Long road to audit reform leaves path littered with questions

Three years, three reviews, 450-odd pages and about 150 recommendations later, and what do you get? Another 232-page document and 16 more weeks of consultation on the future of auditing.

The glacial pace of UK efforts to patch up the credibility of the audit profession would frustrate even the most dedicated of corporate governance enthusiasts. 

The government’s proposals on how to overhaul the audit industry after failures and scandals at the likes of Carillion, BHS and Patisserie Valerie are voluminous, in part, because the problems are so numerous: a toothless regulator lacking the necessary statutory powers; confusion over the purpose of auditing; lacklustre investor engagement in the process that is supposedly done in their name; insufficient competition in the market — the list goes on.

There is much to be welcomed in the equally daunting list of reforms the government has suggested: a beefed up regulator with new powers to oversee the largest unlisted companies and to hold company directors, and not just members of the audit profession, to account; a formal way for shareholders to flag areas of concern or risk as part of the audit process; and greater focus and transparency around payment of dividends and business resilience.

All of which, of course, will now be picked over by every interested party with a view to influencing the eventual legislation, which could take until mid-2023 on some estimates to come into force.

But in two significant areas there are still questions to answer.

First, it is indeed “not healthy” that 97 per cent of FTSE 350 audits are undertaken by just four audit firms, especially as internal conflicts of interest and auditor rotation mean not every Big Four firm will be bidding for every mandate. 

But the government here has gone against the recommendation of the Competition and Markets Authority to mandate joint audits in the FTSE 350. Its proposal of a “managed shared audit” in theory gives smaller challengers the chance to develop capacity and skills without taking on full liability for the audit, with fears that could drive up costs.

In reality, this is a halfway house that probably pleases no one. At least France has tried joint audits (successfully, according to the CMA), whereas this is the UK forging a brave new path. It evidently creates a junior-senior dynamic within the audit duo. The Big Four firms will still complain about duplication, logistical complexity and rising costs. Investors, meanwhile, don’t get the creative tension, as it were, from having two firms responsible for the audit process.

Second, the tougher rules holding directors responsible for the accuracy of the numbers may yet end up a tad flimsy. The government’s three options in this area span a broad range of outcomes, from a simple director statement in the annual report to a fully vetted opinion from the auditor as to the effectiveness of the company’s internal controls.

Only the latter amounts to a UK version of the Sarbanes-Oxley regulations in the US. Given that the scope and ability of auditors to root out fraud has been a key source of confusion and frustration around the industry in recent years, a lighter-touch solution risks continuing the same old debates.

The government, itself, seems a touch confused about the aim here: no amount of audit reform and corporate governance wizardry can “avoid company failures”, especially after a year where lashings of public support have pushed insolvencies towards record lows.

A better mark of success was provided by Donald Brydon in his contribution to the trio of audit reviews. Anxieties around auditing were, he said, remarkably similar to those considered by the MacFarlane Report in 1992 — joyously brief at 23 pages: The “desire for seemingly endless discussion of the detail” had meant a lack of action.

Please, let’s not need another 680 pages in 30 years’ time.

helen.thomas@ft.com
@helentbiz