And then there were four: audit's lack of competition

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The recent story on the FRC absolving KPMG for its HBOS audit sparked a thoughtful debate on the purpose and state of the audit profession on AccountingWEB.

In the case of KPMG’s HBOS audit, both the bank and the auditor claimed they couldn’t know the banking sector would collapse. An argument that the FRC seemingly accepted in its assessment.

It’s a conclusion that prompted AccountingWEB member Sheepy306 to comment: “So the audit committee of a bank, and the senior partners of the largest auditors in the world, sat around a table and were oblivious to what state the market was in and what risks there may be? Despite banks having a credit and risk committee specifically dealing with things like this, and KPMG getting paid millions for advising banks day in day out.”

KPMG's troubles don’t reflect too well on an audit profession that is, at present, extremely top heavy. As Paul Merison, a lecturer in audit at the London School of Business and Finance, points out: “under the Big Four, the size of firms drops off quickly – if you merged firms 5-9 they still would be no higher than fifth biggest”.

The disproportionate clout of the Big Four makes it hard to see beyond them, too. “Even if you did want to consider a firm from outside the Big Four, the costs of putting the tender together for a smaller firm might seem excessive,” says Merison. “Especially given the unlikelihood of winning.

“So imagine you use one of the Big Four as auditors and want to switch. You have a choice of three others. And if you already get significant other services from the others you might be down to a choice of one only (or possibly even none).”

The example Merison points to is BT’s recent troubles with PwC, after the audit giant failed to spot accounting irregularities at BT Italy. It’s a mistake for which PwC is being investigated. Left without an audit firm, BT jumped ship to KPMG. “It could not consider Deloitte because of IT consultancy work Deloitte does for BT. So it had a choice of just two – EY and KPMG,” Merison says.

It also seems as if - perhaps understandably - the government finds the idea of the Big Four shrinking into the Big Three unacceptable. The chances, according to Merison, of one of the Big Four being either fined so much they collapse or “being told by an investigation that their work is negligent and thus suffering huge reputation damage, seems small”.

It creates a status quo that the big firms have an interest in protecting, Merison tells AccountingWEB. “Under the status quo, the value of an audit report is being eroded by audit failure after audit failure. The FRC either fails to find fault, or where it does the fines are pitiful.” The FRC’s current record fine is about £5.1m, levied against PwC for its audit of RSM.

So what can be done? If auditors can’t be truly independent of their clients, what are the other options? ”Abolish the audit requirement entirely as the whole endeavour is inherently pointless?” stated AccountingWEB regular JohnGroganja, “Or nationalise the auditing profession and make them all civil servants remunerated from public funds?”

Not a bad idea perhaps, says Merison. “Maybe companies should pay audit fees into a central, independently run fund which then allocates audits to audit firms. I mean, do shareholders (who currently choose auditors) really care which firm they get?”

But a more reasonable solution is for big audit firms to become resolute when they deal with their clients. “Big firms pay good money, attract high quality staff, and, one would hope, develop improved rigour in audit going forward. If their work is properly scrutinised and penalties applied of sufficient size, we should be able to rely on high quality auditing,” concluded Merison.

About Francois Badenhorst

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

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19th Oct 2017 08:53

Thy should do what should have been done a long time ago, make audits a standalone activity, and not allow them to do non-audit work.

This would force them to split the companies into essentially 8 businesses, 4 audit, 4 advisory.

This then removes a lot of the conflicts of interest. It would take time for the companies to diverge from their "pals" but over time if you restricted movements between "audit" and "advisory" for say a 5 year wilderness period they would in time become independent businesses.

The other option is to nationalise auditing, and have it as a branch of HMRC, paid for by the businesses themselves. This may be more effective from a tax point of view but would be perpetually subject to cuts and government interference.

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By DJKL
to ireallyshouldknowthisbut
19th Oct 2017 12:20

Makes sense re the conflicts issue, but still leaves just four, a wider field would still be preferable.

If the next tier firms are reluctant to tender re cost and time, the creation of say a streamlined automated tendering platform (think internet dating for audit) might make smaller firms more willing to pitch- of course would need stakeholder willingness to use smaller firms, but the big four are themselves doing a pretty good job of making the argument that size does not guarantee satisfaction.

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By ShayaG
19th Oct 2017 13:02

Here's a further idea - publish audit evidence in the accounts of large listed companies. I'm thinking bank confirmations, listings of debtors (to assess counterparty risk), detailed P&L schedules and similar. If privacy is important to you don't take public investment.

Sunlight is best disinfectant.

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19th Oct 2017 16:08

The reality is that the directors hire and fire the auditors so they can never be truly independent.

Perhaps if the auditor was chosen by a Government department - a bit like the insolvency practitioner rota and could not be sacked by the client without good reason, they would be more robust in standing up to the client when difficult issues arise.

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By ShayaG
to jon_griffey
20th Oct 2017 13:18

Can't see life as a low - mid ranking civil servant appealing to many of the current crop of self employed audit partners.

Auditors' value to society lies not in the audit but in the other services and advice that they can deliver despite being auditors.

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