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House of Lords report - IAB verdict

Audit market concentration is a serious issue that requires robust regulatory changes in order to create a fairer and more transparent audit market, according to the UK House of Lords Economics Affairs Committee. International Accounting Bulletin examines some of the key recommendations from the committee’s inquiry into the audit market


Regular mandatory tendering of audit contracts

HoL: Recommends that FTSE 350 companies carry out a mandatory tender of audit contract every 5 years. The audit committee should be required to include detailed reasons for their choice of an auditor in their report to shareholders.

IAB verdict: Mandatory retendering may provide firms with greater opportunities, but there needs to be a cost-benefit analysis, which has not been carried out. Tenders cost significant money and time for clients and firms alike. It is questionable that mid-tier firms would find mandatory retendering desirable as much as companies would find it burdensome. There’s also the question of how the frequency of change could impact upon the relationships between management and auditors. Improving competition is an important goal but more work needs to be done to assess whether this is a practical solution.

Non-audit services

HoL: The committee said a complete ban on audit firms carrying out non-audit work for clients whose accounts they audit is not justified. The committee recommended that a firm’s external auditors should be banned from providing internal audit, tax advisory services and advice to the risk committee for that firm. The committee recommends the OFT investigates which services should be prohibited.

IAB verdict: It is positive the committee realises that audit firms are sometimes best placed to provide their clients with non-audit services. Independence within audit firms is extremely strong in the UK and knee-jerk reactions to suggest otherwise are often based on assumptions rather than fact. It is puzzling, though, that a competition watchdog has been asked to determine which services are suitable.

Hol report

Living wills

HoL: The government’s introduction of living wills for the Big Four auditors would lay out all the information the authorities would need to separate the good from the failing parts of an audit firm so disruption to the financial system from a collapse would be minimised.

IAB verdict: The whole notion of ‘living wills’ for an accounting firm has been a source of mystery to this publication. How can you devise a plan that forces your staff or clients to go to another firm against their will in the event of a failure? A contingency plan has merit but the buzz term ‘living will’ needs proper explanation.



The regulators are too fragmented

HoL: The regulation of accounting and auditing in the UK is fragmented and unwieldy with manifold overlapping organisations and functions. This is neither productive nor necessary. Wider powers sought by the Financial Reporting Council would go some way to simplifying and streamlining matters for audit but further impetus needs to be given to rationalisation and reform.

IAB verdict: It never hurts to review regulatory structures in the wake of the global financial crisis and improving efficiency is always welcome. It is unclear to this publication that there has been any significant problem with the current system, but reflection does not hurt.


IFRS a rules-based standard

HoL: IFRS is more rules-based than UK GAAP. IFRS might be limiting auditors’ scope to exercise prudent judgment. The government and regulators should not extend application of IFRS beyond the larger, listed companies where it is already mandatory. Continued use of UK GAAP should be permitted elsewhere.

IAB verdict: Why is this even a part of the discussion when competition is a problem for the FTSE 350 companies, which are all required to report under IFRS? This publication does not endorse IFRS as being perfect or a panacea to all accounting ills, but we fail to understand how UK GAAP would have made a difference to global financial crisis or how it is even inferior to UK GAAP. Whether IFRS should be rolled out to SMEs is a discussion worth having but the SME market is not where competition problems exist. Strange inclusion.

Risk committee advisers

HoL: Recommends that every bank should have a properly constituted and effective risk committee. It should be up to the external auditor to ensure that this is done, by making clear that if it is not, the auditor will say so in a qualification to the accounts.

IAB verdict: A sensible move and perhaps risk management is an area that auditors could look at more carefully.

Public sector work and the Audit Commission

HoL: The report recommends that the Government should make greater efforts, within EU procurement rules, to enable non-Big Four firms to win public sector work.

The report also states the abolition of the Audit Commission could provide an opportunity to increase competition and choice in the audit market. We recommend that the Government should work to encourage the emergence of such a competitor.

IAB verdict: There are a couple of ways at looking at this. If there is a perceived bias towards Big Four firms in the awarding of public sector work than this should be addressed. If there is not and the mid-tier is competitive in this market, it goes against competition principles the mid-tier should receive positive discrimination. This proposal needs to be developed further and with EU public procurement policies in mind. Needs work.

Recommendations to the OFT

HoL: The committee makes several references to the OFT, recommending it looks at several issues, including restrictive bank covenants, the role and scope of an auditor, unlimited liability, and the provision of non-audit services.

IAB verdict: The OFT should look at all issues that relate to competition, as is their mandate. This is where the OFT can add value to the whole discussion and hopefully abolish Big Four restrictive lending clauses. However, is the OFT best placed to advise on non-auditor services or unlimited liability? On non-audit services, probably not. On unlimited liability, this should be explored if liability concerns are preventing mid-tier firms from pitching to clients of a certain size. The Big Four will maintain that it is a competitive market, but wider stakeholders contest its not. What needs to happen is that the scope of the OFT investigation is limited to competition matters and not areas it has no expertise.

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