July saw the Financial Reporting Council (FRC) reveal that 29% of 103 FY21 public interest entity (PIE) audits reviewed from the seven largest UK audit firms required “improvement or significant improvement”. While this represented a marginal improvement from FY20’s 33%, Sir Jon Thompson, chief executive at the industry watchdog, stressed that “significant change still needs to happen to meaningfully improve audit quality”.
The FRC report merely reaffirmed the extent of the problem which has come to light time and again through major stories such as the Carillon, Silentnight, and Stagecoach failures. Chris Biggs, partner at the firm of chartered accountants Theta Global Advisors, recognises that he was used to “spotting a story every month, but now it’s almost weekly if not becoming daily”.
Yet, for Biggs, the issue of underperforming auditors leading to audit failures goes beyond just the Big Four and largest mid-tier firms. “I think it’s happening across the board,” says Biggs. “The big firms are the ones that grab the headlines because they’re dealing with household names, but I get to read the various rulings that circulate via the FRC where people have messed up and there are lots of smaller firms there as well, we just don’t know the names of their clients.”
Despite this reality of audit failures across all sized firms confirming the need for reform for improvement, the impacts on these mid-sized FTSE 100 and 350 firms is not wholly self-inflicted. “You can’t get away from the fact that the mid-tier firms are intrinsically connected to the profession, to the audit product and to how it all works,” says Biggs.
He adds: “At the end of the day, it’s all about the consensus of public and investor confidence in the audit as a product. As much as I’m sure the mid-tier firms would like to separate themselves from the problems the Big Four have, it’s still a problem with the perception of what an audit actually is.”
So, what can be done to turn around this negative trend of poor-quality audits? One proposal set out by the FRC, and subsequently rejected by the Big Four, was that of shared audits. According to the Financial Times, those largest auditors have voiced their concerns that joint audits with smaller groups would fail to improve audit quality – an opinion also voiced by Biggs.
Biggs highlights that for a smaller accountancy firm to take on part of the audits of these larger PIEs, it doesn’t just centre around “technical audit” but a whole range of other requirements such as “derivative and trading expertise”. He adds: “For the smaller firms and mid-sized firms to get that experience in house, it’s incredibly expensive, particularly whilst it’s not just the Big Four that have those skills now. The top mid-tier are trying to get those people, so there’s a bit of a drain of specialists into those mid-tier firms.
“For the small firm trying to take on anything more than what they’re doing at the moment, the cards are somewhat stacked against them, both from a reputation experience, and also a resource cost and skillset.”
Biggs claims that as a matter of fact, for small to mid-sized firms, “there is a population of audit clients which they are perfectly suited for, and vice versa”. To take on anything more, and step out of their “comfort zone”, could in certain circumstances without significant investment in skills and resources by those firms, according to Biggs, break current legislation in the form of the “very clear policy that you only do the audit work that you are capable of doing and have the experience and skills to do so”.
If, then, shared audits isn’t the answer, what is? Biggs says that the FRC and other regulators need to have “bigger teeth” in order to “clamp down on those nonperforming” firms with tougher fines and individual bans. “I think directors need to be held far more responsible for what goes on,” he says. “When I first started training, my audit 101 was that the auditor is a watchdog, not a bloodhound. Yet, that seems to be what the auditors are getting criticised for now.
“A lot of it comes down to the fact that directors have done things they shouldn’t have done, and the auditors are complying with legislation, but because they don’t pick it up when doing what they are meant to do, then legally they’re still in the firing line. So, if you want the auditors to be more of a deterrent and a bloodhound and to really seek these things, then legislation has to change as well.”
Secondly, Biggs highlights the question of pricing. He suggests that the rotation of auditors then depressing audit costs is causing issues for audit quality across the board. Biggs says: “The fees going down means that the amount of time the auditors can spend on doing what they need to do is really limited. There has to be an acceptance, particularly with a large set of FTSE 100 companies, that at the end of the day companies need to pay a decent amount for what they get.”
Evidently, the fate of the Big Four, large, and mid-sized auditors are intertwined. Biggs claims that proposals of shared audits could be ditched for a tougher set of regulations against company directors and a reevaluation of audit fees to ensure auditors of all sizes have the available resources, and correct set of rules, to avoid being thrown under the bus.
For a situation that is encompassing companies of all relevant sizes that audit FTSE 100 and even FTSE 350 firms, it is thus only fair that all of these groups be consulted on audit reforms. Biggs adds: “Hearing more from the mid-tier firms will be positive because that will hopefully then start to come out with some thematic issues, as opposed to just those limited by the Big Four.”
For Biggs, audit reform is a necessity. Yet, it is key to remember the impact and importance of mid-tier firms when promoting change. A further realisation of what audits actually are, in terms of costing, legislation, and relationships between companies and their auditors, is needed to improve outcomes for both auditors and clients.
Change is needed, but industry watchdogs must consider those outside of the largest auditors if a compromise and real improvement is ever to be made.