A Labour party report on the ‘dysfunctional’ audit market has recommended that audit firms should be banned from selling any non-audit services to clients, and recommends the creation of a state-backed audit body for the financial services sector and a new ‘companies commission’ to formulate accounting standards
The review was ordered by shadow Chancellor John McDonnell and carried out by a team headed by Prem Sikka, professor of accounting and finance at the University of Sheffield.
It says statutory auditors of large companies and other entities must act exclusively as auditors and the audit business of accounting firms must be legally separate from everything else, with no cross holdings.
It recommends introducing a criminal offence for statutory auditors of large companies and any entities related to them to offer or perform non-auditing services for audit clients, and says members of the audit team cannot join the staff of the audit client for five years after ceasing to be a member of the audit team.
The review also suggests the state can become the fifth largest supplier of audit services, saying a statutory state-backed body must be created to conduct real time audits of banks, building societies, credit unions, insurers and major investment firms. In addition, the recommendations include offering financial sector regulators ‘unhindered access’ to the files of the statutory auditor.
In order to expand the supply of auditing services the report calls for the removal of all restrictions on the ownership of auditing firms in order to attract new entrants, capital, competition and choice and create pressures for improvement in audit quality.
Joint audits should be made mandatory for large companies, with an independent body to be created to appoint and remunerate auditors for all non-financial sector large companies, as defined by the Companies Act 2006 (CA 2006).
The Big Four share of the audits of FTSE 350 companies should be capped at 50% of that market, while the report advocates accompanying audit firm rotation with a 10-year cooling-off period so the outgoing firm cannot return for another 10 years.
A new Companies Commission would act as an independent regulator and would oversee all aspects of the UK company law, including accounting and auditing. It would also licence auditors and monitor audit quality.
Writing in a blog, Sikka said: ‘Anyone selling crisps or sweets has to ensure that the product is fit for purpose and will not injure the public. None of these considerations apply to auditors and the auditing industry has shown no inclination to embrace responsibility routinely accepted in most other fields.
‘It is almost impossible for any individual stakeholder to secure redress from auditors even when they admit negligence. A major reason for this state of affairs is that auditors owe a “duty of care” to the company only and not to wider stakeholders. This does not incentivise auditors to improve the quality of audits.
‘It is time for stakeholders to be empowered so that the firms and partners have to face the consequences of their failures.
‘We are well aware that our reforms will be opposed by the big firms who have continued to delivering poor audits for mega fees. However, they know that society cannot continue to bear the cost of their failures.’
Reforming the auditing industry is here
Report by Pat Sweet