FRC could ban Big Four from consultancy work for audit clients

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The Financial Reporting Council is considering a ban on Big Four firms doing consultancy work with the businesses they audit. The potential step follows a series of scandals that have rocked the sector.

The high profile audit failure is by now its own sub-genre on AccountingWEB. The sector has witnessed a catalogue of disastrous failures in recent years. Carillion, Tesco,  HBOS - to name just a few.

The Big Four (and, indeed, Grant Thornton) have all been implicated in their own scandals. And the FRC itself has been blasted as feeble and timid, and all too content with "apportioning blame once disaster has struck". It is currently the subject of its own review, led by Sir John Kingman, to determine if it is fit for the future.

The FRC’s strategic programme is perhaps their attempt to get ahead of audit scandals and, crucially, to rebuild audit’s public reputation. The programme includes work on auditor indepedence, audit quality, and corporate viability.

In its annual ‘Developments in Audit’ report, the FRC said it wants to ensure audit better serves the public interest. Developments in Audit is a “state of the nation” review for audit in the UK.

“This comprehensive reform programme addresses fundamental issues underlying falling trust in business and the effectiveness of audit, whilst also looking to ensure that the requirements on what companies say about themselves are fit for the future needs of stakeholders,” said Stephen Haddrill, the CEO of the FRC. “If stakeholders are to have confidence in audit, they also need to have confidence in audit rules and regulation.”

Chief among the FRC’s concerns is the independence of the auditor. According to the FRC review, tendering has resulted in strong competition (usually between Big Four firms), but “it has not done anything to dilute the levels of market concentration”, and “there remains public concern about whether the provision of non-audit services undermines auditor independence”.

The review added, “If auditors cannot demonstrate their independence, they cannot address the perception held by some stakeholders that auditors are sometimes driven more by their commercial considerations, and the sale of non-audit services than they are by acting in the public interest.”

The FRC report illustrates the modern reality of the Big Four’s fee income. All four firms are heavily reliant on income generated from consultancy work rather than auditing. In 2017, the Big Four earned over £2bn in audit fees, but that’s dwarfed by the £8.4bn earned from non-audit consultancy. Over £1bn of that consultancy income came from companies they also audited.

Big Four fee income

The FRC’s proposals to uncouple audit and consultancy is a step in the right direction. But it won’t remedy the concentration of their power. The Big Four firms snapped up over three-quarters (78%) of the total audit fee income.

A more radical proposal enjoying increased popularity is breaking up the Big Four audit oligopoly. Stephen Haddrill has publicly backed the idea in the past and John McDonnell, Labour’s shadow chancellor, has been a vocal advocate in the past.

The Big Four’s leadership have all reportedly drawn up contingency plans for when the break-up happens. The break up will cleave the Big Four’s audit arms from its ever-growing consultancy business, ergo ending a pesky conflict of interest.

About Francois Badenhorst

Francois

I'm AccountingWEB's business editor. Feel free to get in touch with comments, tips, scoops or irreverent banter. 

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10th Oct 2018 09:09

Have to wonder however how profitable the audit work is (hint: not much). This would either push up audit fees, or drive audit standards even lower.

How attractive a 'audit only' business would be is questionable.

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to andyjdicker
10th Oct 2018 10:33

pfft big 4 audit is highly profitable. I got charged out at over £60-£80/hour in the late 90's in the 2nd/3rd year. I earned less than £15/hour, even after allowing for study leave. I think after overtime is was not much over £10/hour.

The thing is consultancy is even more profitable. Ie write a report to confirm the opinion of the person asking you to write the report. See HS2.

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By Robbo
to ireallyshouldknowthisbut
16th Oct 2018 11:48

My experience was similar in the 80's when subcontracted to London based practice with no local office, charged as manager when merely a senior.
In 90's my biggest multi million £ was sold, , big 4 due diligence , sent by own admission trainees who had little experience or idea.

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By jimeth
10th Oct 2018 10:07

Such a ban on non-audit work for audit clients is long overdue. The conflict of interest is otherwise unavoidable. If it pushes up audit fees then it means that these were being subsidised by non-audit work which makes the conflict of interest even more clear to see.

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10th Oct 2018 10:13

I wonder how mobility of staff would be monitored within the big 4 - Self Regulation for ethics & honesty? One week a big 4 accountant was a lead consultant for A Ltd at an audit client of a second big 4 firm. He then joins that second big 4 firm a few months later and is back at A Ltd as a senior part of an audit team. I appreciate that their should be conflicts of interest checks undertaken but all too often the word "should" seems to suggest "were not because ...."

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10th Oct 2018 10:14

As has been mentioned here many times, the only sure way to solve the conflict of interest problem is to have public (civil servant) auditors doing the job (which would be a hell of a lot cheaper too).

