Friday, October 11, 2019

Joint audit proposal could have global implications

UK proposals to require some of Britain’s top listed firms to have joint audits and the potential for breaking up the big four firms, raise more questions than they answer — and could have global implications, according to Baker Tilly

Recommendations were put forward by the UK Competition and Markets Authority (CMA) earlier this year in relation to statutory audits, and the Department for Business, Energy and Industrial Strategy has been engaging in consultation over its final report.

Key recommendations from the CMA included requiring joint audits of firms in the FTSE350 — meaning two audit firms would need to sign off the accounts of an audited entity. The two audit firms would divide the necessary fieldwork between them, and both firms would audit areas that involved a high level of judgment.

Critically, responsibility for the audit opinion, and audit liability, would rest with both auditors.

Baker Tilly Director of Professional Standards Dr Paul Winrow says the proposal has been designed to reduce the dominance of the Big Four accounting firms in the audit space, given 97 per cent of FTSE350 firms use one of the four.

Smaller, so-called challenger audit firms have traditionally been dissuaded from competing for market share among big listed companies, given the low likelihood of securing an audit berth coupled with the high cost of bidding against a big four competitor.

A second key driver for the proposed reforms is ongoing concern about the implications of a concentrated audit market — the risk of widespread financial damage in the case of a big four collapse and lingering questions over the quality of some high-profile audits.

“I think some people see joint audits as a silver bullet,” Winrow says.

“They feel it is going to solve all of these problems because if you have joints audits, then you get more competition, and you get the challenger firms involved.

“Then they build up the experience, and therefore they can get more of those audits.”

Baker Tilly believes there is ample skill and experience within challenger firms for audits, but is sceptical as to whether joint audits are the best approach.

“Most countries don't do joint audits, and while in France, it's mandatory for listed clients, they have quite a different system,” Winrow says.

“France has, for example, a six-year mandatory appointment. So, if the company doesn’t like what you're saying, they can't get rid of you or say they prefer what the other auditor says about its accounts.”

Another key difference between the French and British jurisdictions lies in the relative liability of the auditors.

The UK proposals describe auditors as being jointly and severally liable for a joint audit but note that one party may receive as little as 30 per cent of engagement fees. In France, the legal protections are different.

In the UK, for example, this means that one of the auditors could be liable for the full damages in the case of litigation even if they undertook only part of the audit work and received as little as 30% of the engagement fees.

“This does not, in our view, represent a sensible risk-reward for a challenger firm,” Winrow says.

“If I'm a challenger firm, would I go into an arrangement where I'm only getting a third of the fees, but I've got as much risk as the other firm? I don't know if that would be attractive.”

Although the CMA proposals would apply only to the UK at this stage, Winrow argues there are broader implications given the role UK audit has played in setting global standards and the importance of the UK as a major financial market.

“I think this one has potential ramifications around the world,” he says.

“There are already discussions going on in Australia, for example, along the same lines that we've had here and in our response on this consultation, we point out that UK Government describes our system as a world-leading audit and corporate reporting sector.

“That’s absolutely right. But it brings with it some responsibility not to do things that would have a knock-on effect in the rest of the world that might not have the same problems, or perceived problems, we do.”

Perhaps one of the most contentious ideas put forward by the UK competition regulator is that of ‘breaking up’ the big four firms by mandating an operational split between audit and non-audit practices.

Given the businesses now earn more than 75 per cent of their revenue from non-audit activity — and audit partners share in the overall benefit of non-audit work — concerns have been raised that this can undermine the independence and integrity of audits.

The CMA recommended spinning off audit practices with a separate CEO and board, and ending profit-sharing between audit and non-audit practices.

Winrow says this proposal poses serious questions about the future attractiveness of audit as a career.

“I think if you break up audit firms, you potentially make audit less attractive,” he says.

“It is a great training ground to go into a firm — and not necessarily just the big four, but in any of the top 15-20 firms — and train to do an audit knowing you can do a secondment in tax or in corporate finance or other parts of the firm to broaden your experience.

“If you break up the firms and people are restricted to just audit, it makes it a less attractive proposition to join in the first place. Does it remain an attractive career? Do you want to be an audit partner where you've got all that liability, and there's no protection effectively, and there's no sort of sharing across the firm of that risk?”

Given the widespread concerns over audit, it was clear that regulators would want to look more closely into the power dynamics of the big four, Winrow says, but it was necessary to consider any proposals carefully to avoid unintended consequences.

“In the current political environment there is a need to do something and be seen to do something,” he says.

“The challenge lies in not rushing in to do something which could well make things worse.”

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