A parliamentary committee has called for a break-up of the Big Four's audit stronghold. Philip Fisher considers how the MPs' proposal will work.
At the end of last year, the Competitions and Markets Authority (CMA) recommended that the profession needed some serious surgery to remedy failures by auditors, which have dramatically reduced public confidence in their abilities.
Following such high-profile collapses as Carillion and BHS, some kind of review was inevitable. And now the CMA and Financial Reporting Council, both of which were highly critical of the upper echelons of our profession, have been joined by with Parliament’s Business, Energy and Industrial Strategy (BEIS) committee.
Where the CMA and FRC were willing to stop short of the nuclear option by recommending only a stronger split between different divisions of the Big Four, the committee goes the extra step.
It is proposing that there should be a complete break-up of the Big Four to remove any possibility of conflicts of interest.
According to committee chairman MP Rachel Reeves: “The client relationship, and the conflicts of interest which abound, undermine the professional scepticism needed to deliver reliable, high-quality audits.”
Indeed, Reeves went as far as to talk about “vested interests” which she believed adversely affected the quality of audit work.
Readers may disagree with this analysis but, in the current climate, there has to be every possibility that these proposals will carry forward and eventually be implemented.
The committee also called for auditors to focus on fraud, noting somewhat ungrammatically that "In light of the failings at Patisserie Valerie, audits must state how they have investigated potential fraud, including by directors".
Compare this with the recent statement by Grant Thornton CEO David Dunckley following the Patisserie Valerie collapse. Dunckley, perhaps misguidedly and misleadingly, suggested that the firm’s auditors do not look for fraud.
There is a need for significant change to bring back confidence in the industry but some may be fearful about an obligation to identify frauds since almost by definition these are generally very well disguised.
It is also not immediately obvious if forcing major accounting firms to split up will have the desired effect of improving audit quality.
At present, there is very little doubt that audits are loss leaders, which effectively receive funding from the profits made on more lucrative consultancy work.
This may be an unsatisfactory situation, in that some auditors are apparently perceived to give clients an easy time to maintain the profits from additional services.
If this is the case then serious ethical issues must be resolved and these are already covered by guidance from professional bodies.
There could be a further problem in that if consultancy work is profitable and audits are not, fewer accountants may be willing to commit themselves to audit work when they could become much richer by specialising in other disciplines.
This issue is then further compounded by the risk element for any practice carrying out audits, especially if they could be penalised when frauds are discovered.
Were that to be the case, then either large companies might struggle to find anyone to carry out an audit or, alternatively, only low-quality auditors would be available to do the work.
It is easy to find a parallel in the legal profession where few top barristers are willing to pursue careers at the criminal bar, when they can make so much more money specialising in commercial and other work.
It will be fascinating to see how this battle between the big guns of our profession and those in Parliament develops.
If these proposals finally go through, then one solution might be for the government to employ auditors to deal with large companies directly, rather than effectively subcontracting the work to the profession. In principle, this might kill several birds with one, very large, stone.