The UK Competition & Markets Authority has suggested that splitting the audit and advisory businesses of the Big Four might be a method of improving audit quality as part of a number of far reaching proposals outlined in its market study update.
The study, which was only launched in October, suggested a number of reasons why the CMA believes audit quality if falling short:
Companies choose their own auditors, and as a result we have seen too much evidence of them picking those with whom they have the best ‘cultural fit’ or ‘chemistry’ rather than those who offer the toughest scrutiny
Choice is too limited, with the Big Four conducting 97% of the audits of the biggest companies
Auditors’ focus on quality appears diluted by the fact that at least 75% of the revenue of the Big Four comes from other services like consulting
The CMA has put forward four main proposals to help combat these issues; peer reviews of audits, separating audit from consultancy services, increasing the accountability of those chairing audit committees, and introducing joint audits to allow mid-tier firms to have a role in the auditing of the UK’s biggest companies.
One of its most controversial proposals is to create a greater divide between the audit and advisory businesses of the firms. While there is already a limit on what advisory services a firm can provide, the CMA proposes splitting these services into ‘clearly defined separate operating entities, with separate management, accounts and remuneration, but to remain under the same operating entity’.
The CMA noted that a ‘full structural split’ would be hard to accomplish due to the international nature of the firms.
When the firms presented their initial responses to the CMA review, the idea of splitting firms into audit and non-audit practices was considered largely unfavourable. According to firms, it could lead to detrimental effects on audit quality.
Joint audits were also widely unpopular, due to the fact it would increase the amount of fees companies would have to pay without necessarily increasing audit quality. Under the CMAs proposals, FTSE350 companies would be required to be audited by two firms, with at least one of the firms coming from outside of the Big Four. The CMA believes this would allow other firms’ access to largest clients while also allowing for a cross-check on quality.
The CMA has also called for more scrutiny to be placed on the chairs of audit committees in an attempt to reduce the bias towards the Big Four and to ensure audit committees have independence from companies.
CMA chairman Andrew Tyrie said: “Addressing the deep-seated problems in the audit market is now long overdue. Most people will never read an auditor’s opinion on a company’s accounts. But tens of millions of people depend on robust and high-quality audits. If a company’s books aren’t properly examined, people’s jobs, pensions or savings can be at risk.
“The CMA will now consult on a number of proposals for robust reform. These intractable problems may take some years to sort out. If it turns out that the proposals are not far-reaching enough, the CMA will persist until the problems are addressed.”
CMA Chief Executive Andrea Coscelli also commented: “We have moved fast to come up with a comprehensive package of proposals for legislation, which we will now consult on. Successful reform of the audit market will require legislation, in combination with planned improvements to regulation as recommended by Sir John Kingman.”
The CMA review was released at the same time the Kingman Review into regulation of the UK’s audit market, which recommending replacing the FRC with a new regulator.
Commenting on the Kingman and the CMA review, ICAEW CEO Michael Izza said: “The proposals announced today from Sir John Kingman and the CMA tackle the underlying issues of regulation, quality and competition in the audit market, and taken together they amount to the kind of bold intervention that we have been calling for. We will now need to study them in detail, and of course they will be subject to further consultation and debate, not least during the forthcoming parliamentary select committee inquiry.
“We have argued for some time that the natural follow-on to this work should be a fundamental and independent examination of the role of audit itself. The expectations of investors and wider society have increased in recent years, and we need to ensure that audit keeps pace.
“Chartered accountants accept the need for change. We look forward to working with all parties to produce effective recommendations for regulation and legislation which will improve quality and increase choice in the market, while ensuring that audit meets the future needs of British business and wider society.”
The CMA has given firm until 21 January 2019 to comment on the proposals before it makes a final decision on any recommendations to the government.