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March 29, 2011

House of Lords report – industry reaction

Recommendations published by the House of Lords into UK audit market have provoked both positive and negative reaction. The International Accounting Bulletin documents reactions from across the industry.

IAB spoke to PwC head of UK Public Policy Pauline Wallace, Grant Thornton UK partnership oversight board chair Steve Maslin, BDO audit partner James Roberts and ACCA chief executive Helen Brand to gather their thoughts.

The industry has responded fairly positively to the majority of the reports findings and recommendations. 

Pauline Wallace said: “There’s actually quite a lot I think is good in here, especially the stuff around audit committees which supports work by the FRC and indeed the progressive agenda which we’ve been pushing for a long time with our clients”, she said.

Steve Maslin said: “The Committee has delivered a focused report and I welcome its comments on better dialogue between bank auditors and the Bank of England, and recommendations for audit committees to report on difficult financial reporting issues.

“These are the two key work streams the large firms have been working on with the Bank and the FRC in learning lessons from the crisis and I am pleased to see the Committee endorsing the profession’s efforts in this regard.”

James Roberts said: “We think it’s a very good report. They have identified no silver bullet on this competition piece and that’s why they’ve suggested referral to OFT and competition commission and I’m not sure they could have done anything else actually.

“I liked all of it. Regarding the material on competition they’ve identified all the issues that can be fixed straight away. The recommendations will go some way towards making a more even playing field, certainly more than the bumpy one we have at the moment.”

Helen Brand also welcomed the report:  “We welcome the report and agree with many of its observations and recommendations. We are particularly pleased that on several occasions, ACCA’s own recommendations and evidence have been taken on board and specifically referenced by the report.”

“It is very pleasing to see that the Lords have recommended that the audit should expand in scope to provide broader, more up-to-date assurance on matters such as risk management, the business model, and the business review. ACCA also believes reform would do much to reduce the ‘expectations gap’ and meet stakeholders’ needs,” she adds.

The OFT Investigation

The report has recommended an investigation by the UK Office of Fair Trading (OFT) to examine restrictions of competition, conduct a market study of restrictive bank covenants and several other issues such as additional auditor assurance to investors. While most firms are not against an investigation, there is a sense that the next investigation should tackle specific issues head on.

Pauline Wallace says she is “disappointed” that the Lords report has decided to recommend an investigation by the OFT [Office of Fair Trading] into the audit market because she said the market is already very competitive.

“I certainly hope that if there is an OFT inquiry it focuses very heavily on something it could do something about which is the issue of these loan clauses that we’re expected to audit. Otherwise I hope that we’ve now put behind us investigations into all of the auditors in the financial crisis because we’ve had quite a lot of them,” she said. 

Steve Maslin is also sceptical about what the investigation will entail.

“While I welcome recommendations for a detailed investigation by the OFT, I am concerned about the OFT’s current perception. Some of the evidence it provided to the Committee suggested that concentration was caused by investor needs for audit quality and capability to undertake complex audits across the World.”

“The OFT enquiry must, at the very least, lead to the banning of “Big 4 only” clauses in bank agreements, which nearly all commentators, including the 4 larger firms, say are wrong. If not, it will show the UK regulatory framework in a poor light, with lots of regulators conducting lots of toothless reviews,” Maslin said.

Market Concentration

Pauline Wallace said: “We continue to believe that this is a fiercely competitive market. All of my audit partners will also tell you they fight for every audit they claim when they go out to tender. They will also tell you it doesn’t require an audit to go out to tender for them to put pressure on auditors to ensure price is kept to a sensible level. I think it is unfortunate they have failed to see that”.

Steve Maslin: “In urging regular retendering in the FTSE 350, the Lords have recognised that measures to create a more vibrant audit market should be focused at the upper end of the listed market where concentration is a real problem.”

IFRS

Audit Partner at BDO James Roberts agrees with the findings of the report that IFRS might be limiting auditors’ scope to exercise prudent judgement.

“The underlying thing is that the IFRS framework has different weighting from one to another. In terms of reliability and prudence IFRS has gone to the slightly wrong side in a bid to get greater relevance. Our view is accounting has become overly complex in financial reporting sense.”

While the ACCA welcomed most of the report findings Chief executive Helen Brand warned that the Lords’ criticisms of IFRS and its effect on audit quality are “misguided and could have potentially serious implications internationally”.

According to Helen Brand the recommendations from the Lords report need further clarification:

 “It is important to note that the specific IFRS weakness identified by the Lords – around expected rather than incurred loan losses – is already being remedied. The recommendation that UK GAAP should be continued ignores the fact that the key accounting standards in UK GAAP – on financial instruments – are virtually identical to existing IFRS.

“Any shortcomings of the accounts and audits of banks should not be either a reason to deny global standards to other companies or a justification of continuing to impose on other UK businesses the extra costs of maintaining both systems.”

Head of ICAEW Financial Reporting Faculty Nigel Sleigh-Johnson said:

“IFRSs  – a very young set of standards – were of course tested extensively by the financial crisis, and they coped pretty well with the very exceptional stresses. Some improvements were, not surprisingly, necessary, and the IASB is for example well on its way to introducing improved requirements for bank loan provisioning. It’s taken time, but it’s complex stuff.

“The report focuses of course on audit not financial reporting, and I don’t really think it provides sufficient evidence for the assertions that IFRS is ‘an inferior system’ and that there should be no extension of mandatory IFRS reporting here.  On the latter point we should await the outcome of the ASB’s detailed examination of the case for aligning UK requirements with IFRS, already well underway.”

Public Sector Audit

Grant Thornton said it welcomes efforts to make enable non Big-Four firms to win public sector work. Peter Maslin said: “We welcome the Committee’s proposals for the Government to use its procurement power, upon abolition of the Audit Commission, to create stronger firms better resourced to compete with the four largest firms.

“The public sector audit market has some excellent features, in particular demonstrably high quality, good value for money and absence of concentration among the four largest firms. The FTSE audit market should learn from that.

James Roberts of BDO agrees that the public sector should consider the mid tier more often: “Government work is a very small part of our revenue. It was something we suggested in our evidence to the committee.”

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