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As audit quality continues to come under scrutiny, the UK has announced wide-ranging reforms aimed at breaking up the dominance of the big four firms.
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UK moves to break up big 4 audit dominance
22 March 2021
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Sweeping reforms tabled by UK business secretary Kwasi Kwarteng would see the introduction of an audit-share mandate, where larger companies will be required to use a smaller “challenger” firm to conduct a meaningful portion of their annual audit in a bid to break up the dominance of the big four and boost the growth of smaller audit firms.
The proposal would also see the accounting and consulting arms of big four firms undergo an operational split, safeguarding the management of audit activities from the rest of the firms’ business.
The big four could also face a cap on their market share of FTSE 350 audits, if competition across the market doesn’t improve, the proposal warns.
The reforms would also see a new regulatory body emerge. The Audit, Reporting and Governance Authority (ARGA) will replace the current regulatory body, the Financial Reporting Council, usurping its remit, and expanding its scope, moving to oversee the UK’s largest unlisted companies, as well as those on the stock market.
The ARGA would be empowered to impose operational splits upon the big four to reduce conflicts of interest that impact the audit quality they provide. It would cost $70 million (£39 million), and be funded by an industry levy.
The proposed reforms follow mounting concerns over the UK’s audit market over the last two years. The UK’s Competition and Markets Authority released a final report on its audit services market study in April 2019, suggesting many of the changes that comprise the proposed reforms announced on Friday.
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Australian audit quality falls under the microscope
The UK’s move to crack down on the auditing market follows concerns that similar reforms might take shape in Australia, after a final report by the parliamentary inquiry into audit quality was tabled last year.
Recommendations handed down by the inquiry, released in November last year, cast emphasis on ASIC and the Financial Reporting Council to define audit and non-audit categories, and provide clarity on prohibited non-audit services for audit clients.
The recommendations also call for companies to be forced to go to public tender for auditors every 10 years or offer explanations for not doing so, providing more transparency to shareholders about the auditor-company relationship.
ASIC commissioner Cathie Armour in January warned audit firms that their efforts to reduce material misstatement in their financial reporting had fallen short, after a 2020 across-the-board review found that 27 per cent of audit files contained issues, up from 26 per cent the previous corresponding period.
“The current findings suggest firms’ action plans have not sufficiently improved audit quality,” Ms Armour said.
“Firms must strengthen existing initiatives and implement further new initiatives to improve audit quality,” she said. This includes enhancing a culture focused on audit quality, the experience and expertise of partners and others, supervision and review of audits, and accountability of partners and others for audit quality.”
The regulator’s warning came despite a marked improvement among Australia’s six leading firms compared to the previous corresponding period, when ASIC’s dissatisfaction followed a similar refrain.
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