Operational separation of Big Four audit practices progresses

The Financial Reporting Council (FRC) has confirmed that Big Four firms are on schedule to achieve operational separation of their audit practices as the largest auditors look to restructure their businesses

The FRC asked the firms to submit their implementation plans by 23 October 2020. These plans have now been reviewed and discussed with the firms individually and the regulator has signalled it is now content for the firms to move to the next stage of implementation.

Already some of the firms have reorganised their operations with Deloitte selling its restructuring business to Teneo, a global CEO advisory firm, which saw key partners and staff move to the new owner.

KPMG is also discussing the sale of its restructuring business with a number of private equity funds reviewing options. A decision on the divestment is due shortly.

Hywel Ball, EY UK chair, said: ‘We are making good progress towards implementing plans for the operational separation of our UK audit practice. Among a number of upcoming changes, we are currently recruiting for two new independent non-executives for a majority-independent audit board which will be in place by 1 July this year.

“We continue to engage with the FRC on the application of the principles for operational separation. In some instances, we are going beyond what the principles require. For example, over 95% of the revenues generated by our proposed audit business are restricted to services directly required to support the audit – higher than the 75% minimum required by the FRC.

“Our proposals support our focus on delivering the highest levels of audit quality and strengthening accountability and oversight. They also follow sustained investment in audit quality and our ongoing work to provide assurance amid the uncertainties of Covid-19.’

The FRC has made some changes to the principles following analysis of the firms’ implementation plans:

  • to clarify that services provided to non-audited entities should be commissioned by those charged with governance at the entity or be assurance services for third party recipients.
  • to increase the minimum proportion of revenue within the ring-fence that must be derived from audit.
  • to confirm that the audit practice should not receive fees for introducing business to other parts of the firm and that partners in the audit practice should not be incentivised for sales passed to other parts of the firm.
  • the objectives of operational separation are designed to ensure that audit practices are focused above all on delivery of high-quality audits in the public interest, and do not rely on persistent cross subsidy from the rest of the firm.

The FRC's key outcomes include:

  • audit practice governance prioritises audit quality and protects auditors from influences from the rest of the firm that could divert their focus away from audit quality;
  • the total amount of profits distributed to the partners in the audit practice does not persistently exceed the contribution to profits of the audit practice;
  • the culture of the audit practice prioritises high-quality audit by encouraging ethical behaviour, openness, teamwork, challenge and professional scepticism/judgment; and
  • auditors act in the public interest and work for the benefit of shareholders of audited entities and wider society.

 

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