The UK government’s recent consultation on the audit reform proposals is much more than simply audit reform. It aims to restore trust in audit and corporate governance and it is unprecedented in its breadth. In addition to reform of the audit profession and scope of the audit, it spans corporate governance, greater regulatory powers over audit committees and company directors, fraud prevention measures and the introduction of internal control reporting and assurance.
Undoubtedly, the greater emphasis being put on the role of company directors and boards, along with enhanced requirements on auditors and the introduction of internal control reporting and assurance – which are all part of the proposals – have the potential to bring about real change.
However, while the consultation’s proposals are far-reaching, they also include many potential pitfalls and have prompted further questions on the path to reform. Among the many topics covered in the consultation, six are worthy of careful considerations, not only on their strengths but also potential shortcomings.
1. Expanding the public interest entity (PIE) definition
The proposed changes to the definition of PIE lie at the heart of the reform and could more than double the number of entities currently considered PIEs.
Aside from the concerns over the accounting sector’s capacity to manage this vast potential increase in PIEs, the changes made to the UK definition should be made with proposed global revisions in mind. An international review of the PIE definition is already underway and includes more qualitative factors like the importance of an entity to its sector and the potential impact of a company’s failure – neither of which are addressed by the UK government’s proposals.
Of further concern is the inclusion of large third sector bodies, such as charities and universities, in the new definition, as this will add further strain on the accountancy sector. The proposals also raise significant questions about whether the implications of being a PIE are proportionate for such third sector entities.
2. Internal controls framework
The introduction of a UK version of the US Sarbanes Oxley (SOX) internal control reporting regime would be a big step forward in sharpening company directors’ reporting accountability. It would ensure that directors fully and properly consider their company’s internal control environment and whether it is effective to deliver accurate financial reports and uphold high standards of data and IT security.
We support the proposals which go further to include a director’s attestation following their assessment of internal controls supported by a formal audit opinion. That said, the benefits of such a regime for all PIEs needs further evaluation given the proposals to expand the PIE definition.
3. Tackling fraud
The proposals call for greater requirements for directors of PIEs to detail the actions they have taken to prevent and detect material fraud as part of their company’s statement. While this is a broadly positive step, we are concerned that unrealistic expectations may be raised given the relatively restricted changes put forward in the reform, particularly positioning them as the silver bullet solution to the sort of corporate failures we have seen in recent years.
Auditors are already doing more to combat fraud, through enhanced training and better use of advanced technology such as AI, and there is a risk that the changes proposed won’t make a significant difference to what auditors and companies do in reality.
These reforms need to ensure an appropriate balance of responsibilities between directors, auditors and regulators to avoid just making more work that adds little value.
4. Regulator powers over company directors
The suggestion to include greater powers for the Audit, Reporting and Governance Authority (ARGA) over company directors is welcome, particularly in relation to corporate reporting and audit. It’s also positive to see proposals for these powers to apply to all directors rather than just those who happen to be members of professional bodies and to include calls for the oversight of audit committees.
5. New professional body for corporate auditors
In principle, it is easy to see why a distinct professional body for corporate auditors is an attractive solution to any issues with audit quality.
However, the Brydon review of 2019 and the new proposals provide a lack of clarity as to how such a professional body should be established and how it would deal with the different requirements of statutory auditors and other corporate auditors. Unfortunately, this leaves significant uncertainty over whether such a professional body would indeed drive better audits.
6. Managed shared audit
A centrepiece of the proposals is for managed shared audits to replace joint audits, which should be a welcome step-change. There are many reasons, in addition to the often-quoted auditor liability issues, why joint audits wouldn’t work in the UK legal and regulatory framework without other fundamental changes to company law and regulations.
Shared audits are already successfully delivered in cases where challenger accountancy firms undertake the audit of significant components of larger listed entities, such as Ford, Goldman Sachs and JP Morgan, which are audited by the ‘Big Four’. The new element in these proposals relates to the “managed” aspect of shared audits which isn’t fully explained in the proposals. It is important that the introduction of any arrangements to manage shared audits, the details of which remain thin in the consultation, doesn’t stifle existing arrangements and innovation.
Overall, these reform proposals have been largely welcomed as a progressive step in restoring trust in audit and corporate governance. However, as the government evaluates the responses to the consultation, many questions remain on how the proposed changes will be implemented and the full extent of their impact on accountants and businesses alike.