Report: Auditors brace for “imminent” proposals

Report: Auditors brace for “imminent” proposals

BEIS’s initial recommendations and consultations on audit reform expected to be made public before Christmas with full implementation in 2023

  • Proposals for audit reform due out before Christmas
  • Around 110 recommendations expected stemming from three reports into audit
  • Joint audit “doesn’t have legs” – “Managed shared audit” expected instead
  • ARGA to replace FRC in 2023
  • Regulators not looking at audit technology enough
  • Delays to proposals a consequence of coronavirus crisis and Brexit

Long-awaited reforms to the audit sector are expected to be released by the Department for Business, Energy and Industrial Strategy (BEIS) before Christmas, according to senior auditors at Mazars and MHA.

The proposals will first be circulated during a period of consultation.

Bob Neate, head of audit at Mazars says he expects BEIS to deliver around 110 recommendations drawn out from the three major reports into audit – the Kingman report, the Competition and Markets Authority (CMA) report and the Brydon report. Chief among them will be the creation of the Audit, Reporting and Governance Authority (ARGA) to replace the Financial Reporting Council (FRC) which the government has already announced. There are also plans for the introduction of mandatory “managed shared audit”, according to an audit partner at Crowe, Steve Gale.

“They [BEIS] are 98 percent there,” says Neate on the proposals. “It’s going through its final checks and balances with ministers at the moment and we understand the ambition is to be ready to put those out before Christmas, but BEIS have plenty of headwinds at the moment which may make early 2021 more likely.

“The intention we hear is to try and move to legislation for some of the main elements of it at the end of 2021. So, it is likely implementation will be in 2023. That will cover things like the creation of the new regulator,” he adds.

The government would not be drawn on the exact timescale, the number of recommendations, or what those recommendations would contain.

“Strengthening our corporate governance and audit regime will help to ensure that the UK remains a world leader in corporate transparency and advance it status as a place of the highest standards in audit,” said a BEIS spokesperson.

“The Government will respond with comprehensive proposals for audit reform and will then bring forward legislation as soon as parliamentary time allows.”

Neate expects the creation of ARGA to be front and centre of the proposed reforms, while greater responsibility will be placed on senior executives to express that their accounts are an honest reflection of the business.

“The creation of ARGA with powers to direct and sanction companies and directors more than they have done, to have competition powers for our profession, and to effectively have delegated authority to make changes, that will definitely be in there.

“I wouldn’t be surprised if out of Brydon we have something around a Sarbanes Oxley equivalent, I think it might be a lite version in that for cost reasons it may not go as far as having external attestation by your auditor. But what it will do is put emphasis back on CEOs and CFOs as they will be personally signing a statement each year to say that the control environment within the business is strong and good enough and that they will have had to have the work done to support that statement. It’s holding them out as being really accountable in a way that we don’t see in the UK at the moment,” Neate says.

Reforms to give opportunities to challengers

Speculation over how the government intends to tackle what the CMA called in their 2019 report “the vulnerability of the industry to the loss of one of the Big Four [EY, PwC, KPMG and Deloitte], and the current inadequate choice and competition” in the audit market had been rife.

In its April 2019 report, the CMA called for mandatory joint audit to enable the so-called “challenger firms” to develop the capacity needed to compete with the Big Four. But Sky News reported in January that the FRC had recommended to the government what it called “managed shared audit”.

Gale says despite the CMA’s recommendation, “it doesn’t look as though joint audit has got legs”. Instead, Crowe is preparing to work with managed shared audit.

Under managed shared audit, it is understood that the Big Four firm would retain ultimate control of the audit but a “reasonable proportion” – around a third – of audit work would be undertaken by the smaller firm.

Neate, a prominent voice for joint audit, says one of his major concerns with any form of shared audit is that it won’t get the smaller firm “in the face of the audit committee”.

“I really don’t think it has any of those benefits [of joint audit]. It does pass an economic resource to us, which means we can grow a bit, but it’s not dealing with some of the other issues, particularly, getting audit committees to see just how good we are,” Neate says.

Gale believes that getting challenger firms in front of the audit committees of the nation’s largest companies is critically important for their future success and it is his understanding that the imminent arrival of managed shared audit will achieve that, despite Neate’s reservations.

“You’ve got to have the challenger firm being able to speak to the audit committees to start being able to demonstrate their credibility, their experience, their knowledge such as in future years, the audit committee might be prepared to say: ‘We’ve experienced you for a few years, we know now that you’ve built your skills up, there is a potential that we might appoint you in your own right.’”

