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Audit regulation clanks into action in response to growing unease
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Challenger firms take slice out of FTSE 250 audits

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Challenger firms have increased their share of FTSE 250 audits, but the balance of power still lies with the Big Four who continue to dominate all FTSE 100 companies. 

27th Jul 2021
Editor AccountingWEB
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New data from the FRC’s key facts and trends in the accountancy profession shows the challenger audit firms have increased their share of FTSE 250 from 4.8% to 7.6% over the past year.  

The five largest firms outside the Big Four audited 19 of the FTSE 250, up from 10 last year. One firm outside the Big Four plus the next largest five also audited two of FTSE 250 companies this year compared with one last year. 

Audit numbers

The audit movements of the challenger firms offer some hope for the FRC’s drive to improve competition across the FTSE 350 audit market. It is also a key facet of the government’s plans to shake up the audit sector, with the introduction of a new regulator and greater scrutiny of the Big Four. 

Meanwhile. as audit continues to undergo scrutiny, the FRC’s stats show a decline in registered audit firms. As at 31 December 2020 there were 5,007 registered audit firms, which is down on 5,127 and 5,394 registered firms as at 31 December 2019 and 2018 respectively.

Audit fee income increases

The challenger firms’ increase in share of FTSE 250 audits is reflected in their audit fee income. While the Big Four only saw minor increase of 7.9% in audit fee from 2019 to 2002, compared to 6.9% in 2018-2019, the non-Big Four firms’ audit fee income surged by 20.3% from 2019 to 2020 - a considerable increase on the 2.2% these firms garnered from 2018 to 2019.

A similar story repeated in other fee areas. Firms outside the Big Four reported that their total income in 2019/20 grew by 13.1% compared to a decrease of 0.1% in 2018/19. Meanwhile, the Big Four recorded total fee income growth of 2.7% but this pales in comparison to the 7.1% rate of growth that these firms reported in 2018/19. 

The non-Big Four firms also experienced growth in non-audit fees of 5.2% from 2019 to 2020, while the Big Four’s growth here declined by 2.2%. 

The challenger firms have made inroads into FTSE 250 audits, but they still can’t penetrate the FTSE 100. The FRC stats show that these companies remain closed off to all but the Big Four.

 FTSE audit stats

The fee income gap between the Big Four and the challenger firms is even more pronounced. As an example, PwC has 424 Public Interest Entity (PIE) audit clients with an audit fee income of £754m and a total fee income of £3.48bn. Now compare this to BDO, which has 171 PIE audit clients with an audit fee income of £246m and a total fee income of £661m. 

Big Four dominates FTSE 100

FRC chief executive Sir Jon Thompson said, “It is encouraging that the challenger firms have increased their share of the FTSE 350 audit market, albeit from a low base, however it is clear the Big Four continue to dominate the FTSE audit market.”

“Improving competition across the audit market and ensuring audit firms focus, above all else, on delivering high-quality audit is essential to improving trust in audit and corporate governance and remains a key priority for the FRC as it transitions to becoming ARGA [Audit Reporting and Governance Authority].”

The challenger firms may have made inroads but these firms are not naive to the balance of power in this sector. Under the government's plans to reduce the Big Four's dominance, a FTSE 350 company would be required to appoint a smaller firm to conduct 10 to 30% of its audit. But Grant Thornton has reportedly pulled out from pitching for shared audits of FTSE 100 companies saying that it was too difficult to compete with the Big Four. Instead, Grant Thornton and its nearest rivals BDO will focus on increasing the number of FTSE 250 businesses they audit solo. 

Earlier this year Fiona Baldwin, head of audit at Grant Thornton, told the Financial Times:

“If the challenger firm is just going to get what’s left at the bottom of the barrel, that’s not interesting and doesn’t help.”

Big Four has a competitive advantage

Accounting professor and tax justice campaigner Richard Murphy expects to see the challenger firms further encroach into the FTSE 350. “Quite what the competitive advantage of the Big Four is hard to tell, unless a firm is either into offshore or complex tax planning,” Murphy told AccountingWEB. 

But he said the reverse is true in the FTSE 100. 

“In that market the challenger firms have almost no competitive advantage but massive risk because of their lack of experience in auditing at scale, which basically means that any wise partner there would back away even from the invitation to audit, knowing that in the vast majority of cases this is a market where they cannot and should not compete on grounds of the lack of their own professional expertise.”

“The rumour that audit is not profitable is not true, I think, but it is only when skills and markets match. The whole logic of challenger firms is an artifice that breaks that necessary connection. No amount of regulation will change that.”

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