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Government sets out next steps to reform audit

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The government’s long-awaited response to the consultation to shake up audit outlines their plans to tackle Big Four dominance, ban failing auditors and bring very large unlisted companies under the scope of the regulator.

31st May 2022
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The new Audit, Reporting and Governance Authority (ARGA) regulator, a requirement for FTSE 350 companies to conduct part of their audit with a challenger firm, and new powers to sanction directors of large companies for audit breaches are just some of the plans the business secretary Kwasi Kwarteng announced today to restore confidence in the audit regime. 

“Collapses like Carillion have made it clear that audit needs to improve, and these reforms will ensure the UK sets a global standard,” said minister for corporate responsibility Lord Callanan.

However, the plans have been called a “missed opportunity” for not including a UK version of the Sarbanes-Oxley reporting regime, where directors would be liable for the accuracy of financial statements. 

Watered-down plans

The new threshold for public interest entities (PIEs) has also come under criticism for falling short of what was proposed in the audit reform consultation in March 2021. The watered-down plans will now bring just 600 more private companies under ARGA regulatory scrutiny, compared to the original plans which could have seen the total number doubled to 4,000.   

Stakeholders have now urged the government “not to lose momentum” and accelerate the “glacial pace” of the reform bill following a long wait for this response to the audit consultation. 

The business department said that the “reform is already underway” but stakeholders still await more clarity around timings.

The report outlines plans to overhaul the current regime with changes to public interest companies, the regulator, director accountability, transparency and the audit market. Here are the highlights.

Public interest companies

In last year’s consultation, the government considered an option to extend the definition of PIEs to companies with over 500 employees and with a turnover of more than £500m. However, today’s plans only pull unlisted companies with over 750 employees and with over £750m annual turnover into the scope of the regulator as PIEs. Currently only companies listed on the stock exchange and financial institutions are defined as PIEs. 

Large PIEs will be expected under these new reforms to be more transparent about profit and losses. These companies will also need to explain how they’re preventing fraud. 

New regulator

As expected, the government confirmed the already announced plans that ARGA will replace the Financial Reporting Council (FRC) as the statutory regular. 

The new regulator will be funded by a levy on industry and as the business secretary announced, ARGA will have new powers including directing companies to restate their accounts without going to court and to ban failing auditors from reviewing large companies’ accounts. Currently, the FRC has no power to take action against company directors.

ARGA will also be given powers to oversee the professional bodies’ regulation of the accountancy profession and sanction accountants in public interest cases. This would be a change to the current voluntary arrangements it has with accountancy bodies. 

The FRC’s chief executive officer Sir Jon Thompson welcomed the government’s response and commitment to deliver “much-needed reform”. 

“It was pleasing to see during the consultation process overwhelming stakeholder support for the creation of ARGA with strengthened powers to ensure investors, employees, pensioners and suppliers are better protected against the consequences of corporate failure.”

Audit market

One of the aims of the reform is to break up the “unhealthy” Big Four dominance in the audit market. The government plans to do this with the long-expected requirement for Big Four firms to share part of FTSE 350 audits with a challenger firm.

Big audit firms will also have to keep their audit and non-audit functions separate. We’ve already seen early signs of this with Big Four firms setting up audit enforcement boards and even rumours of EY splitting its audit and advisory operations. However, ARGA will have powers to enforce this and introduce a market share cap if the market doesn’t improve. 

Responding to the requirement KPMG’s chief executive Jon Holt said, “There is work to do to make shared audits function well in practice, and we will play our part to find solutions to these challenges, including by offering to pilot managed shared audits.” 

Large PIEs will also be required to set out how they assure the quality and reliability of information in their annual reports. This would include non-financial information like climate, risk, and internal control, which are not stated in the current annual reports.  

Brexit opportunities

As the revival of imperial measurement will reportedly lead the platinum jubilee celebrations, the government has separately launched a review that looks to “maximise the benefits of Brexit” and reduce corporate reporting burdens on businesses. The first “burden” the government will tackle as part of this “review” will be to update the definition of micro-enterprises. 

It said that the threshold “could be forcing too many of Britain’s smallest businesses to spend time and money preparing accounts to a level of detail only needed for larger companies, distracting them from focusing on growth and creating jobs”. 

The government also wants to review “unnecessary restrictions” on remunerating directors in shares and reporting requirements on smaller public interest entities. 

Missed opportunity

On a whole, the profession has welcomed the plans and the commitment to audit reform; however, there were aspects of the response that missed the mark. 

Despite calling the reforms a once-in-a-generation opportunity to ensure corporate Britain upholds the highest standards of governance, FRC’s chief executive’s comments were also tinged with disappointment.  

Sir Jon Thomson said, “The government’s decision not to pursue the introduction of a version of the Sarbanes-Oxley reporting regime is, the FRC believes, a missed opportunity to improve internal controls in a proportionate, UK-specific manner. We know that well-run companies contribute to a stronger, healthier economy overall.”

KPMG’s Jon Holt also picked up on the omission as he had hoped to see this package go further. 

