How will the CMA investigation impact auditing?

The audit industry has come under increasing pressure in 2018, following a string of high-profile business collapses over recent years. Mounting concerns regarding the Big Four accountancy firms seem to have bubbled over, with the Competition and Markets Authority (CMA) announcing an immediate review of the audit sector on October 9th.

 

It is not the first time the UK Government has shone a spotlight on the industry. The House of Lords scrutinised auditing firms in 2011, criticising them for their role in the global financial crisis. Two years later, the Competition Commission (CC), which was eventually folded into the CMA, conducted a sector-wide review.

 

But the latest investigation could carry more weight, particularly in the wake of Carillion’s unexpected insolvency in January. All four Big Four firms were implicated in the collapse: KPMG provided external audit services; Deloitte was the firm’s internal auditor; EY tried to help the business turn its performance around; and PwC managed the administration process.

What does the CMA review aim to achieve?

The primary focus of the review is to ascertain whether the audit sector is competitive and resilient enough to ensure standards remain high. Critics of the Big Four have highlighted the conflict of interest that often arises when the accounting firms are offering consultancy, audit and administration services. Can the companies be trusted to provide effective business advice and auditing when they still benefit from winding down clients that become insolvent?

 

“If the many critics of the audit process are right, it is not just the companies which buy audits that lose out; it is the millions of people dependent on savings, pension funds and other investments in those companies whose audits may be defective,” said CMA Chairman Andrew Tyrie.

 

Three key areas of auditing are under review:

1. Choice and switching: The CC enforced changes in 2013 that improved competition between the Big Four, but the majority of large organisations still use one of these four businesses for audits.
2. Resilience: Are the Big Four too big to fail? And what impact does this have on competition and systemic risk?
3. Incentives: Companies (rather than shareholders) choose their auditors, which may be leading to a lack of challenging performance reviews.

The CMA has announced it will examine proposals for tackling problems within the sector if the review finds the market is not working efficiently. A preliminary report is expected before Christmas.

A tough year for the Big Four

The CMA review is the latest piece of bad news for the Big Four. In May, the Work and Pensions and Business, Energy and Industrial Strategy (BEIS) committees published a scathing joint report about Carillion’s demise. The results no doubt made grim reading for the leading accountancy firms.

 

“KPMG, PwC, Deloitte and EY pocket millions of pounds for their lucrative audit work – even when they fail to warn about corporate disasters like Carillion,” said MP Rachel Reeves, who is Chair of the BEIS Committee.

 

“It is a parasitical relationship, which sees the auditors prosper, regardless of what happens to the companies, employees and investors who rely on their scrutiny.”

 

Barely a month after the report’s publication, the Financial Reporting Council (FRC) announced the results of a quality review into the Big Four. In 2016-17, 78 per cent of audits performed by the organisations required no more than limited improvements, but this figure had slumped to 72 per cent just a year later.

 

KPMG was singled out for particular criticism. Half of the firm’s audits of FTSE 350 companies needed more than limited improvements, causing the FRC to announce that the accounting giant will be placed under increased scrutiny.

 

Meanwhile, the Labour Party has already commissioned an independent review into the UK’s corporate auditing and accounting regime in an effort to prevent the fallout from Carillion’s collapse happening again.

What options are available after the CMA review?

A damning CMA review could lead to a number of changes for the auditing industry. Meetings to discuss potential solutions to the sector’s challenges have already taken place between the authority, audit firms and representative bodies, according to Compliance Week.

 

Dr Nigel Sleigh-Johnson, the Institute of Chartered Accountants of England and Wales’ Head of Financial Reporting, Audit and Assurance, confirmed various options are already on the table.

 

“Following the discussions, we reported back to the CMA at the end of August that we had found some level of agreement over a package of measures that would likely be a mix of both voluntary and mandatory changes,” he stated.

 

Some organisations – most notably Grant Thornton – showed enthusiasm for the introduction of an independent authority to appoint auditors to companies. Meanwhile, Mazars favours a joint audit system, whereby two organisations would be required to sign off on certain accounts.

 

Stakeholders also suggested shared audits, which would involve multiple companies undertaking different parts of an organisation’s auditing workload. This approach could open up the market to more mid-tier and challenger firms, as they could build a reputation and fine-tune skills by working on major clients.

 

“There is a widespread understanding that something needs to be done,” said Dr Sleigh-Johnson.

Will market changes affect auditing recruitment?

Until the CMA’s findings are published, the true scope of the investigation is still a little unclear. It’s therefore impossible to predict what impact, if any, sweeping changes to the auditing profession would have on hiring and recruitment.

 

Nevertheless, opening up the market to a wider array of accounting firms is likely to help generate growth for these businesses, potentially creating more job opportunities at mid-tier and challenger firms.

 

Top auditors may also start looking beyond the Big Four when considering their career development. Currently, 98 per cent of the FTSE 350 are audited by these firms, so professionals wishing to work on high-profile accounts often have limited choice.

 

If the CMA review uncovers significant failings at the world’s top accountancy firms, businesses could be forced to re-examine their auditing outsourcing processes entirely. This may lead to companies moving away from established consultancies and strengthening their insource internal audit functions.

 

Whatever the outcome, it’s hard to see how the Big Four will come away from the investigation unscathed. Will 2019 bring even more surprises for the auditing industry?

 

Our Market Reports combine our review of the prevailing conditions in the internal audit recruitment market with the results of our latest employer survey.

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