Will the Big Four pull the plug on audit?
As auditors come under increasing attack from the FRC and the media, our roving partner asks whether they might withdraw from the sector completely.
If you ask the average person on the street what accountants are supposed to do, one of the most common answers will be to audit companies’ accounts.
I would have to say that is a perfectly reasonable assumption, although these days the majority of smaller practices have chosen to give up their audit role, partly because many of their clients no longer require formal audits.
When you stop and think about it, there is a big question with regard to the costs and benefits of auditing. It might be easiest to look at this by considering the situation for a typical Big Four firm.
Costs of audit
Maybe there were never 'good old days' as such, but in the dim and distant past, very few firms seemed to suffer serious reputational damage as a result of carrying out audits. Perhaps I am looking at things through rose-tinted glasses but things seem very much worse today.
Every year, the FRC provides a report on the quality of audits carried out by major firms and their inability to get the basics right shines through. Some firms get a little bit closer to acceptability than others but none is even close to the perfection that one might expect. This has led to attacks from the government and politicians, even making it into the Conservative Party manifesto.
Even worse, hardly a month goes by without at least one story splashed across the front pages of the papers about a company going under, followed by embarrassing questions about why the auditors didn’t read the writing graffitied on the wall.
Subsequently, failures could lead to the loss of professional qualifications, jobs and, in extreme circumstances freedom, if auditors are deemed to be too close to fraudulent activity.
Increasing regulation and complexity have also added to the burden of those choosing the strand of the profession.
At a more basic level, it is a given in the accounting sector that you cannot make money doing an audit. While I think this might be a little bit of an overstatement, there is no question that the recovery rates from audit work are way below those on glamorous consultancy projects.
Benefits of audit
In principle, audits should be profitable and at the very least help to boost the top line, which might elevate a firm a space or two up a league table. They also provide a helpful training ground for new recruits.
Ever since I started out in the profession, firms have low-balled in order to get audit work, with a hidden agenda. In fact, I’m not aware of anyone who hides the fact that the reason for doing audits has been to obtain lucrative spin-off work from clients with whom the firm has built a close relationship.
Having decided that the only real benefit from auditing is to get spin-off work, now that the government, the FRC and anyone else with a vague interest in the matter is determined to split the function of auditing from consultancy work, why on earth would any firm want to audit?
If you think about it, on the assumption that, on average, each of the Big Four audits between 20 and 30 FTSE 100 companies, by doing so they are reducing their potential capacity for consultancy work by 20 to 30%.
I may be missing something here, but wouldn’t every major firm benefit from closing down its audit practice? By doing so they would potentially get a sudden boost to business and at the same time either cut the costs of a loss-making activity or alternatively eliminate something that requires a great deal of effort to make very little money.
Where will this lead? If the powers that be at major practices see sense, they will resign from all audits. Since the next tier down doesn’t have the capability to do this work, that will leave the public sector to recruit auditors and do the work instead.
Given the FRC’s view that private audit practices are not fit for purpose due to close connections with clients and very reasonable desire to generate additional business, that might even be a welcome outcome for all concerned.