All change for audit firms?

  • Mercia Group
  • 16 October 2018 00:00

On 9th October 2018, the Competition and Markets Authority (CMA) launched an investigation into the audit market with the issue of an invitation to comment. This was not unexpected, as there had been very public statements by parliamentary committees and ministers, that “something needed to be done” about the state of audit. This scrutiny and concern is based upon high profile audit failures, like the PwC audit of Taveta group and BHS and the collapse, earlier this year of Carrillion, with a presumption that the auditors must also have failed there. As well as these failures though, the AQR reviews have shown that there has been a recent decline in audit quality for the Big Four firms, despite a previous trend of improvements.

One  “something that could be done”, commenced a few months ago with the Kingman review of the FRC. The CMA investigation is therefore the second “something”. There has also been talk, for many months now, of an independent investigation into how audit could be made better, potentially to be led by the ICAEW. But that project has not started, with perhaps too much uncertainty regarding the other elements, to make it attractive to a suitable chair.

Many of you will no doubt be thinking that it wasn’t very long ago that the Competition Commission (CC) as was, undertook its own investigation of the audit market and proposed various remedies. The CMA does, therefore, have a head start on its work this time, as it can concentrate on the changes that have occurred between the last study and now.

The CMA is looking at five themes overall:

  1. Characteristics of the audit market (including the expectation gap, the principal-agent issue)
  2. Incentives (the company does not have the same incentives for a quality audit as the members)
  3. Choice and switching (ie the lack of choice and difficulty in switching due to the cost involved)
  4. Resilience (concerns that the Big Four are too big to fail and/or regulate)
  5. Regulation of audit

The main focus will be on Incentives; Choice and switching; and Resilience. Audit regulation is already being considered by the Kingman Review and the characteristics of audit is least related to the CMA’s area of expertise.

So what might be the outcomes of the investigation? Although this might seem a little early, the invitation to comment already suggests three groups of potential outcomes:

  • Increase competition between the Big Four, for instance by creating audit-only firms;
  • Increase competition from non-Big Four firms, for instance through a market share cap and/or joint or shared audits;
  • Address the incentives arising in audit, for instance by moving responsibility for appointing auditors away from the audited companies and their audit committees to an independent body.

As you can see, these would involve potentially huge disruptions to the current audit market and the Big Four in particular. They may also have a significant impact on the next tier down, if solutions include trying to bring them more fully into the FTSE 350 market place.

The invitation to comment discusses the above possible outcomes and the potential pros and cons of each approach. This is then followed by a series of questions to prompt comments from interesting parties, but with a deadline of 30th October.  This means that there are less than three weeks available in which to comment on the paper, though I am sure those affected will already be well prepared to put forward their arguments and suggestions.

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