Audit Reform: The Conflict Minefield

THE introduction of the audit reforms has caused much comment about audit tendering and audit firm rotation for “public interest” companies and a degree of speculation about whether these measures will do anything to change the shape of the market. There has been less discussion of the impact of the FRC’s new ethical standards on both companies themselves and the firms that audit them. The changes to behaviours that these will initiate are likely to have a greater impact on audit market participants in the short to medium term than the headline subjects in legislation.

The extension of prohibitions on other services that auditors can provide to their clients is wide ranging. Many of the UK’s largest companies have anticipated this and restrict their auditors from doing anything for them that isn’t closely related to audit itself, but anecdotal evidence suggests that many companies haven’t come to terms with the new rules, nor their implications. These can be substantial:

  • Buying from an auditor is now about buying an audit, rather than gaining access to a broad based professional services firm, with whom one can have a close relationship and enjoy their support more widely. This should focus audit committees more sharply on the detail and mechanics of the audit offering and on the quality of its content and service delivery;
  • Audit pricing should become more transparent and robust, as any temptation to provide audit as a “loss leader” (a persistent complaint for at least the last 30 years) becomes redundant; and,
  • Perhaps most importantly choice can be restricted by conflicts.

It is likely that most companies will have relationships with a number of accounting firms. Now they will effectively be forced to. They will have an auditor. Most companies use at least one firm for tax advice. Many will use others for anything from systems integration to valuation services. When they come to an audit tender they may not have many firms to choose from. They may want to keep some firms “clean” from non-audit services for some period prior to a tender, but that may mean changing suppliers of other services and can be disruptive and messy. It is likely that many companies won’t know which firms aren’t conflicted by other services.

The rules apply to international networks as well as domestic firms. Many companies have small operations around the globe-audit committees won’t know who processes their payrolls in Guyana or Guinea-Bissau. The upshot is that audit committees will need to engage with firms at least two years prior to a tender so that they can plan the process and make sure they have candidate firms.

Firms themselves are now busy thinking about whether they want to be conflicted or not, on a potential client by potential client basis. Are they earning more from non-audit services and wouldn’t wish to participate in a tender, which in itself is expensive and uncertain in outcome, and for which they already need to be clean? Many won’t.

Audit committees will want to spend time ensuring they get an adequate choice of audit suppliers to avoid “Buggins’ turn”, in itself an unwanted and anti-competitive outcome for everyone.

James Roberts is an audit partner at BDO

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