Time to split audit from consultancy

This time it’s for real, this time there appears to be sustained political pressure to change the UK audit profession forever.

This time it’s for real, this time there appears to be sustained political pressure to change the UK audit profession forever.

In fact, the time may even have come to split the ‘Big 4’ audit function from consultancy services altogether, says the Business, Energy and Industrial Strategy (BEIS) Select Committee.

It’s ‘Future of Audit’ report endorses the Competition and Markets Authority’s proposed operational split between audit and non-audit, but argues that going further with a complete structural breakup is the only way to tackle conflicts of interest and provide the professional scepticism needed to deliver high-quality audits.

Chair of the BEIS committee Rachel Reeves MP stressed: “If an audit cannot spot a £90m fraud in a £110m-a-year cake shop, you have to ask questions about what use it is at all.”
She felt in many ways audit is a 19th century product trying to adjust to a 21st century global economy. “So, it’s perhaps not surprising that the nature and quality of audit is not what we want or what we need today,” she explained.

Reeves took a swipe at senior management in the Big 4 firms, who prefer to talk about an ‘expectation gap’, and who feel people are expecting too much of audit. Reeves said: “We found not an expectation gap, but serious delivery gaps!” She pointed out that even the
Financial Reporting Council says some 27% of audits are below standard. What other industry, she asked, would survive with this level of quality? A school would have been put in special measures straight away and a supermarket would see customers flocking somewhere else.

The report said that the Big 4 accounted for 97% of the FTSE 350 audits and 99% of the FTSE 100 audits in 201617.

To improve resilience and choice, MPs are recommending a segmented market cap and the use of joint audits, on a pilot basis, for the most complex audits to enable the challenger firms to step up. Audit rotation also needs to move to
seven year nonrenewable terms, with a cooling off period of three years in which non-audit services cannot be offered to a former audit client.

There is a worry that the Big 4 firms are consistently underbidding for audit work. Reeves said across the Big 4 some 37% of audits end up costing significantly more than originally budgeted. In 73% of these cases a higher fee for audit was negotiated. “No wonder it is very difficult for challenger firms to compete on price with the Big 4,” she said. Reeves feels that the Big 4 are both cross-subsidising audit and underpricing in their tender bids. “This is anticompetitive and it must stop,” she said. 

Reeves concluded: “Change in the audit market is long overdue. The reviews from the CMA and Kingman highlight the failings; now we need action. The Big 4’s dominance has fostered a precarious market which shuts out challengers and delivers audits which investors and the public cannot rely on.”

She went on: “For the big firms, audits seem too often to be the route to milking the cash-cow of consultancy business…The Big 4 may not like it, they may seek to undermine the case for reform, but vested interests should not be allowed to get in the way of positive change.”

Some firms appear to be trying to get ahead of the curve. It is being reported that both KPMG and BDO are exploring how they could spin off their audit arms. KPMG ‘s audit practice currently has 200 partners and about 5,000 staff. This could become the standalone entity or a subsidiary of KPMG if the plans go ahead.