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Summary
- Big four accountancy firms are responsible for auditing 95 per cent of the firms listed on the FTSE 350 index
- As per the FRC, the audit divisions are expected to operate as a separate entity by 2024
- The purpose of FRC is to catch hold of the defaulters and serve the public interest by setting high standards of corporate governance, reporting and audit
The Financial Reporting Council (FRC), the industry regulator has directed the top accountancy firms in the UK to separate their auditing divisions from their consulting and other divisions. These firms are popularly known as ‘Big Four’ consulting firms, which consist of Deloitte, KPMG, PWC and EY. It is important to note that these four firms are responsible for auditing 95 per cent of the companies listed on the FTSE 350 index.
Every now and then, several questions are raised on the existing accounting and audit framework prevalent in the UK. A lot of people have lost their jobs in the past due to corporate failures. The collapse of the outsourcing giant Carillion, a couple of years back, resulted in more than 3,000 job redundancies. The company collapsed with a debt-laden balance sheet and a loss of billions. The big four have recently drawn a lot of flak for perceived inaction during the recent years, which eventually led to the financial collapses of companies like Carillion and BHS.
The British government needs to bring reforms with respect to auditing, controls and corporate governance being practised by these companies. The stripping of audit arms of these consulting companies is just a step towards bringing reforms in this sector. These audit arms are expected to operate as a separate entity by 2024.
Also read: The Financial Reporting Council (FRC) issued a financial decision notice against KPMG and a Partner
A milestone in bringing reforms to the audit sector
The idea behind stripping the audit arms of the ‘Big four’ are to ensure high-quality audits in the best interest of the public and all the stakeholders of the company. The audit as a separate entity would stress more on audit quality and protect the auditors from any undue influences that might arise from the other functions of the company. For instance, people with similar credentials work in the accounting and auditing department; therefore, there is a high probability of people getting influenced between the departments. Hence, it is important to recognise that accounting and auditing are two different streams which should be kept mutually exclusive.
The FRC aims to prioritise high-quality audit by promoting ethical standards, basic hygiene, professional scepticism/judgement, and teamwork. The auditors are expected to work in the best interest of all the stakeholders and a wider section of the society. The FRC expects the ‘Big four’ firms to comply with the operational separation of their audit practices on the basis of that and provide with a transition timeline. The implementation plan, which includes the transition timeline is to be submitted to the FRC in October. Based on the plan submitted, the FRC would discuss the timetable with each of the Big four. Based on the outcomes of operational separation, the FRC will thereafter publish an annual assessment of firms which are doing well in terms of audit quality.
The sole purpose of all this exercise of FRC is to catch hold of the defaulters and serve the public interest by setting high standards of corporate governance, reporting and audit. FRC works as an independent body and is responsible for setting UK standards with respect to accounting, auditing, and ethical standards. The financial reporting should allow effective monitoring of audit practice performance, financial resilience, and should be transparent to the regulator and the public.
To improve the quality and effectiveness of corporate reporting and audit in the United Kingdom, the FRC has taken a strategic initiative to separate auditing practices from other verticals of the company. This step taken by FRC could prove to a milestone in bringing reforms to the audit sector by setting protocols for carrying out audit processes across the industry. The FRC is likely to introduce further aspects of the reform package over time and would remain fully committed to the broad suite of reform measures on corporate reporting and audit reforms.
Few months ago, a health care company, NMC Health Plc went into administration. United Kingdom’s accountancy watchdog, FRC then opened an investigation into the audit of NMC’s 2018 accounts which was done by EY. Travel & Leisure group, Thomas Cook Group Plc, which collapsed months ago, was also audited by EY and PWC. FRC aims to conclude these investigations within a span of two years. If EY is found guilty of any wrongdoings, the tribunal is expected to come into play and could penalise or refer EY for legal action. Earlier in April, the high court in London charged EY for breaching code of ethics for auditing accounts of a Gold refiner. The accounting firm had to pay the whistle-blower $11 million.
At the peak of the financial crisis a decade ago, KPMG was severely reprimanded and fined £5 million for a series of flaws in its audit of the Co-operative Bank by the financial regulator last year. KPMG lost several prospective clients after it emerged that the firm was charged for a failure to detect potential fraud in the form of corruption by a family-owned business in South Africa. Due to lack of professional competence during 2011 and 2012 audits, Deloitte was fined £4.2 million over Serco tagging scandal by the accounting watchdog.
Auditing is very important when it comes to maintaining a healthy ecosystem in the financial world. Audits are supposed to be carried out by trusted third parties on behalf of investors, banks, and the government, it provides with reliability, processed information in standardised form accepted across the industry. Auditing is not just about tallying the vouchers; it is about checking the internal controls and compliance of the company with the legal framework. Auditing plays a major role in the success of the capital markets as investors and creditors need reliable information to make their decisions.
