, the new profession would promote a forensic accounting mindset — with a place for suspicion — and make clear that auditors must watch out for fraud.
Auditors should also be encouraged to look outwards, beyond company executives, by giving them a duty to alert regulators if they have concerns about a company’s financial viability. They could also become an official port of call for whistleblowers. More positively, firms can use external contacts to help improve audit quality by asking investors to suggest questions and concerns about corporate accounts.
The audit market is set to change in 2020 just as much as it did nearly 20 years ago. At that time, the US created the Public Company Accounting Oversight Board to protect investors and the public interest. Now the PCAOB is pushing US auditors to follow their international colleagues and give investors more information about the most important issues, which they call “critical audit matters”. Meanwhile the UK is set to replace the FRC with a new Audit, Reporting and Governance Authority that is expected to have similar clout to its US peer in dealing with auditors and, importantly, company directors.
Auditors should see these changes as an opportunity, not a threat. As their autonomy from consulting increases, they can rebuild the reputation of their profession. Opportunities also abound as investors seek independent audits of alternative performance measures including those applied to environmental, social and governance factors.
Audit firms will be more attractive to talented recruits if they are seen as serving the interests of savers, lenders and the economy. That is what the public interest in capital markets is about — a prize well worth pursuing.
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