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to Justin Bryant
10th Oct 2018 10:27

I've not come across many public servants who end up cheaper than the private sector, as the public sector would add endless layers of complexity, committees, sub committees etc and end up taking four times as long and cost ten times as much whilst delivering half what was promised.

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to Ian McTernan CTA
10th Oct 2018 10:46

I agree it's a case of choosing the least worse option, but that would kill the conflict issue for sure (having worked as a civil servant and in Big 4 firms I disagree with you re the costs regardless, as there is just as much incompetence and inefficiency in the Big 4 I can assure you). Perhaps with the advent of AI etc. the job could be done efficiently & competently by government robots.

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By ShayaG
to Justin Bryant
10th Oct 2018 10:50

I have a different suggestion, which is that public interest entity auditors report to and are paid by an audit committee set up and funded by shareholders, completely independent of the company, its directors (NEDs or not) and its resources.

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to Justin Bryant
10th Oct 2018 11:25

Brilliant! Nationalise public audit, and endow the British Audit Corporation with monopoly powers. It works every time it's tried.

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to John Downes
10th Oct 2018 12:12

I don't see too many complaints or problems with the National Audit Office. On the contrary, they seem to do a pretty good job (compared to the Big 4 at least).

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By ShayaG
to Justin Bryant
10th Oct 2018 12:40

With due respect to the NAO, they are a fairly boutique organisation far smaller than the combined headcounts of PwC Audit - never mind PwC + Deloittes + EY + KPMG.

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to ShayaG
10th Oct 2018 15:59

So what? That's totally beside the point. (We are talking about the future here, not the present and it would only take about 2-3 years to implement this change if they really wanted to.)

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10th Oct 2018 10:24

Ha! Ha! Ha! Ha! Ha! Ha! Ha!

Clearly, no one remembers WHY the FRC was created in the first place!

And the Cadbury, Greenbury and Hempel reports.

And precisely why the Accounting Practices Board and The Auditing Standards Board were formed (Both APB and ASB subordinate to the FRC and the FRC - supposedly! - providing oversight.

And the compulsory divestment of Consulting Arms by the Big Ten. (PwC, for example, sold their consulting arm to IBM).

So, another series of wonderful Government plans came together...or didn't actually.

Yet another Government QUANGO which in reality is about as much good as a chocolate teapot.

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By RIqbal
10th Oct 2018 10:30

Whose independence are we talking about - the audit firm or the audit partner. Is he easily influenced by the consultancy arm of the firm or does he maintain his independence? I think putting a time bar on the audit partner to do consultancy work or vice versa seems more appropriate because denying the firm non-audit business would not go down well in the professional community.

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By ShayaG
to RIqbal
10th Oct 2018 10:47

I agree with you that the non-audit fees are a red herring. I completely disagree with you that the view of "the professional community" should be paramount, when this community has failed investors and the public interest time after time after time.

There is no "expectations gap." People have a right to expect auditors to take responsibility when accounts are misstated. There is a performance gap. Audit reports are not doing what it says on the tin, and, after decades of audit failure, nothing is changing.

Public interest auditing needs urgent and drastic reform and half-measures tailored around a perceived need to keep big 4 audit partners in their Mercedes and second homes are simply unacceptable.

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By ShayaG
10th Oct 2018 10:35

This change misses the fundamental problem. Lack of integrity in senior statutory auditors is not driven by non audit fees, which are attributed to another partner's score-card for appraisal purposes anyway.

Lack of integrity in SSAs arise because of the audit fees themselves. Auditors work for management, and if there is one thing money cannot buy, it is independence. In the Big 4, partners are assessed and remunerated - let's be honest here - 1) on fee income 2) on profitability and 3) on not being embarrassing to the firm. You will struggle to succeed as a professional auditor in today's commercial environment by being Mr Awkward, and, 90% of the time, nobody will notice or care if trade receivables are subject to a questionable revenue recognition policy which is not 2% of turnover anyway.

The reason why there are so few ethical audit partners is because those with a moral backbone are labelled cantankerous troublemakers and eased out before they even make manager level.

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to ShayaG
10th Oct 2018 10:48

That is undoubtedly 100% correct as has been similarly stated here many times before by others (like me) with many years experience of working in the Big 4.

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By RIqbal
to ShayaG
10th Oct 2018 11:36

If audit partners are not independent or they lack integrity it does not matter if non-audit business is taken away from the firm because he will always be vulnerable to outside influence. No fair reporting, no public interest! Do we now have to choose between being Mr. Awkward or being Mr. "Goody Goody". I would definitely go for being Mr. Awkward, at least there is professional satisfaction and peace of mind.

