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Audit risks trickle down to smaller firms

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Regulatory pressure on the Big Four has forced the increasingly risk-averse auditors away from certain clients. But while some challengers enjoy the bounty, industry voices say it’s often not worth the risk to land a whale.

24th Aug 2022
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Lifestyle management firm Quintessentially is seeking its third auditor in three years after a breakdown in relations with BDO, reports the Financial Times. Last year, the concierge company admitted to accounting errors of £7m in its accounts and having erroneously paid £1.4m of unlawful dividends to its shareholders.

BDO took over as auditor from PwC in 2019, after PwC had signed off the 2018 accounts. BDO audited the 2019 accounts, filed in May 2021, which contained accounting errors and unlawful dividends.

The decision to walk away from the engagement comes on the heels of criticism by the Financial Reporting Council (FRC) for “unacceptable” standards of auditing by BDO and Mazars, who were deemed to be growing too fast without adequate controls. 

Trickle-down effect

Scrutiny of KPMG, EY, Deloitte and PwC began to heat up following the 2018 collapse of outsourcer Carillion, and in the suceeding years the quartet began to shed risky clients. In July, the FRC, which monitors audit standards, reported a second consecutive year of improvements by the largest firms. 

Mid-tier firms have been quick to chase the lucrative business of auditing former Big Four clientele with mixed results. “These firms have been growing too fast, picking up higher-risk audits being dropped by their peers, without adequate controls to ensure high-quality audits,” concluded the regulator in a damning verdict. 

The trickle-down effect within the profession sees comparatively smaller audit firms increasing their share of the FTSE 250 audit market, according to the FRC’s accountancy key facts and trends report.

John Toon, chartered accountant at Beever and Struthers, said such large volumes of work are spilling over from the top six audit practices that many in the next tier are passing opportunities further down the chain.

“Bigger firms are not wanting to do that work, partly due to reduced risk appetites and a strategy to focus on the best-quality clients who generate the most fees,” Toon said.

Capacity crunch

Some larger firms are pricing themselves out of contract renewals by inflating quotes for future work on account of the heightened risk levels, opening the door to smaller, less expensive audit practices.

“One of the challenges is that as audit work passes down the chain, the middle-size audit firms are beginning to creak with resource requirements,” said Toon. “They don’t have the resources or skills to deliver them on time and to budget.” 

There is a “huge capacity crunch” in public-sector audit problems, and a “training need to provide that function”, he added.

Raising standards

Firms must be prepared to push back against risky clients, or conduct tougher due diligence to consider their appropriate levels of risk, according to Steve Collings, partner at Leavitt Walmsley Associates. Collings said his firm had already turned audit business that did not fit the firm’s risk profile. “I think very carefully before acting for an audit client,” he said. “We wouldn’t take on one where it’s clear the outgoing auditor has had problems with the client. Nor would we take one on where we suspect the client could be difficult to deal with. It’s not worth the risk anymore.”

Where audits are spilling over down the chain, some firms may not have the resources needed to service the audit properly, Collings said.

“There is a shortage of skilled auditors in the market so this is an issue that firms need to consider carefully before they take on any risky audits,” he told AccountingWEB. “With audit firms having their audit work rigorously inspected by professional bodies and the FRC it’s getting to the point where risky audit clients are going to struggle getting an auditor.”

Data analytics specialist Dudley Gould of Circit, a former auditor, said some mid-tier firms have set up special teams to service larger clients. They are hiring former Big Four talent with the know-how required to audit these clients, and investing in technology to generate efficiencies. 

But the same problems remain. “All firms are struggling to hire enough staff,” he added.

Replies (4)

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paddle steamer
By DJKL
24th Aug 2022 13:11

So how long until there is a government created auditor of last resort (Audits R Us) which of course itself, in the fullness of time, oversees some cracking audit failures and of course faces the self same staffing problems in the market.

Seems to me all that is happening at the moment is each tier is sweeping the crap down to the next level which is fine as far as it goes but eventually all that crap needs dealt with by someone- unless of course certain types of entities are just too risky to even exist in the UK and they head for other countries, that will be really great for GDP growth.

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By ireallyshouldknowthisbut
25th Aug 2022 10:54

In our role as money laundering capital of the world, the old fashioned concept of audit seems a quaint concept.

Essentially you pay in inflated sum for a firm to sign off the accounts, do very little and pay £1million salaries to partners, who in turn risk getting a small slap on the wrist from the regulators when the business collapses (or at least some years later) and have to put up some junior to get a kicking and act as the fall guy.

I think that is just about how it works now.

Its not really much removed from how the mafia works who extort protection money albeit not partners at the big 4 get shot.

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By tedbuck
25th Aug 2022 11:06

The Government Auditor is almost inevitable. The Big firms won't want the dodgy clients now that they are being held responsible for their failures. The next tier, if they have any sense at all, will look and walk away as will those in the third tier and so on.
So where will be the Auditor of Last Resort other than the Government?
And who on earth would want to work for AoLR? The 'clients' would be the dodgiest in the market who couldn't get an auditor elsewhere and would therefore be shamed by being audited by AoLR. So I suppose that idea, logically, wouldn't work. Quo vadis ICAEW and FCA?
This is going to be a major problem in the near future. No-one in their right mind is going to want to take on one of the dodgy clients rejected by Big4 so what happens then?
I suppose we could ask HMRC to devise a program to solve the problem - after all if it's digital it's ok. They wouldn't have any knowledgeable staff but hey it's digital so who cares?
Seriously though, I think there is a big problem on the horizon, audits have never been profitable according to the people to whom I speak and are usually done to retain the work of other types from the client. My own feeling is also that it has become such a tick box endeavour that it is hard to envisage it being effective anyway.
I think I read that the lady who blew the whistle on Carillion had been there about 4 months so if someone in a position of responsibility takes that long to suss the situation out what chance does the outside auditor really have?
Are we perhaps heading towards having an Auditor on site in a supervisory capacity throughout the whole year just sticking his/her nose in wherever is deemed appropriate?
I certainly can't see another logical answer short of abandoning audits completely and making Directors personally financially responsible for the accounts they sign.
Over to you FCA - do a bit of thinking about where this is going before it has gone.

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By 2TunTed
25th Aug 2022 11:36

It is apparently OK those in charge of high risk companies to chance their arm with daring strategies and exciting new ways of doing things secure in the knowledge they are highly unlikely to be held to account publicly for their actions (and even if they are, no action is taken) and for the auditors to criticised/fined/penalised etc for not telling the world what the directors and senior management should have made very clear to everyone they deal with.
What about a few more directors heads on sticks, and dodgy dealers being sent to prison for their dishonesty? As matters stand there is little or no jeopardy for miscreant directors and senior managers. In the absence of stiff penalties for company managers in delinquent companies there is really no hope of things changing for the auditors. The gap is unbridgeable

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