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‘The jury’s still out’: Lukewarm response to government audit reform plan

The government has released its long-awaited plan to radically reform the audit profession following multiple high-profile scandals, but many in the profession remain unconvinced of the suggestions.

24th Mar 2021
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Abandoned Carillion crane for One Chamberlain Square
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After several years, three reviews and countless political soundbites, the government’s grand design to clean up the “broken” audit sector has finally landed.

The 232-page consultation ‘Restoring trust in audit and corporate governance’ treads familiar ground rolling out several of the old hits, with one or two new numbers regarding the accountability of senior management when things go wrong.

The government wants to create “a new audit profession” by pushing large companies to use a challenger auditor; cap the Big Four’s number of FTSE 350 audits; and hand powers to a new audit-only regulator, the Audit, Reporting and Governance Authority (ARGA).

ARGA would be given tools to impose an operational split between the audit and non-audit functions of accountancy firms to reduce the risk of any conflicts of interest that may affect standard quality.

Just how ministers intend to do that has not been made overtly clear, and in the sections headed “Next steps” and “When will new measures take effect?”  there is no definitive date, or even date range, beyond hints that any changes are likely to be phased in.

The UK’s challenger auditors, who stand best positioned to gain from the proposals (not including general public), told AccountingWEB they are still poring over the document, but initial feelings are somewhat mixed.

Once-in-a-generation opportunity (don’t mess it up)

The overriding feeling is this will be the only chance in a generation to make amends following decades of scandal, and the government cannot afford to later water down its pledges.

“We’ve reached a landmark moment in the UK’s history of audit and wider corporate governance, and this unprecedented opportunity to implement meaningful change must not be squandered,” said Scott Knight, head of audit at BDO.

The UK competes internationally for top companies to list on the London market, and improved corporate reporting will enhance its position as a world-class destination for investors, Knight said. “However, the government’s reforms must be proportionate and carefully managed to recognise the significance of growth markets, particularly as businesses emerge from the pandemic. Here we can learn some important lessons from the US,” he added.

The Sarbanes-Oxley Act, a US federal law drafted following several huge accounting scandals including Enron and WorldCom entered force in 2002. It aimed to protect investors by making corporate disclosures more reliable and accurate, and some of the UK government’s proposals echo the sentiments of the Act.

Knight said it was “frustrating” to see Covid-19 disruption slow down the already “pedestrian pace of reform”, but added BDO was encouraged that the business department’s “impetus to deliver a stronger and more competitive audit market” has not been lost.

“Increased powers for ARGA, including the ability to impose operational separations, as well as a potential cap on FTSE 350 audits are particularly welcome measures,” Knight said. “Managed shared audits will add unnecessary complexity, however the exemption from shared audits for companies appointing challenger firms is also a positive step.”

He said it is imperative the industry and the companies they represent read the plan and put forward their view.

“This important debate has made clear that the utility of audit, the market dynamics and the oversight of this industry require systemic change to deliver for all audit stakeholders – and no less so in the context of wider economic revival post-pandemic and strengthening the UK’s global competitiveness,” a spokesperson for Grant Thornton UK LLP said. The UK’s fifth-largest auditor will publish an expanded response in the coming weeks, it said.

Accountability

It took the downfall of several listed companies including Carillion, BHS, HBOS and Thomas Cook to shake the government out of its inertia and like London buses, three probes came along in quick succession.

Sir John Kingman’s Independent review of the Financial Reporting Council;  the Competition and Market Authority’s statutory audit market study and Sir Donald Brydon’s independent review of the quality and effectiveness of audit.

Frustration with the glacier-like revamp was best exemplified in the appointment, and subsequent resignation two years later of former chairman of the Treasury select committee Andrew Tyrie. The former Tory MP took on the role of spearheading the Competition and Markets Authority after gaining some notoriety for his uncompromising criticism of the government’s handling of audit failure. He quit last year citing the limitations of the role.

Tyrie’s criticism of both the regulator and the government often centred on the lack of accountability inside firms that fail, or at the auditors who watch over the collapse, and the minimal redress for consumers and investors harmed in the fallout.

These issues will be tackled, the government has promised.

“Audit failure isn’t an abstract problem, it has real-life consequences,” said Lord Callanan, Minister for Corporate Responsibility. “Thousands of jobs have been lost in the wake of collapses like Carillion, and many more lives impacted, while wider confidence in big business is undermined.” Regulators will finally have the power to intervene and mete out appropriate penalties, Lord Callanan said. “Auditors and rogue directors who have been asleep at the wheel must be held accountable,” he added.”

Lots of words, little detail

Grand promises indeed, but where firms sought detail, they found very little substance beyond positive words.

“The jury’s still out,” said Paul Winrow, partner at MHA MacIntyre Hudson.

“A greater emphasis on the role of directors and company boards, including the potential for the new regulator to have powers over directors, could bring about real change when taken together with enhanced requirements on auditors,” said Winrow. “The introduction of internal controls and risk management reporting and assurance could also lead to a significant improvement in governance.”

A key question is how the government intends to balance the enhanced responsibilities of all those involved in the “financial reporting ecosystem”, he said. This covers auditors to boards of directors, company management, standard setters and regulators, who all have an extremely important part to play in providing assurance to users of financial statements, he said.

“We are also pleased to hear that the government is not proposing joint audits as a way to boost the presence of mid-tier and smaller auditors in the Public Interest Entity (PIE) market,” said Winrow. “Managed shared audits are a better solution for the UK audit market but we still need to see more detail to determine the extent to which they will really help to increase competition in the audit market,” he said.

A big concern is how the government’s proposals will affect all sectors of the economy, Winrow added. “The focus of the reforms seems to be more skewed towards the larger PIE market, which is understandable. However, it is not clear how the proposals will apply to SMEs, the lifeblood of the British economy.” He said it could lead to an unnecessarily bureaucratic for smaller companies, and the SME sector risked falling behind in a two-tier system.

“At a time when many businesses are still reeling from the effects of Covid-19 and coming to terms with the changes brought about by Brexit, there is an important balance to be struck between ever-increasing regulations and the need for British businesses to remain competitive,” said Winrow.

Other experts were more dismissive of the government’s response.

The Big Four 'must be cock-a-hoop'

Richard Murphy, a chartered accountant, director of the Corporate Accountability Network and visiting professor in accounting at the University of Sheffield said the proposals ignore that modern audit is “simply a process that confirms that the accounts have been properly prepared in accordance with an agreed accounting framework”.

“What is being called audit failure is actually in that case very largely the failing of the IFRS/UK GAAP accounting framework,” Murphy said. “Without either changing the accounting framework or the definition of audit, or both, this review is going nowhere because it is asking the wrong questions and is bound to get the wrong answers."

He said the Big Four “must be cock-a-hoop” with the proposal that they should pass over “the audit of some of the boring subsidiary companies in large groups to smaller firms”.

“Not only have they got out of tedious work, they will now always have someone else to blame when things go wrong,” Murphy said. "This review retains the age-old myth that the audit is primarily for the benefit of the shareholders when that is not true. The audit is now for the benefit of all stakeholders, including suppliers, employees, pensioners, government and civil society. This review ignores the information needs of all those groups. As a result, it is bound to deliver the wrong outcomes."

He said plans to ensure the auditor looks at internal controls in greater depth is the Sarbanes Oxley approach, “being delivered many years too late in the UK and after it's already been shown not to work in the USA.”

“What is the government thinking of in that case?” Murphy said.

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