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to ShayaG
11th Oct 2018 18:54

Ah, now we come to the meat! Using my knowledge of the directors, the company and quality of staff and records resulted in my reports of directors hiving off stock and so on being too contentious and the audit partner being asked to make sure I never visited the clients again. I didn't stick to the tickbox audit program because that is a one size fits all load of rubbish and just used my (very long) nose. Someone else ticked the boxes so that side looked OK. And that's why the big firms cannot do a decent job.

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10th Oct 2018 10:50

And still nobody addresses the elephant in the room - the directors in effect appoint the auditors and agree their fee, and so the auditors independence is fatally compromised from the outset. Having audits done by a public body is a step too far, but should auditors be appointed by the Government rather than the directors?

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By ShayaG
to jon_griffey
10th Oct 2018 11:07

Agree 100% re independence. Regarding changing who commissions audits, I would have suggested that the path which would cause the least amount of upheaval in the audit market while delivering in the public interest is for auditors to be appointed by an unremunerated committee of shareholders utterly independent of any company directors, rather like how a block of flats' service charge accounts is audited.

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to ShayaG
10th Oct 2018 12:21

But shareholders would naturally vote for the most shareholder friendly auditor i.e. one without a reputation for qualifying the accounts etc. Someone totally independent would need to appoint the auditor on pure quality, competence etc. terms.

Having someone independent to choose the auditor has its own problems and that leads you back to my suggestion of having a truly independent auditor in the 1st place to solve the conflict problem.

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By ShayaG
to Justin Bryant
10th Oct 2018 12:38

I accept that, by virtue of being long on a particular stock, shareholders are disincentivised in the short term to support an auditor looking to qualify or emphasise a going concern issue. And the insider trading issue, if adverse audit issues were discovered, would need to be discussed.

Perhaps if the auditors were appointed by market makers in publicly traded stocks - those brokers who undertake to buy or sell shares come what may in return for which they earn a brokerage fee - and who would be left carrying the can if a stock collapses - then the incentives for short and long-term transparency would be there.

EDIT: Or if the auditors were appointed by the stock exchange itself.

I'm really not keen on nationalising a multi-billion pound industry which needs to operate multi-nationally in most cases.

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to ShayaG
10th Oct 2018 13:01

Think of it this way. HM Land Registry is publicly owned and does a very good job indeed of ensuring UK land records are true and accurate and as a result the UK property market has extreme confidence in that publicly administered system that impacts on land values of course (you do not even question it's inaccurate in any way when bidding on a property) and most people do not want that system privatised. If only the same could be said for UK PLC share values and the underlying company records (accounts) i.e. why are UK PLC share values (c.f. UK land values) any different?

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By ShayaG
to Justin Bryant
10th Oct 2018 14:15

There's obviously a huge difference between being a passive registry of documents lodged by third parties and expressing an opinion on them HMR LR would not opine, for example, what the fair values of land it registers holds. If all we needed was a passive registry, we already have Companies House. Were we to nationalise the audit teams of the big 4, we would have an organisation with a headcount of around 45,000.

By comparison, the headcount of the NAO is 796, in HMLR 4,486 and in Companies House is around 1,000.

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to ShayaG
10th Oct 2018 14:30

I disagree. Why is HMLR's accurate and prompt confirmation of UK land information records not analogous to auditor's confirmation of accounting information records (both involve simple checking/vouching etc. of information and HMLR is not at all passive and will actively raise enquires if they are not satisfied with anything)? Auditing is not exactly rocket science after all (anyone who has done auditing knows a monkey can do it after a bit of training).

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By ShayaG
to Justin Bryant
10th Oct 2018 14:49

Judgement areas like going concern (RBS, Northern Rock) revenue recognition (Enron), recognition policy for purchase credits (Tescos), elimination of intercompany transactions (Enron, Lehmans) and provisions for legal claims and the like. It's not a mechanistic process at all.

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to ShayaG
10th Oct 2018 15:56

I didn't say that. I said it's not rocket science and it definitely is not rocket science. Any intelligent school leaver (OK, not a monkey) with a bit of good training can be a reasonably competent auditor within about 12 months but cannot be a competent rocket scientist in that time.

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By ShayaG
to Justin Bryant
10th Oct 2018 17:44

It took me 3 months to fully understand debits and credits. I'm still learning new things every day 10 years on.

By contrast, the orbital mechanics module (incorporating the famous rocket science equation https://en.wikipedia.org/wiki/Tsiolkovsky_rocket_equation) in my aerospace engineering degree took around 20 hours of taught time.

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to Justin Bryant
10th Oct 2018 12:56

Quite agree.

However, with the major Multi-National transnational corporations, the same names appear on the director's Remuneration Committees: thus the quid pro quo, means in effect, you don't disagree with our obscene Director's Fees and Stock Options, etc and when we sit on yours, then we will do likewise.

Same with auditors.

The whole thing is a charade!

