FRC found to be ‘asleep at the wheel’ over audit, says Reeves

Rachel Reeves MP, chair of the Business, Energy and Industrial Strategy (BEIS) select committee, has slammed the Financial Reporting Council (FRC) for being an ill-led regulator, highlighting that the incoming Audit, Reporting and Governance Authority (ARGA) must have new leadership and that this ‘cannot come soon enough’

On the same day that BEIS published its review of the future of audit, Reeves made a keynote speech at the ICAEW, highlighting key recommendations in the report and answering questions from members of the profession.

When pressed on the subject of the FRC’s transformation to ARGA, Reeves said that ‘a new [audit] regulator cannot come soon enough’ while highlighting that it will have a new leadership teams to bring in much needed reforms.

In the year before Carillion collapsed the FRC looked at the audit and discovered failures. These failures were addressed, and KPMG was allowed to continue on the audit. However, the FRC never went back to check the audit again.

‘We want a regulator that will go back and ensure that things have improved,’ said Reeves. ‘The FRC has been found too many times to have been asleep at the wheel. It is not a regulator that has been led well and this needs to change.’

Reeves went on to say that there are too many examples of regulators that have a relaxed attitude and are too close to the businesses which they are supposed to be regulating.

When introduced, the ARGA will need to have stronger enforcement powers and ‘should also be unapologetic about using them’.

Audit split

The BEIS report proposes that ‘objections to full audit separation are overstated’ and said that if the operational split is chosen instead, the Competition & Markets Authority (CMA) and ARGA should conduct a review of the arrangements after three years to determine whether the split has ended cross-subsidies and improved culture, independence and transparency. If not, the CMA should then move to implement a full structural break-up of the Big Four into audit and non-audit businesses in the UK.

Other recommendations include increasing the frequency of audit rotations to seven-year non-renewable terms and (should the CMA go ahead with an operational split) a cooling off period of three years, in which non-audit services cannot be offered to a former audit client.

Reeves said that currently FTSE 350 companies are not getting a choice of four firms. This is because one firm is the current auditor and another may be doing consulting work, leaving a choice of two. ‘If the Big Four reduced to the Big Three, which happened when the Big Five went to the Big Four, then there would be no choice at all,’ said Reeves.

The committee chair was questioned on whether the seven-year audit followed by a three-year cooling off period would be a barrier to entry for challenger firms against the existing model. Reeves argued that the seven-year tender process would give more opportunities to mid-tier firms as they would have to bid more frequently and would likely win more business. The smaller tender period would also change the fact that the majority of FTSE 350 companies are audited by the Big Four.

According to Accountancy Daily’s FTSE 100 auditors survey, the FTSE 100 audit market is worth £899m, with 1.7% of these total fees from BDO and Grant Thornton, who each have one audit.

The £269m FTSE 250 audit market shows the same level of domination. In 2018 out of the 250 listed companies, only eight (3%) had their audits signed off by a non-Big Four firm. These eight audits were worth £3.5m, compared with the £188.7m the Big Four firms earned. That is just 1.8% of the market value.

If the current model continues it would mean that change to the audit market would happen at a much slower pace.

Reeves admitted that in previous committee hearings ‘it was a struggle to get the leaders of the Big Four to admit that audits were not up to scratch’ with them claiming there was an expectation gap as individuals were expecting too much from an audit. However, Reeves rejected this reasoning saying that there was in fact a delivery gap.

When carrying out the future of audit report, BEIS found that the level of lobbying was high with members of the profession defending their practices.

Diversity issues

The committee also highlighted diversity issues as it invited 25 representatives from accounting firms but not one was a woman and said that nine times out of 10 firms and businesses send a man to attend committee hearings.

Reeves explained that for firms to attract talented individuals they will need to start recruiting from a much wider pool.

When Michael Izza, CEO of the ICAEW, explained that the profession was ‘working on it’, a sceptical Reeves questioned this saying ‘But are they? If things are improving, they are doing so at a slow rate. Talented people do not want to work at a place which is full of white men, which unfortunately is what many firms in the city look like’.

Going forward, Sir Donald Brydon’s review will look into the practice of audit. The profession already has recommendations from the CMA, Kingman review into the FRC and BEIS’ review into the future of audit.

Reeves said: ‘We have made the recommendations, so it is now down to the industry to carry them forward. We in parliament will be behind the profession and will be prepared to push if we have to.’

The Future of Audit report

A recording of Rachel Reeves MP: Report into the Future of Audit at ICAEW

Report by Amy Austin

Amy Austin |Reporter, Accountancy Daily [2016-2019]

Amy Austin was reporter, Accountancy Daily and Accountancy magazine, published by ...

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