As the consultation on the future of audit closes, Peter Manser, head of audit and assurance at Kreston Reeves LLP, argues that managed shared audit needs careful consideration but could open up much-needed competition among audit firms
The government’s proposals for audit reform are part of their initiative to ‘restore trust in audit and corporate governance’. Audit is one strand, along with corporate reporting and corporate governance including the role of a new audit regulator.
As a mid-tier network, Kreston International supports the bigger picture concept that trust in corporate reporting involves auditing and corporate governance and the work of the regulator over auditors, directors and companies.
High profile corporate failures inevitably and rightly fuel debate over improving audit quality. Carillion failed in 2018, BHS in 2016. Three significant public consultations have subsequently examined the different issues.
Reform in the corporate world always takes time and inevitably the proposals for audit reform are going to take time to produce change. Some commentators are looking at 10 years plus. That’s a long enough time window for further corporate failures to add to the ongoing debate.
The key issue for audit quality for listed and larger companies is the lack of choice. Increasing competition through wider choice will drive innovation and improve audit quality. Mid-tier firms can add to both quality and choice in the right circumstances. Yet there are significant barriers to entry to listed audit work for challenger and mid-tier firms. These include the management of liability and risk including reputation, recruiting, and retaining resource, adapting our audit processes and developing our quality control and management systems.
Managed shared audit
In response to the consultations the government has proposed managed shared audit which provides opportunities to overcome these barriers. For our member firms, shared audit could provide a route to gain experience and build reputation in an area where we are effectively currently excluded.
For firms to engage in shared audit will require boldness, and significant investment. The lack of competition for listed company audit has become extreme with the Big Four accountancy firms auditing 100% of the FTSE 100 and 97% of the FTSE 350. Such market concentration raises questions over the resilience of the audit profession for listed and other large entities.
Failure, or even the perceived risk of failure of the one of the Big Four would result in severe disruption and of course yet further market concentration.
There is a significant difference between the Big Four firms, challenger firms and mid-tier firms in terms of resource and expertise. Increasing the number of viable competitors for the more complex audit assignments is a sizeable project but a vital one. The conclusion of public consultation is that more audit firms enabled to compete for listed and large company audits will improve both resilience and quality of audit for these entities.
The main barriers to entry are usually seen as capacity, capability and reputation. Would changing the rules currently precluding majority control by external investors help (as has recently been suggested by the former head of the Financial Conduct Authority (FCA))?
Building capacity, capability and reputation will require investment, but this is only one factor. Lack of investment due to the constraints on ownership of audit firms has not been identified as a significant factor during the current public consultations. After all, the current ownership rules spawned the Big Four.
Access to further investment will be necessary to challenge the Big Four, but to build the infrastructure is a long-term project that will necessitate careful planning and oversight. Changing investment rules for audit firms will require detailed consideration of the independence issue that will arise, and the impact on audit quality.
Mid-tier firms will also need to thoroughly consider the cost of the compliance regime for auditors of listed and large entities.
At least one of our member firms has made representations that the role of the regulator needs to be proportionate, one of enabling competition through education.
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