“The apparent decision not to include a UK version of Sarbanes-Oxley in primary legislation leaves corporate Britain with no clearly defined framework for internal controls, and risks a pick ’n’ mix approach to reporting and measurement. It will result in investors and stakeholders receiving inconsistent information across different companies unless ARGA provides clear guidance going forward.”  

“Stop kicking the can down the road”

Another common complaint was the speed of the reform. John Wood, chief executive officer of the Chartered Institute of Internal Auditors, called the report “long overdue”.  But as we still await clarity on timings of the reforms, Wood said: “Despite the announcement made today we remain very concerned about the glacial pace of audit reform and believe that an Audit Reform Bill must now be accelerated.

“The government must stop kicking the can down the road on audit reform and get on and pass the legislation that is now urgently required to prevent any more unnecessary corporate collapses linked to audit and governance deficiencies.”   

KPMG’s Holt also pushed to see the draft Bill “as soon as possible”. He added, “It is important not to lose momentum.”  

Big Four response

Holt’s Big Four cohorts also largely supported the progress on the reforms.

Hemione Hudson, head of audit at PwC UK, said the government’s response to the consultation “acknowledges that all parts of the corporate governance ecosystem have a part to play in reform” and that “holistic reform will deliver the best outcome”. She added, “The detailed response marks a step forward and its significance should not be underestimated.”

Stephen Griggs, UK managing partner at Deloitte also pledged the firm’s commitment to reform and listed the changes they have already made. These include “launching our independent audit governance board, ringfencing our audit business three years before the deadline for operational separation, and investing significantly in the development of our audit processes and technology.”

“Meaningful change is ultimately going to require policy makers, auditors, regulators, directors and investors to work together and play their part in improving the system.”

KPMG’s Holt echoed this: “The challenges we face in sustaining and developing the UK’s leading position as a place to do business are complex and need all of us to play our part – company boards, executive management, the regulator, auditors and investors.” 

Audit scandals and corporate collapses

A lot of the announcements in the white paper shouldn’t come as a surprise as the plans for shared audits and the creation of ARGA were raised in the March 2021 consultation, and confirmation of the audit reforms was featured in the government’s legislative agenda at the start of May. 

News of the government’s plans comes only weeks after the FRC fined KPMG a record £14m over misleading the regulator in the Carillion audit. The collapse of the outsourcer and the Big Four’s involvement is still used as shorthand to describe audit failures and was one of the sudden big company collapses that prompted the audit reform overhaul. 

The reforms take into account recommendations by Sir John Kingman, Sir Donald Brydon, and the Competition and Markets Authority. 

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Replies (8)

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By Hugo Fair
31st May 2022 09:06

What will 'shared audits' change?
If you were responsible for one of the 'challenger firms', would you want to gain a reputation as a 'supplier' to the big 4 who queries things fastidiously?
Or would you rather they kept doling out juicy jobs to you (the two options being mutually exclusive in a world driven by partners' profits)?

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Replying to Hugo Fair:
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By Hugo Fair
31st May 2022 09:18

These proposals lay bare the fundamental problem at the heart of government (of any party persuasion) ... that of predominantly 'looking after their mates'.

The consultation responses had a common thread which could be summed up as the need to rock the boat (i.e. shake things up more than a bit) ... whereas the govt's proposals seem designed to minimise rocking the boat by applying compromise after compromise to (i.e. watering down) each area of change.

In particular they've ducked any radical change to the liabilities of directors (via a Sarbane-Oxley reporting regime or whatever) for the accuracy of financial statements of companies where they (or were) directors. Sticks aren't popular with those who are threatened by them - but that's why they're effective!

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By johnjenkins
31st May 2022 09:14

Doesn't make any difference what you do. It is the people that do the audit that is the problem. To do a proper audit on a large company, these days, would cost more than business are prepared to pay. So the more bits you put in, the more the cost, the more the shortcuts.
As the Directors are responsible for "presenting" the accounts, then surely it makes sense for them to be liable for any "material" inaccuracies. Do I have an answer? Yes. Give auditors proper training so they know what to look for not just tick boxes.

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By Rgab1947
31st May 2022 10:19

Splitting advisory from audit. Only now discussed!?

Talk about being behind the curve.

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By Michael C Feltham
31st May 2022 11:29

And here we go again...

Years back, the large firms were forced to divest their consulting biz. Yeah right. At the time my dear wife had the misfortune to work for PwC: who sold their consulting arm to IBM; and immediately started up accepting and indeed selling consultancy services!

Those of us with a bit of a memory, might well remember:

The Cadbury Report:
The Greenbury Report:
The Hempel Report:
The foundation of The Financial Reporting Council (FRC):

And so on.

What changed?

Not a lot!

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By tedbuck
31st May 2022 11:31

Well there you are - all done and all OK.

Plus ca change, plus c'est la meme chose.

Except a lot more regulators (box tickers) and we already know what they achieve.

This lot of ******* couldn't run a party in a brewery.

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Replying to tedbuck:
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By johnjenkins
31st May 2022 13:31

Yer but they know how to run a gathering in no. 10.

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By brown-yuk
02nd Jun 2022 11:40

Surely hiving off non-audit work has been done several times over the years.

But the audit firm remaining then grows a new non-audit business because it is more lucrative?

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