Rentokil-style audit gains in popularity across listed companies

Almost two out of every ten listed companies have embraced a controversial extended audit model, despite concerns from regulators the arrangement may skirt ethical boundaries.

The UK’s reporting regulator, the Audit Inspection Unit (AIU), which sits within the Financial Reporting Council (FRC), found 17 % of FTSE 350 companies were using some form of “extended audit” arrangement which first came to light when Big Four firm KPMG won the audit of business services firm Rentokil in August 2009.

The package, marketed as “extended assurance”, fulfills all the functions of an external audit, while performing tasks usually performed by internal auditors.

The package shaved 30% off Rentokil’s audit costs, but raised ethical questions.

Regulators worry that if auditors fill roles usually performed by internal auditors, this might inadvertently influence management and taint the reliability of the external audit.

In November, the FRC urged caution if companies were considering taking on the audit arrangement which would be prohibited in the US and France where independence criteria is more strict.

In September the Institute of Internal Auditors chief executive Dr Ian Peters warned about the potential of “serious conflicts of interest” if internal and external audit are merged.

"Internal auditors answer to management and the non-executive directors… external audit reports to shareholders. Merging these two important functions has the potential to cause serious conflicts of interest and reduce the effectiveness of internal controls and the management of risk," he said at the time.

In August 2009, Richard Sexton, PwC’s audit chief, responding to questions on the issue, said it was important auditors were not seen to act as part of management infrastructure.

"The UK ethics model relies on a risk and safeguard analysis. It is vital that we maintain our independence from – and in no way are seen to act as part of – management infrastructure,’ he said.

"Internal audit can often be regarded as acting as part of that infrastructure."

Some businesses have been supportive of the package. In November, Kevin Chidwick, finance director of FTSE 100 car insurer Admiral Group, admitted the arrangement “would be potentially controversial”, but said he was interested in learning more.

"If they can add value to what we're doing, and overall it somehow [can be] combined to keep down external audit costs, I'm all for it," he said at the time.

The AIU found in some cases the extra work was subject to a separate engagement letter and billing arrangements, but in other cases it was treated as part of the audit engagement.

The body said it would continue to monitor developments “including the application and
effectiveness of safeguards in practice”.

KPMG has consistently defended the arrangement as “perfectly feasible to do in the spirit and letter of the law".

A spokesman said yesterday it was looking for a “broader assurance model” to address a range of risk-related issues.

“This is what we are seeking to provide to clients, while fully adhering to the ethical guidelines for the profession,” the spokesman said.

Further reading:

Cut-price Rentokil-KPMG deal raises ethical questions for auditors

Audit reports targeted for reform

Rentokil audit - All their own work