Professor Robert Jupe comments on the criticism of the large accountancy firms by the select committee on Business, Energy and Industrial Strategy.
‘In a very critical report (The Future of Audit) published on 2 April a cross-party group of MPs has called for the Big Four accountancy firms – Deloitte, EY, KPMG, and PwC – to be broken up.
‘The select committee launched an inquiry into the future of audits in the UK in the wake of much concern about a series of high-profile accounting scandals at companies including the contractor Carillion, the retailer BHS and the bakery Patisserie Valerie. Carillion and BHS both collapsed into bankruptcy without any warnings being raised by the auditors. Patisserie Valerie required emergency funding earlier this year, when it went into administration after the company was found to have net debts rather than the cash shown in its balance sheet – a position which had not been uncovered by the auditors.
‘The select committee’s investigation follows an interim report by the Competition and Markets Authority (CMA) published in December 2018. The CMA investigated the audit market because of concerns about the lack of competition for large company audits. The Big Four audit 99 out of the top 100 companies listed on the UK Stock Exchange. Further, they audit 97% of the top 350 listed companies. The CMA interim report made three major recommendations:
- Accountancy firms should be required to have a clear division between audit and non-audit work, such as consultancy, with each division having separate management and accounts.
- The audit committees within companies which appoint auditors should have more accountability.
- A “joint audit” system should be established whereby a Big Four firm and a non-Big Four firm could work together on large company audits in order to give medium-sized firms experience of large company audits.
‘The CMA’s proposals were supported by the select committee, but it argued that it would be more effective to have a full break-up of the Big Four by separating completely their audit and non-audit arms. Rachel Reeves, chair of the select committee, argued that the Big Four’s “dominance has fostered a precarious market, which shuts out challengers and delivers audits which investors and the public cannot rely on”.
‘For the big firms, she argued, “audits seem too often to be the route to milking the cash cow of consultancy business. The client relationship, and the conflicts of interest which abound, undermine the professional scepticism need to deliver reliable, high-quality audits … splitting audit from non-audit business would be a big step [towards] boosting the culture of challenge needed to deliver high-quality audits”.
‘In addition to the break-up proposal, the select committee argued that there should be a cap on the number of large listed companies in any sector each Big Four firm is permitted to audit, and that large companies should be forced to change auditors every seven years rather than the current position of once every 20 years.
‘While some of the select committee’s proposals were welcomed by business and the profession, there was significant opposition to a full break-up of audit firms. The Deputy Director General of the Confederation of British Industry argued that the break-up proposal was “heavy-handed”, and the Chief Executive of the Institute of Chartered Accountants in England and Wales argued that the proposal could be counter-productive as it might “drive out incumbents and discourage new entrants”.
‘After many years of debate about the quality of audits in the UK, and the continuing accounting scandals, it now seems time to adopt radical change in the form of the break-up proposal. This should ensure that the audit arms of the Big Four firms improve the delivery of their audits, as they would be reliant on audit fees and no longer able to use audits to gain consultancy business.
‘Whether or not the break-up proposal is accepted, however, some reforms to company audits seem very likely. As Rachel Reeves argued, “We must not wait for the next corporate collapse”.’
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