FRC urges government to implement audit reform

The government must act quickly to bring further reform of the audit sector as the FRC are unable to enact the full range of measures without a new statutory footing, according to Claire Lindridge, resources, capability and projects director at the Financial Regulatory Council (FRC)’s audit quality review team.

Yesterday the FRC outlined the principles for an operational separation of audit amongst the Big Four firms, but Lindridge says these reforms, while significant, are just the first of several steps. The main concern is in replacing the FRC with the audit reporting and governance authority (ARGA), for which legislation is required.

“We definitely need government to enact some legislation to set ARGA on a statutory footing and to give ARGA the powers that it needs to enforce operational separation… but also to make changes into what companies are required to do,” she says.

Lindridge is aware that the government has been preoccupied with the coronavirus crisis engulfing the world, not just the UK, and prior to that Brexit and a general election. However, the economic knock-on effects of coronavirus are likely to mean that audit comes under even more intense pressure than before, she says.

“Clearly you could see this environment as one where there is going to be a lot more public interest in the health of companies, particularly those that have been the beneficiaries of government help in all its various forms that is there at the moment.

“And so, it’s really important that directors are properly being held accountable for what they’re doing with that government support and the auditors are doing high quality audits on the financial statements that the directors are publishing.”

Cross subsidy a problem of ‘perception’

One of the objectives of the principles laid out by the FRC is to ensure that “no material, structural cross subsidy persists between the audit practice and the rest of the firm”. However, it is unclear to what extent cross subsidy exists, Lindridge adds.

“The firms don’t do their accounts in a way that you can easily ascertain how true or not it is [that there is cross subsidy] but there’s definitely a perception that there’s a problem.

“I think it’s a problem about perception. The BEIS [Business Energy and Industrial Strategy committee] report talks a lot about the risk that the audit partners had one eye, or more than one eye, on what was going on in the consulting parts of the business.”

“It’s a trope that persists in the press and with other stakeholders. To what extent it’s true or not, the reality is that it’s a perception – and that weakens confidence in audit. So, by making it clearer that it’s not happening that should enhance confidence in audit,” she adds.

Lindridge adds that the new measures will help the FRC to understand to what extent the problem of cross subsidy exists. As the Big Four are forced to implement the operational separation, the picture should become clearer, she says.

“What we will discover as the firm’s work their way through implementing these principles is we will start to get under the skin of those numbers and understand truly whether it was a problem and how the firms are then seeking to sort it out.”