Ringfencing quality people to ensure quality audits – can it really be done?

By Jessica Hodson Walker, Account Director

It’s a coincidence that within days of the collapse of Wirecard, the Financial Reporting Council (FRC) has set out plans to reform The Big Four accounting firms – in effect forcing them to ringfence their audit practices. 

Auditors have faced significant reputational hits over the last three years as business failures such as Carillion, Patisserie Valerie and BHS have focused attention on the role of the auditor.  

Today’s news that Deloitte, EY, KPMG and PwC should have finalised plans for the operational separation of audit units by 23^rdSeptember 2020 for a completed implementation by 2024, whilst ‘welcomed’ by the firms, is not a small ask. 

The new rules require the finances of the audit divisions to have a separate profit and loss account with an independent board to oversee practice.  Auditors pay cannot be cross subsidised from elsewhere in the group.  The intension is to ensure that audit quality is not compromised by factors such as cross-referral for business, fees or client relationships and that cases which have caused waves across the UK economy, such as Carillion, are prevented. 

No one honest is going to complain about moves to improve the quality of auditing.  However, with any change of this magnitude there are potential issues. 

Firstly, protecting and attracting talent will be a challenge. Many audit teams are made up of a number of specialists from different units, including valuations, tax, IT and actuarial teams. The best talent in these fields are likely to want to maintain variety and complexity in their professional portfolios and sit in their specialist team rather than move to an exclusive audit practice. Similarly, this means they have their finger on the pulse in terms of what is happening in the market, for example on valuations etc.  

Depending on the level of separation required, relationships between the audit team, specialists and their clients may become increasingly expensive or complex.

Audit itself also needs to remain an attractive profession for accountants. One important factor in this is renumeration and there are difficult questions being asked regarding pay structures for both partners and audit teams following a ringfencing. In order to attract and retain the best auditors, and therefore provide quality audit work, there needs to be financial incentives for people to stay or join the profession, particularly within the Big Four. 

In terms of structure for operations and renumeration, those firms which operate as a European operations rather than country by country, will find it more difficult to carve off small parts of one country’s business to satisfy the UK regulator. 

Their reaction today shows that the Big Four understand the implications for their reputations of the perceived audit failures and are looking to work with their regulator. But perhaps better to work with the FRC than wait for the alternative.  The FRC will soon be replaced by the Audit, Reporting and Governance Authority (ARGA) which will have greater powers and autonomy and consequently the Big Four have every reason to keep their new regulator on side.