What is the future of audit?

What is the future of audit?

As the CMA prepares to release its study on the market for statutory audit, we look at the options for change which are getting more support from professional bodies and industry insiders

The Competitions and Markets Authority (CMA) has promised its review of the audit market will be out before Christmas, which means we are just weeks away from its release. A consultation of interested parties closed on October 30. Some responses have not been made public officially, but several big and mid-tier companies have now published detailed proposals and others have apparently being leaked.

Scandals from Carillion to Patisserie Valerie have led to public mistrust and a clamour for change, and politicians such as Vince Cable have gone as far as calling for a break-up of the Big Four into smaller companies. This would be a way of tackling a perceived conflict of interest, but it would not be without its practical challenges.

Deloitte has published a statement detailing its response to the CMA consultation. Among other measures, the company suggested a market cap as being one of its preferred measures to increase competition in the market. Deloitte also favours a UK Sarbanes-Oxley equivalent, where senior bosses would take individual responsibility for audit errors.

Last week, it was reported by Sky that Steve Varley, EY’s UK chairman, told the firm’s partners in a memo that the company should back a UK Sarbanes-Oxley measure. And Mazars went on the record saying that the market share of the audit market for the FTSE 100 should be capped at 80 percent for the Big Four. Currently, 97% of that market goes to Deloitte, EY, PwC and KPMG.

What is on the table?

The CMA review is not the only one happening. At the same time, an independent review of the audit regulator, the Financial Reporting Council, is being conducted by Sir John Kingman. The organisation was described as “toothless” in a parliamentary report earlier this year, although in theory the FRC has powers such as the ability to punish management teams who give the wrong information to auditors, for example. ICAEW is conducting its own review, although this has stalled while the organisation searches for the right person to chair it. Accounting professor Prem Sikka will be conducting a review on behalf of The Labour Party, too.

There are a lot of options being discussed, from breaking up the Big Four to joint audits, where a bigger company could work with a mid-tier firm on an audit. Here, we outline some of the ones being most talked about.

Break-up of the Big Four

This move might please those members of the public who see the dominance of the Big Four as unhealthy. But it would be complicated to do in a global world where multi-national companies employ one of these companies for their international networks. This would not apply if these businesses were separated, so they would lose competitive advantage.

Deloitte, in its statement on the CMA review, said that breaking up the Big Four “would undoubtedly impair audit quality.” This is another concern, especially where considerable expertise has been built up over time. Smaller firms may not have the financial resources to be able to invest in new technology such as artificial intelligence to evolve the audit product.

It may also be difficult for the UK to do this acting alone when so many auditors and their clients are international businesses. Smaller, separated firms would no longer have the size and scale which makes them appealing for their ability to weather many adverse events.

Independent body to appoint auditors

This option did not win Deloitte’s support, but it could help reassure the public regarding the question of conflict of interest. It has the advantage that the auditor would be accountable to the independent body instead of the company, making it more independent. The CMA points out that it the company and its shareholders may well feel disenfranchised if they do not get to choose the auditor which is best for them.

Joint audits

This option was suggested by Mazars in its statement ahead of the CMA review. This system already exists in France, where joint audits are mandatory. Mid-tier audit firms have greater market shares there than they do in the UK. For instance, the Big Four audited approximately 85% and 42% of PIEs in the UK and France respectively in 2015.

An advantage of this could be that expertise including technical knowledge could be shared, increasing the number of firms able to offer a quality service. Some have pointed out this option could lead to a more critical eye. Data analysis firms may be able to replace some aspects of audit in the future. A shared model could be of advantage to these new entrants to the market.

Even if the review does not propose a fully shared model, some aspects of the audit could still be shared with one company retaining the responsibility for signing off the accounts.

Technology and knowledge-sharing

Not only is it costly to tender for an audit, but much of the IT needed is also expensive. The CMA review is looking at ways the Big Four could support smaller firms by sharing this technology and their knowledge base, though a precise model remains to be determined. The Big Four could share licences between each other or among mid-tier firms.

Another option, suggested by Deloitte, is that the Big Four fund a third party dedicated to developing training, skills, and technology across the audit market. This could be set up to operate for a designated period of time with the aim of increasing competition.

A market cap

Gaining support across the spectrum of audit firms and accounting bodies, this appears to be one of the more likely measures to be adopted. The cap of 80% of FTSE 350 companies going to the Big Four, while not without its challenges to implement, could make the market more competitive.

In its official statement, the ICAEW said: “Any such cap will need to offer the Big Four the prospect of enough business to keep them in the market, while encouraging their challengers to invest in the capacity and resources required to operate at this level.”

The ICAEW suggested this could be reviewed regularly, initially after three or five years, to check that the right impact is really being made. The organisation would ultimately like to see the number of firms dominating the audit market rise from the current four to seven or eight.

What happens now?

The CMA will publish its initial findings in the coming weeks here, as companies continue to publish their responses to the consultation.

The answers may be far from clear right now, but as more stakeholders nail their colours to the mast, a picture of what the future might look like is slowly emerging.

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