Blunted audit reforms risk “pick ’n’ mix approach” to reporting

Blunted audit reforms risk “pick ’n’ mix approach” to reporting

The FRC and major audit firms have criticised the UK government’s watered-down proposals

Blunted audit reforms risk “pick ’n’ mix approach” to reporting

UK lawmakers’ U-turn on plans to create a tighter, US-style framework for internal controls in the UK has been met with backlash from across the accounting and audit industry.

The UK government today published its long-awaited response to a consultation on restoring trust in audit and corporate governance, only to announce that plans to make company directors personally liable for internal controls over financial reporting (considered to mirror the US Sarbanes-Oxley Act) would be scrapped.

Instead, the government has said that it is “inviting the regulator” to address the matter by strengthening the UK Corporate Governance Code, which only applies to the largest listed companies and is not legally-binding.

“The apparent decision not to include a UK version of Sarbanes-Oxley in primary legislation leaves corporate Britain with no clearly defined framework for internal controls, and risks a pick’n’mix approach to reporting and measurement,” said Jon Holt, chief executive of KPMG UK.

This is likely to result in investors and stakeholders receiving inconsistent information across different companies, Holt added.

The sharp pivot also provoked criticism from the UK’s audit regulator, the Financial Reporting Council (FRC). Despite welcoming the proposals, CEO Sir Jon Thompson lamented the government’s “missed opportunity”.

“The government’s decision not to pursue the introduction of a version of the Sarbanes-Oxley reporting regime is, the FRC believes, a missed opportunity to improve internal controls in a proportionate, UK-specific manner.”

The FRC has said that it will shortly be outlining a work plan to advance reforms.

Lawmakers have also watered down proposals to expand the number of companies subject to the tightest requirements, meaning that just 600 new “public interest entities” (PIEs) have come into scope, as opposed to a possible 2,000.

In its original proposals, the government suggested a possible test of 2,000+ employees and £200m+ turnover. However, today’s consultation response details a revised scope of 750+ employees and £750m+ turnover.

“Cautious” optimism remains

But according to Gavin Hayes, head of public policy and external affairs at the Chartered Institute for Internal Auditors (CIIA), the updated PIE definition still represents a positive step for the industry.

“We have always maintained that the government should be proportionate and reasonable in its approach to widening the definition of a public interest entity,” he said.

“We believe that the new definition, while slightly narrower in scope to the options originally set out, represents a positive step forward, ensuring more companies of public interest will be better protected.”

Market participants have also welcomed plans to convert the FRC into a new, more powerful regulator called the Audit, Reporting and Governance Authority (ARGA), which was confirmed in today’s announcement by the government.

The new regulator will have the power to:

  • Scrutinise the largest private, unlisted companies for the first time;
  • penalise company directors who breach their legal duties;
  • and ban failing auditors from reviewing the accounts of large companies.

“We’re glad to see Arga being given the teeth it needs to bite,” said Mike Suffield, director of policy and insights at the Association for Chartered Certified Accountants (ACCA).

“Its ability to ban failing auditors from reviewing large companies’ accounts and to investigate and sanction directors of large companies for breaches of duties around corporate reporting and audit gives it the necessary power to tackle any future issues.”

In a bid to reduce dominance and increase resilience in the market, FTSE 350 companies will also be compelled to offer part of their audit work to a non-Big Four firm. Failing this, ARGA will be given the power to force larger auditors to keep their audit and non-audit functions operationally separate and enforce a cap on market share.

Progress still “glacial”

However, according to CIIA chief executive John Wood, the government’s latest response does little to remedy the critically slow pace of audit reform.

“We strongly support putting the audit regulator on a statutory footing with the legal powers it needs to do its job properly, however we remain very concerned about the glacial pace of audit reform,” he said.

Wood went on to argue that, in addition to today’s developments, an Audit Reform Bill must now be accelerated.

“The government must stop kicking the can down the road on audit reform and get on and pass the legislation that is urgently required to prevent any more unnecessary corporate collapses.”

The package of reforms announced today has been three and a half years in the making. It began with a series of independent reviews (conducted by Sir John Kingman, Sir Donald Brydon, and Competition and Markets Authority), followed by a public consultation that ran from March-July 2021.

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