Audit reform: The devil is in the detail

The BEIS inquiry brought together the heads of the Big Four and of the challenger firms last week to discuss the future of audit.  All agreed that that quality and the perception of quality must improve to restore public trust in company accounts.

And so it must. The combination of the various ongoing reviews, CMA, Kingman and Brydon, mark significant and welcome change for the audit industry, but the devil will be in the detail.

A powerful signal

The Kingman review is a transformation in both the practice and the philosophy behind the corporate governance regime in the UK. Self-regulation has been totem of UK governance up until now. Moving governance of auditors out of the hands of those linked to the firms themselves is a powerful signal that things really are changing.

There is a great opportunity to design the Audit, Reporting and Governance Authority [ARGA] specifically to avoid the challenges the FRC has struggled with. Giving it real teeth and a robust backbone to deal with negligence and malpractice makes it possible to make a real difference.

However, the CMA review is more complicated, and it is important to work through the practicalities of the proposals in detail.

Joint audit dilemma

For example, one of the chief proposals, joint audits, could be made to work – we have seen that elsewhere – but they will not necessarily build up the capacity of mid-tier firms to undertake the premium audits by themselves, and certainly not in the short run. However, none of the Big Four firms is in favour of joint audits, and as David Sproul of Deloitte said at the committee – there is no evidence that they will necessarily improve quality of audits.

Another interesting proposal is to put more on an onus onto audit committees to ensure the quality of audits. However, although it will provide a useful regulatory backstop, and give more backbone to audit committees, we should remember that the practice of putting more and more governance matters onto a few non-executives must have some practical limit.

Modern audits increasingly need specialist skills in audit so the CMA is right to look for approaches to tackle conflicts of interest that don’t put that at risk. Ring-fencing the audit business should mean that audit partners have less incentive to cross-sell, although, given the lower level or profitability, it might also make audit less attractive as a career. Looking ahead, practical arrangements for trainees will need to be resolved – there is a need to protect the integrity at the middle and top of an audit firm, but there must be a way to allow younger accountants to get experience in all the different aspects of the business before they choose to specialise.

Overall, this is a big moment for the UK industry and a chance to deliver significant improvements, but as with all change there is a risk of unintended consequences. So it is vital the practicalities are being thought through thoroughly. Otherwise, we risk ending up in a worse place than where we started.