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By Tim 59
10th Oct 2018 14:29

May I suggest that the conflict of interest concern, which is principally focused on consultancy work is only one factor. There are more deep rooted issues.

1. The outdated model of recruitment/retention and training of audit staff. Generally, firms still operate on the basis of bright young classics graduate, promise of a chartered accountant title, salary in exchange for three years ticking and then moving them on to another service. It was apparent to the banks and now subsequently the general public, that the bank auditors did not understand what they were auditing. The model worked in the 1980's, no longer today with complex globalisation and information systems. Sadly, with the exception of financial services, where auditors have always been observers rather than inquisitors, most errors still relate to basic revenue recognition errors.
2. The accountancy institutes are in a battle for membership numbers. Each new accountant represents a life time of subscriptions. The major firms are an important source of income to the Institutes, with the potential to exert an unhealthy influence.The Institutes have a conflict of interest.
3. The various political parties are closely aligned to the major audit firms. Embedded tax advisors, sponsorship of party presentations etc. A further conflict of interest.
4. The failure of the FRC/Institutes/ Government to act promptly with meaningful sanctions and remedial action after the catastrophic failure of the audits of the banks. It is not surprising that the general public perceive major accounting firms (to big to fail) as untouchable. The fact that the FRC did not name and shame the banks and auditors that performed so poorly when subject to external review, emphasises the weakness of the regulatory bodies and the secretive and unhealthy reliance on a small band of influential but apparently less than satisfactory audit players. It also demonstrates the failure of the directors of the audited entities to engage and receive an appropriate service.
5. The initial responsibility for the information provided to auditors rest with the accounting function within the company. With large global companies, misfeasance will be known to a group of employees. Staff below director should share the responsibility. How many bank directors were fined, barred or sanctioned by a professional body? Clearly the audit committees of the various banks could be considered to have failed in their duties?
6. LLP status. I would suggest that there is a degree of recklessness introduced with the introduction of limited liability partnerships, without an adequate compensating capital adequacy/ indemnity insurance requirement. The 'to big to fail attitude' to certain audit firms is partly due to the lack of capitalisation and indemnity insurance that characterises the audit firms of today.

I am not convinced that breaking up the large firms would have the desired effect of improving audit reporting. Ethics is now quite clearly an outdated concept within the audit profession. What is understood is fines and penalties.

I would suggest:

a. Significantly higher fines and penalties to geared to turnover.
b. A review of the capital/professional indemnity threshold of audit firms to be undertaken.
c. Enhanced whistle blower protection and compensation (say geared to two years annual salary as fear of unemployment is a major deterrent).
d. Review of the audit business model. To encourage long term retention of experienced staff.
e. Regulate the association/ lobbying between audit firms and political parties.
d. Audit committees to be appointed and responsible to shareholders with separate legal status. Auditors to be appointed by the audit committee and not the directors. This will separate the audit from other services. The directors will appoint consultants.

Just some thoughts.

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By ShayaG
to Tim 59
10th Oct 2018 14:45

Regarding d. I have yet to hear of an audit failure where the audit staff were genuinely clueless about what they were auditing - generally, they knew exactly what the issues were, but lacked the guts to stand their ground.

I completely agree that the fines and penalties regime have been utterly ineffective. There is a reason for this - a big enough fine will knock one of the Big 4 out of business entirely, exacerbating the concentration problem.

Regarding f., unfortunately, so long as the audit committee is appointed, remunerated and effectively controlled by the chairman and management. It simply isn't independent. Also, as Justin points out, shareholders in an active market are incentivised to bury bad news until they've sold their shares rather than the frank and honest reporting we need.

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12th Oct 2018 11:47

I was burned by Conviviality (CVR) where the published accounts made fools of not only the shareholders but Questor in the Telegraph, the Investors Chronicle, and the company's own directors. The FRC seems to have done nothing except announce an investigation into Keep Paying Money Guv - an investigation which I anticipate will conclude long after the scandal has been forgotten by everyone except those who lost money and will not cause any great inconvenience to anyone.

And now we have Grant Thornton's audits of Patisserie Holdings plc. I am writing this on the morning of 12 October. The Finance Director has been arrested and it is beginning to look as though the reported "black hole" is not just a chunk of missing cash, it's a mis-statement of profitability and cash generation which may jeopardise the survival of the business and will add to what the BBC described yesterday evening as "another log on the fire burning under the big accountancy firms".

I'm not an accountant. I'm a very long-standing director of a statutory company and a private investor whose wife is asking whether we ought to sell our listed investments whose accounts we no longer trust and go back into property which is not risk free but at least we will stand or fall by our own decisions with no risk of having the wool pulled over our eyes.

The accountancy profession must work out a solution to this mess and implement it quickly - within a year. The profession is being discredited by the inept and incompetent performance of the audit function in this country.

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