Can a problem like audit be solved? Others have tried before—and others are set to try again.
There have been multiple, consistent concerns about the audit process, governance and even its raison d’être.
The concerns are that auditors fail to understand the risks built into business models, thereby impacting on auditors’ ability to provide assurance. Also, that those being audited are effectively ‘clients’ and too close to the auditors.
These issues, and more, have seen previous investigations into the market’s workings. Both UK and European regulators have pushed for auditors to rotate out from their positions. But this has seen an inevitable merry-go-round of work for the ‘Big Four’ accounting firms.
And the aim of this action, and other initiatives—to ‘improve’ audit quality—seems to be failing.
Carillion’s collapse, for which MPs gave strong criticism of the role of auditor KPMG, along with the firm facing more robust overview from the Financial Reporting Council (FRC), seems to have tipped things over the edge.
The Kingman review is looking at the future of the FRC, the UK’s audit watchdog. The Competition and Markets Authority (CMA) has been asked to investigate the audit market, and the largest firms have launched their own project, “From four to more”, to find ways to encourage new entrants to the large audit market.
Finally, the FRC is conducting its own investigation into auditor independence, how auditors judge whether a company is a going concern (viable), and what additional elements investors need from audit. The FRC says it has already worked to strengthen audit quality through enhanced monitoring and enforcement.
There are huge questions to be asked, and much at stake.
For starters, is conducting numerous investigations and reviews better than one? And, following much navel-gazing and external investigation in the recent past, can a conclusion be reached that satisfies the market participants, the regulators, the capital markets, and politicians?
While too many cooks would normally spoil the broth, there is some support for the multiple angles of approach.
“The many attempts to get to grips with these issues reflects their complexity,” says Andrew Likierman, professor of management practice in accounting at the London Business School, and one of the most senior accountants to have straddled both central government and the private sector.
“If an answer was straightforward, it would have been done and dusted by now.”
In the Big Four firms’ favour, the ‘nationalisation’ of audit would seem to be off the agenda. For instance, the auditing of local government was effectively privatised just a few years ago. And the government is always looking for private sector ‘solutions’.
“While the Big Four in particular will have the burden of dealing with multiple reviews, it’s in their interests to have workable ideas,” adds professor Likierman.
The FRC finds itself in a difficult position: urgently trying to improve audit’s quality, while under existential threat itself.
Its chief executive, Stephen Haddrill, has pushed the body to beef up in the past two years, including broad reforms to governance, stewardship and a push for tougher powers. But the FRC has been embattled, over its approach to both the collapse of BHS and its investigation into HBOS’s audit.
So, can these reviews work separately but coherently? Or will they, ironically, conflict?
There appears to be an “informal hierarchy”, with the Kingman Review and CMA investigation at the top of the pile. Conceptually, these reviews fit together, explains Andrew Gambier, head of audit and assurance at the Association of Certified Chartered Accountants (ACCA).
Kingman focuses on the FRC as a regulator, while the CMA focuses on the market’s operation. However, the extension of Kingman to cover auditors’ appointments and fees could have, arguably, come under the CMA’s remit.
The FRC’s own review may be superceded by the former reviews. Both Kingman and the CMA have tight timetables.
But audit’s ecosystem of members is vast, encompassing investor bodies, directors, accountancy firms and more.
While this might suggest difficulty in running a fully-fledged process, there is the possibility that, rather than dragging on beyond the current timetable, the reviews will look to push through tougher proposals more quickly.
“This ambitious timeline may lead to faster, tougher proposals being preferred to slower, more effective responses,” suggests Gambier.
In a world where the FRC is described as “like a prison that was designed by the inmates” by Tim Bush, head of governance and financial analysis at investor consultancy PIRC, it seems that the regulator’s attempt at modernising itself and the market has been overtaken by events as well as government.
“Now that the [FRC’s] set-up is transparently not working, there have been rushed and superficial attempts to make it suddenly look more like an Alcatraz. But it looks to be merely a case of putting tomato sauce on a few shirts,” adds Bush.