Time for a degree of separation!

August 2020

PQ magazine explains how the biggest shake-up in the audit market
in a generation will unfold.

The date is set: 23 October 2020. That’s the day the UK’s Big 4 accountancy firms must submit their plans for the separation of their audit firms from the rest of the business.

After that the Financial Reporting Council (FRC) will agree a transition timetable, including a medium-term plan with a firm, and everything should have happened by 30 June 2024. That means the Big 4 firms have four years to enact the biggest shake-up of audit for a generation.

The FRC unveiled its ‘Principles for Operational Separation’ in early July, with its desired outcomes, which include:

• Audit practice governance prioritises audit quality and protects auditors from influences from the rest of the firm that could divert their focus away from audit quality.

• The total amount of profits distributed to the partners in the audit practice does not persistently exceed the contribution to profits of the audit practice.

• The culture of the audit practice prioritises high-quality audit by encouraging ethical behaviour, openness, teamwork, challenge and professional scepticism/judgement.

• Auditors act in the public interest and work for the benefit of shareholders of audited entities and wider society.

The FRC intends to publish annually an assessment of whether firms are delivering these objectives and outcomes. It will also seek backstop powers to require firms to deliver these outcomes as part of the forthcoming audit reform legislation.

CEO Jon Thompson said: “Operational separation of audit practices is one element of the FRC’s strategy to improve the quality and effectiveness of corporate reporting and audit in the UK, following the Kingman, CMA and Brydon reviews.”

He felt the FRC has now delivered a major step in the reform of the audit sector by setting principles for operational separation of audit practices from the rest of the firm. Thompson stressed: “The FRC remains fully committed to the broad suite of reform measures on corporate reporting and audit reform, and will introduce further aspects of the reform package over time.”

PwC said it took proactive steps a year ago to create a distinct audit practice as part of its Programme to Enhance Audit Quality, which means it is already aligned with many of the principles.

Deloitte’s Stephen Griggs welcomed the clarity from the FRC and said “Deloitte has been consistent in our support for reform.” He went on: “Today’s announcement… must be considered alongside a wider package of reform, including in vital areas such as corporate reporting, the role of directors, and the regulatory environment in which we operate.”

EY’s Hywel Ball felt the right reforms, properly implemented have the potential to restore trust and reinforce the UK’s status as one of the most attractive markets worldwide. He agreed with Griggs that improved director accountability and changes to the scope of audit is required to deliver effective and sustainable change.

Check out the FRC’s ‘Principles for Operational Separation’ here.