Concern over costs of new ‘comply or explain’ audit code

The landmark audit corporate governance code released this week may have the
unintended consequence of restricting growth in the already top-heavy audit

Eight firms will be party to the code, which will be enforced using a “comply
or explain” system and will require them to appoint independent non-executives –
among a raft of governance measures. However, amid the enthusiasm for the new
code, concerns have been quietly raised about the smaller firms’ ability to
absorb the cost of the new code.

The code envisages at least two non-executives to be hired by the firms,
which Baker Tilly has estimated would cost as much as £250,000 per year.
This may seem a drop in the ocean for the billion-pound turnovers of the Big
Four, however the cost might fall disproportionately on the smaller two firms
captured by the code – Baker Tilly and PKF.

The code has been recommended to apply to firms that audit more than 20
listed companies, with voluntary adoption by firms below this threshold.
Baker Tilly audits a number of listed entities, In 2008, the firm audited A.G.
Barr, the FTSE 250 company behind Scottish drink IRN-BRU, which brought in
£112,000 in audit fees, £24,000 in audit-related fees and 77,000 in non-audit

Similarly, PKF audits FTSE 250 communications business Telecom Plus, among a
range of clients, with which it earned £115,000 last year in audit and other
fees. In a statement, Baker Tilly described the code as “well-intentioned”, but
said “only time will tell whether anything of real substance will be achieved by
its introduction”.

In an earlier submission during the code’s drafting in October 2009, Tom
McMorrow, director of policy at Baker Tilly, said the firm was “genuinely
apprehensive” about the value of having non-executives.

“The new code will cause obstruction to the very market choice the
consultation paper says it wants to help broaden,” he said in the submission.

“Imagine, for example, a firm, in the course of a tendering process, having
to explain (as it will) that it is not covered by the code.”
PKF was unavailable for comment.

One of the key figures behind the code, Robert Hodgkinson, executive director
at the ICAEW, said cost was taken into account during drafting.
“Having explored the issues, there is nothing that people are telling us that
makes this prohibitively difficult and it is now for the firms to work out how
to do it,” he said. “There is always a little bit of uncertainty about what the
benefits will be, in terms of the cost.”

Compliance with the code will be documented via the annual transparency
reports the firms release each year.

Hodgkinson said he expects to see a mix of skills in the non-executives
choices. “As with all these things you need to have the number but also the mix
of experience and skills,” he said.

Plans are already afoot to review the code by 2014.

The biggest eight auditors

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