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Heading different directions

EY’s plan to split audit and advisory divides opinion


A sign of things to come elsewhere, or a cynical ploy to wipe away the bad smell of corporate scandals? Critics take different views on EY’s rumoured move to break off its audit arm and create an entirely new company.

31st May 2022
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EY blinked first. The Big Four firm is examining how to separate its audit and advisory functions into different companies. 

As reported by the Financial Times, the decision from EY is expected in the coming weeks, but experts say the genie is out of the bottle in regards to breaking up the behemoths, and the top end of the audit market may look very different in 12 months’ time.

The housing of both audit and advisory under a single roof has been one of the most contentious wrangles of the modern era in professional services. But now it seems the quartet that has dominated the market since the fall of Enron and its auditor Arthur Andersen are no longer in lockstep.

Ringfencing audit functions

The Financial Reporting Council (FRC) ordered EY, Deloitte, KPMG and PricewaterhouseCoopers to ringfence their audit functions from the rest of the business by 2024 to assuage conflict-of-interest concerns. 

Deloitte set up a new audit governance board in January 2021, but EY’s plan goes way beyond that in its intention to create an entirely new business.

Under the plans reported by the Financial Times, EY’s business would be split into an audit-focused partnership and a separately owned advisory operation with most of its consulting and deals advice teams. Options include a public listing or the sale of a stake in the advisory business, with Goldman Sachs and JP Morgan advising the 312,000-person firm, according to people familiar with the matter.

Small share

Audit is a relatively small share of the revenue of the average Big Four firm, while the far more lucrative consulting work makes up much of the rest. Critics argue that there is little incentive for an auditor to raise concerns when the same client, usually a FTSE 100 firm, accounts for a huge chunk of advisory income. Big firms also admit to running their audit arms as loss leaders in order to secure more work from the same client.

“I believe we have reached a tipping point whereby one more audit scandal will simply trigger more stringent measures given that patience has run out,” said Clive Pacey, owner of CPCM Finance consultancy and brokerage. “Hopefully we will be entering a new era whereby auditors are unencumbered by close connections to divisions that have conflicting interests. Shareholders, lenders and unsecured creditors must surely demand this.”

Loss of confidence

High-profile corporate failures have made headlines, but what is often overlooked is the impact of the loss of confidence in the veracity of filed accounts, Pacey told AccountingWEB. 

“Britain rightly prides itself on accessibility to company information and that accessibility drives and supports the appetite to extend credit which is, of course, the lifeblood of the economy,” he said. “This confidence has been undermined badly and it is imperative that it is restored.”

Regulatory pressure aside, the profession is facing up to a future where it will take on climate change and tougher standards of corporate governance, which calls for a new kind of auditor, said Karthik Ramanna, professor of business and public policy at the Blavatnik School of Government, University of Oxford.

“It’s a bold move, less motivated by short-term regulatory pressure and more reflecting the changing economics of audit in the face of new risks from AI, climate change, and deglobalisation,” he said.

“The audit practice might feel more confident that they can survive on their own with the new opportunities, just as the non-audit practice might feel they want to offload the emerging risks from their balance sheet.”

Some critics believe the move will not cause the dominos to fall, however, and that it is EY’s attempt to shake off its bad reputation. 

“Increasingly it seems like any potential split of audit and consulting practices is being driven by EY specific, rather than industry-wide, issues,” said Jeffrey Johanns, McCombs School of Business associate professor and former Big Four partner.

Multitude of scandals

A new identity would allow it to move on from a multitude of scandals such as the collapses of fraud-riddled German payment processor Wirecard and medical group NMC Health, where it was auditor in both cases.

“Wanna bet which entity gets out from under all the bad vibes of Wirecard, Luckin, NMC, and all the independence issues pending at EY US?” said Francine McKenna, accounting faculty expert at the Wharton School of the University of Pennsylvania. “In any event it would be a massive undertaking. Having personally helped manage the creation of KPMG’s consulting spinoff, Bearing Point, in Latin America and seen how reluctant some other countries were to make the move – Germany was one of the most stubborn – I know it is nearly impossible to herd these cats.”

The Big Four’s plans

PwC and KPMG are thought to be keen on retaining their existing model of having audit and advisory as part of the same brand.

“KPMG believes that a multi-disciplinary model brings a range of benefits, such as diverse talent, technology, and global capability, that drives innovation,” the firm said.

“Access to a wide range of expertise and competencies is essential to serving our clients and all other stakeholders,” added PwC.

Deloitte has not commented officially.

EY’s move would have to be approved by partners and while briefing financial media on the plans, insiders say the decision won’t be quick or straightforward. Industry experts also said there are unanswered questions on how this strengthens audit, given the many other underlying issues in the sector.

“Prediction: this won’t improve audit quality,” said Dan Neidle, founder of Tax Policy Associates. “The problem isn’t the auditors; it’s the client.”

Replies (4)

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By Hugo Fair
31st May 2022 13:26

And we have a winner (in the Inaccurate Soundbite awards):
“The problem isn’t the auditors; it’s the client.”

It's *both* parties isn't it ... supported by their shared interests (which don't include auditing)!

Thanks (2)
01st Jun 2022 12:06

It really is dancing on the head of a pin to suggest an auditor's independence would be undermined if it was paid £x for assistance with tax compliance, but the same auditor's independence is wholly intact even if it is paid £50x to express an opinion as to whether the financial statements are fairly stated.

Thanks (0)
By Jason Croke
07th Jun 2022 10:03

PWC just hit with a £5m fine for failings in in two audits (Kier and Galiford).

£5m is a couple of hours billing for this giant firm and the fine was reduced for "co-operation".

There really is no incentive to improve, penalties and fines, whether they are for speeding in a car or failing to file a tax return on time are all designed to change behaviour or to act as an incentive to perform in a certain way, with penalties as low as this, why change?

Thanks (1)
By Adrienneroy
25th Jun 2022 08:41

EY said it is still in the “early stages” of evaluation. However, senior partners are working out plans to begin the split as part of a wider effort to restructure the firm’s global operations, according to sources who spoke to the Financial Times. The firm will likely retain consultants who specialise in tax concerns while it builds out a division focusing only on auditing.

Thanks (0)