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Five-year audit tender costs disproportionate

LISTED COMPANIES are to be forced to allow auditors to bid for the chance to vet their accounts every five years under Competition Commission plans to shake up the FTSE 350 audit market.

Aimed at increasing rivalry among accountancy firms for Britain’s biggest audit contracts, the proposals are intended to break the dominance of the Big Four firms of PwC, Deloitte, KPMG and EY and end the cosy relationship enjoyed between company management and their auditors.

Though it stopped short of imposing the more draconian measure of mandatory auditor rotation, the competition watchdog’s plans have proved controversial. Critics – including the UK reporting regulator and the country’s leading accountancy institute – argue that forcing companies to put their audits up for tender every five years will fail to encourage competition or lead to higher-quality audits.

Claiming the proposals would be “disproportionately costly” and undermine the chances of fostering more competition, the Financial Reporting Council raised concerns that tendering at five-yearly intervals would not be taken seriously by companies or firms and could result in a “sham process”.

PwC, the UK’s largest accountancy firm, went so far as to attach a figure to the costs, which it claims the commission grossly underestimated. PwC said tendering every five years, as compared with the ten year regime introduced by the FRC, would cost auditors and FTSE 350 companies around £52m more a year, significantly higher than the commission’s estimate of between £10m to £20m.

According to the Big Four firm, £44m is already being spent every year because more tenders have been taking place as a result of the investigation and implementing the FRC’s ten year tendering regime. Taken together, the tendering changes will add around £100m to the annual costs borne by the large company audit market.

“This figure does not take any account of the substantial disruption and transition costs of more frequent tenders to both companies and audit firms,” James Chalmers, head of assurance at PwC, said in his response to the commission’s proposals.

With such frequent tendering – the ICAEW estimates upwards of 70 companies retendering every year – company management will inevitably have to invest more time, effort and money into the process.

Speaking to Accountancy Age’s sister title Financial Director, Craig Smith, finance director of the British Standards Institution, explained the business had “an extremely lengthy process in terms of resource” when it retendered its audit earlier this year.

“All the firms met the chairman, CEO, audit chair, another non-executive director, myself and all my direct reports at central and regional level,” Smith explains. “We then had a selection panel, which was the chairman of the audit committee, the CEO, a non-exec, me and the financial controller.”

Similarly, when Schroders put its audit up for tender last year, the process comprised 28 interviews for each firm with Schroders management, written proposals and a presentation to the audit committee and management. And the end result of such an arduous process? KPMG was appointed but later replaced by incumbent PwC because of conflicting interests.

Rational procurement exercise
Finance directors will also find that their involvement in the process eroded as the new rules will restrict close personal relationships between management in favour of handing audit commitees more formal powers to set and agree contracts.

For instance, only the audit committee will be permitted to negotiate and agree audit fees and the scope of work, initiate tender processes, and make recommendations for the appointment of auditors.

According to James Roberts, senior audit partner at sixth-largest UK firm BDO, this will make choosing an auditor a “much more rational procurement exercise”, with the buck stopping with the audit committee chair.

However, the ICAEW voiced reservations about requiring audit committees to take control for authorising non-audit services. “It would be impractical for an audit committee to have to approve every single non-audit service provided by the auditors of a large or complex business, regardless of size or impact: this could be a full time job,” the institute says in its response to the Competition Commission.

The ability of shareholders has also been strengthened with the inclusion of a shareholders’ vote on whether audit committees reports contain sufficient information. David Herbinet, partner at mid-tier firm Mazars, says the inclusion of a shareholders’ vote will give investors everything they need “if they want to create competition” but raised concerns about how audit committees might align their interests.

“The question is whether they align their interests with investors and be totally independent of the board or align themselves with management,” Herbinet says.
The preferred option for many was that the commission give the FRC’s own guidelines on audit tendering time to bed in. Introduced last year, the FRC guidance requires companies to put their audit up for tender every ten years or explain why they didn’t.

Arguing that the commission has undermined the approach already being shown by companies in the FTSE 100 – the likes of HSBC, Hargreaves Lansdown and Land Securities have all recently replaced incumbent auditors – the FRC adds that the commission has undermined “the successful comply or explain approach at the heart of the UK’s corporate governance philosophy”.

If the audits changing hands – not to mention a changing mood among corporates not required to adhere to the changes (in addition to BSI, Lloyd’s of London also retendered last year) – are anything to go by,  it would not be unreasonable for the commission to monitor the effect of the FRC’s requirements.

“We urge that the proposed remedy in this area be deferred for a few years pending review of the impact of those recent changes to the corporate governance code,” the ICAEW says.

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