Rachel Reeves: "We must not wait for the next corporate collapse" © TO AKMEN/AFP/Getty Images
Rachel Reeves: "We must not wait for the next corporate collapse" © TO AKMEN/AFP/Getty Images

Audit and consultancy services must split says BEIS

2 April 2019

MPs are calling for the break up of th UK’s Big Four professional services firms to improve transparency and neutrality after auditing failures linked with the collapse of Carillion and BHS.

A report by the Business, Energy and Industrial Strategy (BEIS) Committee said there should be a full structural break-up of EY, PwC, KPMG and Deloitte into audit and non-audit businesses by the Competition and Markets Authority (CMA).

The Big Four conduct 97% of big companies' audits – 99% for FTSE 100 companies - and also provide them with consultancy services. This has led to fears that the audits may be influenced by the prospect of gaining further business from the firms.

Vested interests should not be allowed to get in the way of change, said BEIS Committee chair Rachel Reeves: "We must not wait for the next corporate collapse.

"For the big firms, audits seem too often to be the route to milking the cash-cow of consultancy business.

"The client relationship, and the conflicts of interest which abound, undermine the professional scepticism needed to deliver reliable, high-quality audits."

The Financial Reporting Council (FRC) announced it is to investigate KPMG's audit of Carillion following the construction firm's demise.

The CMA has already proposed an “operational split” between audit and non-audit functions, with both having separate management and accounts. It is also seeking greater accountability for those appointing auditors to strengthen their independence, and a "joint audit" system with a Big Four and a non-Big Four firm working together on an audit.

However the BEIS – which said that the FRC "has for too long been a weak and ineffective regulator" – argued that a structural break-up would better tackle conflicts of interest and provide the professional neutrality needed to deliver high-quality audits.

It recommended piloting joint audits in the first instance – featuring one of the Big Four but also a smaller firm for the most complex audits to provide more competition and enable smaller firms to gain a better foothold in the market.

And once an audit has been carried out there needs to be “a cooling off” period of three years, in which non-audit services cannot be offered to a former audit client, the committee said.

Other recommendations include limiting the number of large listed companies in any sector where each Big Four firm is permitted to audit and forcing large companies to change auditor every seven years rather than once every two decades.

Auditors had attempted to paint the crisis in audit as a “perception problem” arising from what they dubbed an “expectation gap” – saying audits only tended to attract attention when there was an problem.

But MPs rejected this, saying 27% of audits reviewed for 2017/18 did not meet FRC quality standards. They said it was a “delivery gap” and a “serious failure of audit to deliver on its own current terms”.

The report also called for more effort by auditors to tackle fraud at companies. When café chain Patisserie Valerie went into administration in January its accounts were found to have been overstated by £94m, according to administrators KPMG.

"In light of the failings at Patisserie Valerie, audits must state how they have investigated potential fraud, including by directors," the committee said.

Michael Izza, chief executive of the Institute of Chartered Accountants in England and Wales (ICAEW), welcomed the report, which he said contained sensible suggestions and would help achieve better choice in the market for audits.

But he rejected the call for break-up of the Big Four. "We are concerned that some of its ideas for reducing conflicts of interest, such as the break-up of the largest multi-disciplinary firms, might prove counter-productive," said Izza.

"This could both drive out incumbents and discourage new entrants and it would be unfortunate if an attempt to guarantee the independence of audit firms ended up undermining the resilience of the audit market."

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