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.
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.
