Audit shake-up a good ‘first step’

The Financial Reporting Council (FRC) has today made public their plans for the “operational separation” of audit practices, in what appears to be the biggest reform of the sector in decades.

Deloitte, KPMG and EY called for operational separation to be the “first step” in audit reform.

Stephen Griggs, deputy CEO and managing partner of audit and assurance at Deloitte said in a statement that the reforms “must also be considered alongside a wider package of reform, including in vital areas such as corporate reporting, the role of directors and the regulatory environment”.

Jon Holt, head of audit at KPMG UK said: “It is clear however that operational separation of the UK’s audit firms is just the first step on the journey to restoring trust in UK plc. Along with the creation of a new, stronger regulator in ARGA, there must be an ambitious package of wider reforms across the corporate landscape. Including clarifying and enhancing the responsibilities of Boards, Directors and management in respect of corporate entity governance and the success or failure of the enterprise.”

An EY statement declared that “these proposals alone will not deliver all the changes needed”.

The reforms announced today have two key objectives. First, to improve audit quality and focus on delivering high-quality audits in the public interest. And second, to improve audit market resilience, ensuring that no subsidy exists between audit practice and the rest of a firm.

The proposals laid out by the FRC aim to “ensure that audit remains an attractive and reputable profession and increase deserved confidence in audit” and include 22 principles which firms must abide by and have implementation plans ready by October 2020. The reforms must then be completed and implemented by June 2024.

From June 2024, firms must ensure that profits distributed to audit partners do not “persistently exceed” the contribution to profits of audit practice. Audit partner remuneration should also be linked “above all” to audit quality. Firms must also protect auditors from potential influence from the other sections of a firm which could “divert their focus away from audit quality”.

The news comes as audit quality has been thrust into the limelight once again after the Wirecard scandal, where EY signed off on the accounts of the German payments group between 2016 and 2018 before it was reported by the Financial Times that €1.9bn on the balance sheet “probably did not exist”. Wirecard then collapsed into insolvency, and a special audit by KPMG has found the company to be lossmaking for a number of years.

While the rules do not yet apply to the so-called challenger audit firms, Mazars’ head of UK audit, Bob Neate said in a statement that they were a “welcome first step”.

“Whilst we welcome this FRC initiative, operational separation of audit will not alone achieve the objectives of enhancing audit quality and building a truly competitive and resilient audit market… We continue to believe the proposals of the CMA, which recommended a package of joint audit, strengthening audit committee oversight and robust operational separation, is the best route to fully achieve these objectives,” he said.

Fiona Baldwin, head of audit at Grant Thornton UK added that the firm welcomed the proposals as a “step in the right direction”. Meanwhile, ACCA UK’s executive director Maggie McGhee also welcomed the reforms and praised the FRC for acting “decisively”.

Professor Chris Humphreys, University of Manchester, who served on Sir Donald Brydon’s advisory board said that the reforms were important commitments, but felt they raised more questions than answers. He claimed more had to be done than just “adjusting the mode of organisation”.

“If society lacks confidence in a function that is supposed to be helping to build deserved confidence in companies, their directors and the information they publish, this is a problem that demands more than just adjusting the mode of organisation for that function.  It requires an embracing of the type of conceptual reframing of audit proposed by Brydon.  When the demands for ‘audit’ to serve the public interest and the wider society are becoming ever more prominent and visible, and are explicitly acknowledged by the FRC, audit reform must not treat the conceptual role of audit as static and fixed,” he said.

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