Can reform fix the UK’s auditing crisis?

Recently, Britain’s accounting and auditing services have undergone a series of high-profile scandals. In the wake of the government’s audit reform proposals, Patrick O’Donnell examines why trust in auditing has plummeted and what needs to be done to fix it

Auditing in the UK, as well as its reputation globally, has been tarnished by a slew of scandals committed by some of the country’s ‘Big Four’ key players within the accountancy sector. Major misconducts, such as the collapse of Carillion and EY’s Wirecard scandal, have put the industry on the backfoot and have resulted in the government having to step in.

Wirecard collapsed into insolvency in June 2020 after it emerged that £1.6bn (€1.9bn) of corporate cash did not exist. EY, the German financial services company’s auditor, came under an immense amount of scrutiny for failing to verify the existence of cash reserves in what appeared to be fraudulent bank statements.

Two years ago, KPMG were criticised by the government’s Work and Pensions Committee and the Business, Energy and Industrial Strategy (BEIS) Committee for their “colossal failure” as auditors of Carillion. The construction giant, which employed 19,000 people in the UK, went into compulsory liquidation on 15 January 2018, with liabilities of almost £7bn.

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In order to restore public and business trust in auditing and corporate governance, the government published a white paper, seeking views on proposals to strengthen the UK’s framework for major companies and the means in which they are audited.

In response to the BEIS consultation paper, Kevin Ellis, chairman and senior partner of PwC UK, welcomed the government’s proposals despite its criticism of the ‘Big Four’s’ monopoly on the market. “The UK has an opportunity to lead the world on corporate governance,” he said.

“As the country recovers from the pandemic it’s vital that any reform enhances the business environment, making the UK an even more attractive destination for foreign investment and world leading as a capital market. This consultation is a crucial step in driving trust and confidence in our reporting and regulatory frameworks.”

For many industry professionals, outside of the ‘Big Four’, it’s about time. Hugh Scantlebury, CEO of cloud-based accounting firm Aqilla, is “supportive” of the initiative to restore public confidence in auditing, as well as the creation of “all-encompassing” principles to ensure good practice across the industry.

“Whilst they have in many cases had change enforced upon them, such as with KPMG, there will still be instances where organisational fraud has not been brought to the surface quickly enough due to a conflict of interest,” he says.

“As well as paving the way for improved processes, controls and accountability, the proposed reforms would also provide better shareholder protection.”

As part of the BEIS’s audit overhaul, a new regulator will be established to oversee large unlisted companies, including the FTSE 350. The Audit, Reporting and Governance Authority (ARGA) is set to be given much stronger powers than the Financial Reporting Council (FRC), such as the ability to decide which individuals and firms should be approved to audit PIEs.

However, some are skeptical as to far these reforms go to addressing the accounting and audit sector’s wider issues. Franki Hackett, head of Audit and Ethics for data solutions provider Engine B, believes the proposals are just “one piece in the puzzle” to fixing financial and corporate reporting.

“Audit and accountancy as a profession have lost the trust of almost every conceivable stakeholder as a result of the scandals we’ve seen, and markets can’t function without trust in corporate reporting and trust in audit,” Hackett says.

“So reform is both essential and inevitable. There wasn’t much to surprise us in these proposals, most of the changes having been recommended in one of the major reports into audit and corporate governance in recent years.”

Hackett does believe the introduction of a new regulatory framework to tackle “anti-competitive behaviour by audit firms” is both welcome and essential for the industry. “Some, like the new obligations on directors and auditors to identify material frauds, could hopefully go a long way to closing some of the expectations gap for audit,” she explains.

“Measures like stronger penalties on directors and clawbacks of remuneration where directors have been found to be negligent will help restore some sense of fairness over some aspects of executive pay. These reforms will help, but we need a sea-change in how audits are done before we can expect the crisis to be over.”

Deloitte, EY, KPMG and PwC have each agreed to separate their auditing and consulting departments by 2024, in order to prevent possible conflicts of interest. However, critics believe this does not go far enough.

John Miller, the chief operation officer of financial services firm Addition, is of the opinion that more can and should be done to get the sector through this moral crisis. “Audit reform is long overdue. As with all industries, when there are market incentives that are not in the best interest of the general public, reform is needed,” he explains.

“By that we mean that audit practices conduct other work for companies which they are also auditing. So how can the financials be “true and fair” – the key pillar of an audit – without the party conducting the audit being impartial?”

Miller is in favour of greater transparency regarding any chief financial officers prior history with the ‘Big Four’ firms, expanding auditing outside of financial reporting and an increase in the amount of auditors fines. “This is the question: are Audit partners on failed businesses either incompetent, greedy or fraudulent?,” says Miller.

“So many jobs were lost across these collapses (Carillion, Patisserie Valerie, Thomas Cook, Ted Baker) and the directors and audit partners are responsible. We need more accountability targeted at Audit sub Committees – what is the point of these committees if they are not accountable when they are responsible?”

An emphasis on greater audit training is a factor many experts wish to be considered as part of the proposals. For Charlie Patrick, a partner at forensic accounting firm FRA, this is a necessity. “Audit education should be reformed in line with the greater expectations to include forensic accounting techniques designed to expand fraud awareness and identify and investigate instances of potential fraud.”

“Greater training comes at greater cost, and it is important that this training is made available to all, as these reforms are designed to bring the sector closer together rather than widen the gap between the ‘Big Four’ and smaller firms.”

He added: “The FRC’s Audit Enforcement Procedure currently provides an independent Tribunal adjudicating audit investigations. This Tribunal is made up of members of “appropriate experience and expertise” but as the operation and scope for fraud is ever-increasing, an independent adjudicatory panel should be established to remain at the forefront of fraud-related issues.

“It will be interesting to see the results of the consultation regarding the stakeholders that should be held accountable for the failure to detect and report fraudulent corporate activities, and what duties or sanctions are imposed on those stakeholders.”

In the months before the pandemic, research carried out by Adviser Rankings revealed that the ‘Big Four’ completely dominated the market for large-company audits in the UK, with prior attempts to increase competition having failed. Time will tell if the government’s recent proposals will truly reform auditing in the UK, or be yet another futile attempt at doing so.

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