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 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.
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 is a writer, editor and broadcaster specialising in business.