There are moments - and all too few of them - when you think someone is trying to do the right thing. Andrew Tyrie at the Competition and Markets Authority seems to be trying to do that with auditing. This is their press release on their final report on the future of auditing published this morning, and much to my surprise they have stuck to their guns on separating auditing from consulting firms and on mandatory joint audit. The result may be progress. I welcome this:
The Competition and Markets Authority (CMA) has published its final report with recommendations to address serious competition problems in the UK audit industry.
Legislation is needed to address both the vulnerability of the industry to the loss of one of the Big 4, and the current inadequate choice and competition.
The CMA is recommending the separation of audit from consulting services, mandatory ‘joint audit' to enable firms outside the Big 4 to develop the capacity needed to review the UK's biggest companies, and the introduction of statutory regulatory powers to increase accountability of companies' audit committees.
The CMA's recommendations follow extensive discussions with audit firms, investors and major UK companies on its update paper — published in December. They also take account of the recommendations of a major report from the Business Select Committee, and the inquiry into regulation led by Sir John Kingman.
The recommendations are:
Operational split
Auditors should focus exclusively on producing the most challenging and objective audits, rather than being influenced by their much larger consultancy businesses. Given the difficulties with an immediate global structural split, the CMA is — at this stage — recommending an operational split of the Big 4's UK audit work. This will require separate management, accounts and remuneration: a separate CEO and board for the audit arm; separate financial statements for the audit practice; an end to profit-sharing between audit and consultancy, and promotions and bonuses based on the quality of the audits.
More choice to increase resilience: mandatory joint audit
More choice and competition for the audits of big businesses can and should drive up their quality, but the barriers to entry for ‘challenger' audit firms are currently large. The CMA recommends mandatory joint audit, to increase the capacity of challengers, to increase choice in the market and thereby drive up audit quality. Challenger firms should work alongside the Big 4 in these joint audits and should be jointly liable for the results. There should be initial limited exceptions to the requirement, based on criteria set by the regulator, focused on the largest and most complex companies. In addition, any company choosing a sole ‘challenger' auditor should be exempt. Audits of exempt companies may be subject to rigorous, real-time peer reviews commissioned by and reporting to the regulator. The joint audit requirement should remain in place until the regulator determines that choice and competition have improved enough to address the vulnerability of the market to the loss of one of the Big 4.
Regulation of UK companies' audit committees
It is essential that audit committees choose auditors by seeking those likely to provide the most robust and constructive challenge to the accounting practices of their companies. The CMA recommends that the regulator should hold audit committees more vigorously to account. This may include ensuring that committees report their decisions as they hire and supervise auditors, and that the regulator issues public reprimands to companies whose committees fall short of adequate scrutiny of their auditors.
A 5 year review of progress by the regulator
The regulator should review the effects of these changes periodically, in the first instance five years from full implementation.
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There’s an interesting article on this topic by Prem Sikka in the Guardian this evening. It wasn’t there when I looked earlier.
Good luck with the operational split. External audit is not a big profit maker so if you limit partner and staff pay to external audit profits you will get low quality people and a flight of good people to anything but external audit. The external audit functions of big 4 firms are subsidised by the other services for this very reason.
So the price will change
Why is that so hard to work out?
Considering the crisis in accounting I have to ask the question ‘Are there any good people in the Big 4?’
Patisserie Valerie?
Carillion?
Tesco?
And the rest………………….
Are you actually talking about the malleable, less ethical members of the Big 4 Staff?
I’m no expert about accounting but it is obvious that something is seriously wrong that means that accountants and auditors seem to be part of the problem when they should solving it.
Sorry. But what does one call it when the overseer sees nothing?
And BTW – the industry standard excuses that you invest ‘at your own risk’ and ‘the value of your investment can go up or down’ are just cloaks Big 4 accountants hide behind when the lack of curiosity and morality they display results in losses to peoples’ pensions and savings.
Tony says:
“Good luck with the operational split. External audit is not a big profit maker ….”
We know that. Everybody knows that and that is exactly why the audit system is failing.
If no other solution is forthcoming, such as the private sector suddenly discovering how to run its business honestly, as part of society, (because it has become increasingly self-serving, corrupt and parasitic) then the state will need to intervene and take over the audit process in the public interest.
The cost of doing this will be borne directly or indirectly by the companies concerned in the form of appropriate fees (sufficient to ensure good quality staffing) or it will be retrieved through corporation taxes. Maybe they might pay for the privilege of limited liability too….. proportionate to the perceived risks exposed by a fair audit. ?
You’re obviously cock-hoop anticipating the difficulties which will be involved in bringing to heel what is tantamount to national scale criminality. Do you wear a mask to work ? Some of your peer group really ought to.
….did I say ‘national scale’ criminality?
I mean international scale criminality, of course.
By any standards, both audit and consultancy partners are extraordinarily, if not obscenely well paid. I have little doubt that equally competent people would be able to do the job for less.
Contrary to perception in the City, competence and excessive remuneration are not related
I agree with all that Robin
Actually, there may be an inverse relationship between pay above a normal rate (economists should know what I mean: the rent-free reward) and objectivity
As I think you have Richard, I’ve seen it close up, from the inside. I don’t doubt that there are some competent auditors who would do it for less.
Contrary to perceived wisdom, the international argument is a bit of a red herring. Being partnerships, the international offices of the same firm can regard each other with almost the same hostility as they regard their competitors.
As for the consulting arms, there should be a rule that you cannot be one a consultant until you are at least 35 and have done a number of real jobs! Currently the consultancies suck far too many bright people away from lesser paid jobs where they could be doing something a lot more useful.
PSR asked “But what does one call it when the overseer sees nothing?” I think the short answer is ‘neo-liberal brainwashing’. Greed, ambition, self-interest and a failure to question and challenge perceived norms in all walks of life are signs that the brainwashing has been effective. Obviously there are exceptions to this, but the herd instinct is a strong force that leads to unquestioning belief/acceptance by many and accountants are just as susceptible, especially when a large and easy buck is there to be had.
Surely the fundamental issue is being overlooked: that auditors are appointed, paid and may be dismissed by those they are tasked with policing. Until this conflict between commercial concerns and the public interest is addressed little will change.
I agree
John M says:
“Surely the fundamental issue is being overlooked:….”
Nail …head….bingo…. I would suggest.
It’s rather akin to Government being able to appoint the members of various inquiries into its conduct and also set the remit…. Bent just come close. 🙁