Bumper profits and mounting probes mark watershed year for Big Fourby
Covid may have gutted economies and spelled doom for many businesses, but the Big Four accounting firms weren’t amongst them. Profits soared and headcounts grew as regulatory measures designed to loosen their grip on the audit market sputtered.
A year which began with promise of a fairer, more competitive audit market ended with the Big Four posting record revenues, a plethora of regulatory probes, and little sign of breakthrough from the challengers.
Last week, KPMG announced a 10% rise in annual revenue to $32.1bn, taking the collective turnover of the four largest audit firms to $167.3bn for the year 2021.
As the Financial Times noted, the numbers meant KPMG, Deloitte, EY and PwC reported their strongest annual performance since the collapse of Enron. The 2002 scandal toppled accounting firm Arthur Andersen and caused the Big Five to become the Big Four, leading to legislation (in the US at least) intended to reign in the top names.
In the two decades since Enron went under, and in the face of ever-increasing public anger and government criticism, the largest accounting and auditing firms have consolidated their stranglehold on the market.
“This has been a terrible year for the Big Four, but for KPMG in particular,” said Richard Murphy, professor of accounting practice, Sheffield University Management School. “Most of the firms have had their audit quality slated. Many have picked up fines. Some of those relate to ethical failings.” At the same time, the consulting firms have done “extraordinarily well”, Murphy added.
“The big issue for these firms now is what happens when those consulting partners ask whether they can continue to afford to be part of disreputable audit firms and seek to break away,” he told AccountingWEB. “Accenture survived Andersens. The same could very easily happen again. The real question is why won't it, and soon?"
Peak Big Four
Covid-19 has destroyed countless businesses across the UK, but by contrast the top professional services firms have ballooned in revenue and headcount. It was a banner year for consulting and advisory specialists as demand skyrocketed during the pandemic.
KPMG's advisory division clocked a 17% rise to $13.7bn, making it the firm’s most profitable asset. The firm said clients wanted dealmaking advice and better technology in response to coronavirus. It was a familiar pattern across the street.
Earlier this year, Deloitte topped $50bn in global revenue for the first time, with its consulting business the biggest earner by some margin, raking in more than $20bn. Deloitte’s financial advisory arm alone enjoyed a 12.9% jump, as the company provided services “on thousands of distressed and Covid-related mandates”. Its audit & assurance division grew 6.1%. Deloitte has also signed on to continue to deliver the Covid-19 test and trace system as far as 2025.
In September, EY reported an uptick in revenue to $39.96bn for the fiscal year, up 7.3% from the previous year. Audit is EY’s biggest business, generating 33.95% of total revenue. Consulting brought in 27.9% of revenue, and tax generated 26.2% of revenue. Audit as a proportion of total revenue has fallen since at least 2010.
PwC, Britain's biggest accountancy firm, also reported soaring profits as global revenue rose 4.9% to $45.1bn. The firm credited M&A advisory for the strong results. Accordingly, partners will receive an average payment of £818,000 for the year to the end of June, plus a sum of around £50,000 relating to one-off items. By comparison, the pre-Covid average partner payments in 2019 were £765,000.
The last 12 months may be the high-water mark for the profession, however, if the UK government makes good on its promises to radically alter the market.
Ending the dominance
The Big Four’s audit and consultancy arms have until 2024 to split, but efforts are already underway to separate the two divisions whose overlapping agendas have caused so much controversy. Deloitte went public at the end of 2020 with its new audit board designed to oversee the process.
Earlier this year, the UK’s business department set out a wide-ranging plan to drastically overhaul the audit market, having taken evidence from three large independent probes of the sector. Coronavirus delays to government procedure put the proposals temporarily on ice, but recent reports indicate the final plans may be further watered down.
Businesses have lobbied over the costs of the new proposed rules, which they say will force investment overseas during a difficult time for the UK economy as it struggles to recover from the pandemic and the impact of Brexit.
One proposal expected to be shelved entirely is similar to legislation in the US Sarbanes-Oxley Act, which entered force after the Enron crisis. Directors would have to sign off on businesses’ internal controls for financial reporting, increasing their personal accountability for any errors that later come to light.
The Times reported that the first wave of changes may be published in the new year, and involve FTSE 350 companies being forced to hire challenger auditors alongside their Big Four accountants. The prospect of shared audits hasn’t been welcomed with open arms by either large or small firms, but it may be a necessary step to increase competition.
Earlier this year, the promotion of cybersecurity company Darktrace to the FTSE 100 marked the first time in more than two years a firm with non-Big Four auditor was listed on the index.
The landmark event was not the cause for celebration it may first have seemed, or an indicator of real change, as its place was earned only following the delisting of retailer Morrisons after an acquisition. Less than two months later, Grant Thornton-audited Darktrace, dropped out of the index and returned the FTSE 100 to a closed shop for Big Four auditors.
“Against the backdrop of the Covid-19 pandemic, which has increased the public’s need for reliable financial information, the audit profession needs to achieve consistently higher standards of audit quality and contribute to a more resilient audit market,” the Financial Reporting Council wrote at the end of 2020.
Several months later, it became clear the lofty standards aimed for by the regulator were somewhat lacking.
The FRC publicly chastised KPMG for the poor quality of its banking audits, and dished out a near record £15m fine for the firm’s lack of objectivity and integrity in its work on the sale of Silentnight to a US private equity firm in 2011.
EY continues to stare down investor revolt and criminal probes for its audits of Wirecard. The ongoing yarn became the stuff of Netflix drama when EY finally admitted last year more than €2bn was missing from the payment company’s balance sheet. Senior executives at the Munich fintech are facing jail, and the alleged mastermind behind the plot is still on the run from Interpol while Germany’s politicians continue to ponder how best to punish EY whilst reforming their own audit laws.
Troubles in Germany aside, EY is also dealing with claims regarding its auditing of London-listed NMC Health, a health-care provider that collapsed with $4bn of debts.
Meanwhile, PwC is being sued by administrators of racing car dealership JD Classics Ltd, who accuse the auditor of failing to spot fraud in the accounts which led to around £41m of losses. PwC maintains its innocence and said it intends to fight the case.
And Deloitte is also the subject of ongoing regulatory probes, for its audit of car dealership Lookers, which has reported a £19m hole in its balance sheet, and for alleged shortcomings in an audit of multinational conglomerate Essar Oil UK.
The glut of regulatory probes announced in the last six months, which stretch beyond the Big Four and down into the firms challenging that dominance, indicates “systematic failure” within the UK’s audit market. Regulators have their work cut out convincing both the public and industry watchers that the forthcoming proposals will make any real dent.
“The Big Four, like the giant multinationals Google and Facebook have become, are beyond public control and accountability,” said Atul Shah, accounting professor at City, London University. “They show how extreme business destroys all we held dear about professions and their pride in upholding public interest,” he told AccountingWEB.