MHA’s Andrew Moyser, head of audit innovation, believes the reforms will provide opportunities to firms like his, but says the most important thing for the reforms is that they help rebuild the profession as a whole.

“I’d like to think it helps our firm in the sense that it provides us with opportunities, but really, I want the reform to help the industry… Let’s be honest, auditors have had some difficult cases that have arisen over the last few years and for me, building that confidence with the public is really important,” Moyser says.

Gale says he is hopeful that the reforms will provide a meaningful step forward for the sector and give challenger firms a greater opportunity to participate at the top-end of the market but warns that the proposals must not merely give the illusion that they will increase choice as patience among challenger firms is already running thin.

“We’ve been invited into tenders [in the past], it’s costing us a lot of money to do it and we’re sick of doing it, and never being picked, and realising the Big Four just get picked at the end.

“I don’t want something to be there, which has all the appearance on the outside as though it’s doing it, but you realize it’s not going to change any behaviours,” Gale says.

Regulator still behind on tech

Fiona Czerniawska, co-founder and managing director of consulting firm Source Global Research understands that BEIS is most concerned with managing competition rules after a string of auditing scandals including Patisserie Valerie, BHS, Carillion and most recently Wirecard in Germany. But she is concerned that new regulations will not have a big enough focus on technology.

“There doesn’t seem to be an equal amount of thought going into technology, which I think is by far both the biggest challenge and opportunity,” she says.

Brian Fox, president and founder of audit technology firm Confirmation (part of Thomson Reuters) says the pandemic has meant utilising technology in audit has been “rapidly accelerated”. Moyser agrees, but fears regulators will be slow to reflect the increasing use of technology in the rules and regulations.

“There’s still a long way to go for the standard-setters to really embrace what modern technology offers to an audit file. I can’t see them adapting the standards anytime soon,” Moyser adds.

Fox rejects the idea that technology can be some sort of silver bullet for the industry, saying the “change of mindset” to catch material misstatements due to fraud will be the biggest shift. Even though audit tech can help prevent and catch fraud, the Wirecard scandal wasn’t a “sophisticated fraud” he says.

“The technology is there, it’s a matter of how you’re going to use it,” Fox adds.

Both Fox and Czerniawska are certain that technology can improve audit quality, but they are less sure that it will provide challenger firms with the boost needed to rival the Big Four.

“The size of those largest companies really demands the size of an accounting firm to match,” says Fox.

“I think it will take a very brave challenger audit firm to think that they could come up with the complete audit solution in technology terms in what would now be a very short space of time, and to think that that’s enough to make them take more of a share of the market,” Czerniawska adds.

Delays “frustrating”

There is a mixture of sympathy and frustration that reforms to the sector have been so slow to materialise. Neate told Accountancy Age in July 2019 that he expected legislation in place before the end of 2020, but it was already apparent that Brexit was causing a parliamentary blockage long before the pandemic hit. Yet in July 2020, the BEIS select committee accused the government of “dragging its feet” over audit reform.

Gale says it is “unfortunate” that the reforms lost the momentum created by the publication of the Brydon report, but is glad that impetus is now building back up again.

Paul Winrow, technical partner at MHA, says the delay is understandable after the tumultuous events of the past year and agrees with the government’s decision not to “rush through” half-baked legislation.

“There’s one thing better than a quick answer, and that’s the right answer,” he says.

While Neate agrees that reform is “urgent”, he says the increased risk of business failure brought on by the pandemic could put auditors in the “firing line” once more and brings the need for meaningful reform into an even sharper focus.

“The FTSE 100 still only has the Big Four. There is nobody else auditing in the FTSE 100. The only way that will change is through some form of regulatory reform… They [the CMA] reported that the urgency there was simply, what happens if one of the Big Four fails?”

But there is still a sense of frustration at the slow pace of reforms, Neate says.

“It’s not just me or my firm that are frustrated. I think there are lots of people, including in Parliament, that are frustrated. Other firms…They are frustrated because it just creates an ongoing uncertainty. What we want is a set of recommendations that everyone can get behind that are radical enough to make true change happen,” he says.

Now that change is imminent, auditors across the country will await the government’s proposed reforms with bated breath. There is immense pressure on BEIS to get it right as Gale warned of a challenger firm revolt if the proposals were not up to scratch.

“When the consultations come out, we will carefully look at what is being proposed and if we don’t think it is addressing the issues and going to provide the remedies, we shall be saying so. And I’m sure colleagues from the other mid-tier firms will be doing the same.”

 

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