Audit vs R&D: “There is a clear conflict which accountancy firms aren’t dealing with”

With the future of audit at the top of everyone’s agenda, it seems more likely than ever that 2019 will see real change.

And while that might not mean a break-up of the Big Four, even those firms themselves have acknowledged a separation of advisory services and audit could be the best way forward.

This is a topic which Steve Phillips, who originally trained with KPMG, has been observing closely.

“There’s a clear conflict there which accountancy firms aren’t dealing with,” he says.

Having spent 15 years as an investor in private equity after his stint at KPMG, Phillips has seen the audit process from within the audit committee, often as chair, as well as within a big accounting firm.

“The audit partners of the Big Four and the next tier down would want to make sure there was a happy relationship with the client, so they would be more likely to say, ‘here’s an issue, could you sort of please deal with it? Could we put in place a plan that deals with this over a period of time?’ rather than going, ‘no, here’s an issue, you need to go and deal with it immediately?’ It would be a much softer relationship,” he says.

While this might not entail ignoring anomalies or issues entirely, Phillips says, the feeling that the auditor was part of the team made such exchanges much less clear cut than they might have been.

Dwindling Fees

While audit fees are dwindling, the big money is in other advisory-type services – and this has an impact on the quality of what is delivered, Phillips says.

“The audit fees for PWC now are 35% of the total revenues of the firm and it’s similar for Deloitte, but the advisory fees in PWC are growing at 10% a year, and assurance is growing at 4%,” he says.

“The growth is even bigger at Deloitte, where consultancy is growing at 15% at and audit at only 8%.” The result? Big firms are tempted to drive the advisory fees and “just sort of turn the wheels” on the audit side, Phillips says. And that can only have an impact on the independence and robustness of audit in the long run.

Competition and specialist services

Big scandals such as Patisserie Valerie, Carillion and BHS have created a political hot potato out of the audit market.

Reviews including Kingman’s review of the Financial Reporting Council, the audit sector’s watchdog, and the Competition and Market Authority’s report out last year, have recommended sweeping changes as a result.

And this week, the Business, Energy and Industrial Strategy (BEIS) Committee, an influential group of MPs, recommended a break-up of the Big Four.

But while some options, such as joint audits, have received a lukewarm response from the industry, the idea of separating audit services from consultancy and advisory services is gaining traction.

And Phillips notes another response to these scandals.

“It’s very easy for some of the larger firms to be tainted by these episodes, and then the companies are restricted to one or two options. So the competition really doesn’t exist.”

The only solution, he says, is to separate audit relationships from the wider advisory side.

“Quite often if companies can’t use KPMG because they’ve done some historic work on tax, they can’t use Deloitte some work on, say, R&D, you separate these different services and it would really help in terms of the competition dynamic.”

The value of experience

As a result of nervousness around these conflicts, Phillips says GovGrant is growing by 30% year-on-year, as companies look for specialist firms and try to avoid going to the same firms who already provide other services to them.

And there are benefits to those who do. “We’ve got the technical specialists here who’ve been running businesses for 20 or 30 years, and really know the sort of business world well, and understand the technical side of the service.” That compares favourably to using junior auditors who may not have that breadth and depth of experience, he says.

Companies can also save money by going to a specialist rather than taking a package of services from a brand name accountancy firm, he says.

He gives the example of a FTSE 250 company which was having its R&D tax relief claim handled by a Big Four firm.

“They had identified R&D expenditure of £1.2m and following our detailed review, the total claim identified expenditure of £4.8m – quadrupling the claim,” he says.

In another case of an R&D claim performed by a mid-tier accountancy firm, the original claim identified expenditure of c. £150,000. However, the claim went to an investigation with HMRC, who found that £50,000 of the original claim did not qualify for tax relief.

Despite that, GovGrant subsequently identified another £225k resulting in a total claim of £325k – in other words, they had more than tripled the claim.

And he predicts that an ongoing case with a FTSE 250 company will result in similarly-sized gains. The previous provider made one site visit and assessed a claim at £180,000, but after 32 site visits with GovGrant, this is expected to be much larger.

“It’s really important accountants give their clients the best service, and with the best will in the world if you’re a two partner firm, even a five partner firm, you’ll never be able to have the depth of experience with R&D that we will.

“So we partner up with and share the fees with those accountancy firms because again there’s a liability issue there for those accountants; if they pull together a quick R&D claim and then all of a sudden they go into inquiry for a couple of years and they get asked the question, ‘how many claims have you done in the past?’ and answer, ‘we do three for our clients,’ you just don’t have that depth of experience to understand some of the nuances of the legislation and they’d be far better off finding that specialist to work with,” he adds.