Auditors being audited: FRC issues principles to reform the Big Four firms’ auditing operations
Wednesday 29th July 2020
Since April 2019, the House of Commons’ Business, Energy and Industrial Strategy (BEIS) Committee and the Competition and Markets Authority (CMA) have been calling for the Big Four (KPMG, EY, Deloitte and PwC) to separate their auditing services from the rest of their business. Following the recent auditing shortcomings on EY’s part in the Wirecard AG scandal, the Financial Reporting Council (FRC) has stated that plans for operational separation need to be proposed and implemented by 2024.
The industry regulator has published 22 principles that the Big Four must adhere to, hoping to improve quality in the industry after issuing over £42m in fines to the four firms last year. The principles largely focus on changing the governance structure within the firms, separating the practices through “ring-fencing” and improving transparency. Each firm will be required to appoint an individual from the senior management team to be held accountable for ensuring the outcomes and principles for operational separation are successfully achieved.
What are the implications of this?
Other auditing firms such as BDO have hopped on the bandwagon, expressing their intent to separate their auditing practices from the rest of the firm. This could potentially increase competition in the sector, promoting higher quality services and the erosion of the monopoly that the Big Four currently hold.
With the end of the Brexit transition period rapidly approaching, there may be an influx of new regulations in the area to attract foreign investors and businesses to London. In order to do this, trust must be re-established in the UK’s top auditing services, hence why comments so far from the firms involved have been positive. Hywel Ball, EY’s UK chair, was quoted saying “As part of the audit profession’s evolution, a holistic package of reforms, including improved director accountability and changes to the scope of audit, is required to deliver effective and sustainable change”. This points to a long-term commitment to change the landscape of auditing within the country, and with the current financial context of the UK, auditing services will need to adapt and improve drastically.
What triggered the FRC’s report?
Auditing shortfalls have almost become commonplace with Enron, Patisserie Valerie, Carillion, BHS and recently Wirecard AG all making the news as auditing scandals. These are just a few of the controversies that the Big Four have endured over the past couple of decades, reflecting badly on the UK’s auditing market as their monopoly on the sector has driven away competition. Following the controversy noted in the Commercial Astuteness article on Wirecard AG a few weeks ago, EY in particular has been subject to scrutiny and lawsuits as it was uncovered that they had not even undertaken basic audits on the company’s accounts based in South-East Asia, leading to £1.9 billion “disappearing”.
Implementation plans will be submitted by the 23 October 2020 before transition timetables are confirmed. Further aspects of the reforms will be introduced over time and this is certainly an area to keep up with.
