Audit market constraints are crushing small firmsby
The UK audit market is significantly unbalanced in favour of large firms, with smaller practices left with shrinking opportunities for growth.
New research commissioned by the Financial Reporting Council (FRC) has found significant competition barriers in the UK audit market that limit the chances of growth among smaller firms.
In a report that collated views from across the entire audit market, the “overarching” conclusion is challenger firms are subject to “severe constraints” that limit their ability to meet growing demand.
“The firms indicated that the principal cause of this imbalance was the difficulty of attracting and retaining suitably qualified audit personnel at all levels,” the report found.
In its recent three-year plan, the FRC said small audit firms aiming to compete in the UK market have a “serious challenge” due to difficulties in recruiting and retaining staff.
Significant training costs; the ability to attract experienced staff; a lack of appetite to engage in audit work, which is less lucrative than consulting; and a broadening expectation gap in understanding of statutory audit were all cited as contributing factors.
‘Not a fun place to be’
There was widespread concern among the firms about the capacity shortage being driven by “the unattractiveness of the profession”, the report found.
Typical comments from the firms included: “People don’t want to do audit, there’s too much pressure”; “Clients’ lack of appreciation for audit and lack of understanding of the auditor’s role makes being an auditor really difficult”; and “[Audit is] not a fun place to be”.
While no business of any size was found to be immune from the lack of enthusiasm over audit, the issues disproportionately affect small- and medium-sized audit firms trying to grow, the report found.
“The research makes clear that tackling the barriers to audit firm growth requires a co-ordinated approach to foster an environment that supports sustainable growth at all audit firms, greater capacity and choice in the market while maintaining high standards,” said Mark Babington, executive director of regulatory standards at the FRC.
The FRC will conduct further market studies “to deepen understanding of audit market dynamics from a resilience perspective”, it said.
Big Four domination
Separate data released last year revealed the scale of the Big Four’s domination over the UK market.
Despite some growth from challenger firms in 2022, the Big Four audit firms still commanded 98% of FTSE 350 audit fees, in addition to 90% of public interest entity (PIE) audit fees.
Any inroads made by the challenger firms have been minimal, with the Big Four’s market share falling only by 1% compared to 2021.
“The audit market plays a fundamental role in upholding trust and transparency in financial reporting. By understanding what’s limiting competition, we can cultivate the conditions for greater auditor choice and overall resilience,” said Sir Jon Thompson, chief executive of the FRC. “Tackling these barriers requires co-ordinated efforts across the ecosystem.”
Professional makeover needed
To address concerns around recruitment and retainment, the role of audit must be made to appear more attractive, Thompson said.
“The limited talent pipeline squeezes smaller firms reliant on senior hires to undertake more complex audits,” said Thompson. “We must showcase the dynamic opportunities audit provides to attract fresh interest.”
But not too much – audit provides an easy path into consultancy, which is poaching talent in huge numbers, the report found.
With better development prospects, diverse client opportunities, and the chance to make more money, consulting firms are hoovering up talent that would once have stayed in the profession.
“When audit is viewed as less lucrative or limiting compared to consulting, it’s challenging for firms to prioritise growing audit capacity,” added Paul George, executive director of Corporate Governance and Reporting at the FRC. “We need to spotlight the integral societal role audits play to drive greater commitment and investment.”
The wider system also contains significant headwinds for small firms looking to grow. Greater liability risks surrounding complex audits, such as those of multinational firms, for example, make it hard for challenger firms to move up the chain and audit larger business without experience.
“The perceived complexities of oversight and standards coupled with liability exposure concerns raise the barrier to taking on riskier, larger-scale audits,” said George. “But regulation ensures quality, so we must bridge understanding gaps through guidance and dialogue.”
The report also highlighted the role professional accountancy bodies can play in attracting new students through more focused messaging about the societal impact of audit.
“With a focus on audit quality at the forefront, we take our role very seriously in supporting firms in attracting new talent in the profession and maintaining rigorous standards through our ACCA qualification,” said the Association of Chartered Certified Accountants (ACCA) in a statement. “We are actively engaged in ongoing research projects, which include exploring global talent trends for 2024, building on our 2023 publication, and examining strategies for attracting and retaining talent within the audit profession.”
No love for joint audit
Former government economic adviser, Alex Kirykowicz, manager at Frontier Economics, said the quality of the audit market “is hugely important for the health of our economy”.
“These findings point to further work for the FRC and stakeholders to address the supply constraints that are holding back small auditors, and in doing so support a healthy and competitive audit market.”
Regulatory compliance and audit specialist Nuno Oliveira Matos said he was “disappointed by the lack of attention given to the potential benefits of joint audit” in the report.
A previous solution to the issue of smaller practices not obtaining experience of large audits and Big Four auditors being the only option for corporates was conducting joint audits with two firms involved.
Mangos said this approach “enhances the accuracy and credibility of the financial reporting, as it brings diverse perspectives and expertise to the table”.
“Joint audit is particularly valuable for complex entities, such as public interest entities, which require high standards of audit quality and transparency,” he said. “I think that the FRC has missed an opportunity to conduct a comprehensive and balanced assessment of joint audit, and to engage with the wider audit community on this important topic.”