The UK’s audit sector is “failing society” by coming up short when assessing firms’ finances and governance, leaving the door open to costly, Carillion-style business collapses, according to think tank IPPR.
The think tank said there is an “expectation gap” between what audit currently assesses and what it needs to assess to fulfil the expectations of the general public.
Audit firms have come under increasing pressure in recent years following accounting scandals and administrations such as Carillion and Patisserie Valerie that undermined public and investor confidence in the sector.
Auditors should act as “trustee referees” of corporate Britain, impartially flagging risky finances and communication informatively about the state of a business to investors and society. However, too often that expectation is not met, IPPR said.
The think tank believes a large number of small scale Carillion-style failures are happening each year.
IPPR senior economist Carsten Jung said: “Auditors should be the gatekeepers helping keep financial mismanagement at bay, yet too often they are failing to do so and are failing society. To meet society’s expectations and needs, there needs to be profound audit sector reform.
“A well-functioning audit sector should be expected to flag problematic accounting practices and risky business activities before they turn into damaging debacles. However, the current legal set up does not require this from auditors.”
According to IPPR, auditors are failing on two fronts: a lack of challenge and insufficient flagging of problematic practices, and conflict of interest issues with their consultancy services, where audit firms make the majority of their revenues.
The definition of ‘audit failure’ must be expanded, the think thank argued, from a failure to detect fraud or misstatements, to include where rules are technically not violated, but it goes unreported that firms are using “aggressive accountancy practices”.
IPPR economist Shreya Nanda added: “At present, our corporate finance system does not account properly for risk, encourages firms to take on excessive debt, and allows firm insiders to prioritise their own short-term financial interests above the interests of workers, pensioners and suppliers, and the long-run financial sustainability of the firm.
“We need to reform this system to stop more firms going the way of Carillion, BHS and Patisserie Valerie.”
Government reforms ‘unambitious’
The Department for Business, Energy and Industrial Strategy (BEIS) last month published a consultation on audit reform, that included making directors of the UK’s biggest companies more accountable if they have been negligent in their duties, including fining, suspending or even clawing back the bonus of directors.
It also included plans to water down the supremacy of the big-name auditors’ oligopoly.
However, IPPR said the government’s “unambitious reform” would leave central problems in the sector unaddressed.
A BEIS spokesperson said: “The Government has already published proposals to strengthen our corporate governance and audit practices, helping to ensure that the UK remains a world leader in corporate transparency and advances its status as a place of the highest standards in audit.
“The proposals will break up dominance of “Big Four” audit firms and require large businesses to be more transparent about their finances, helping to avoid company failures and safeguard British jobs for the future.”
A spokesperson from the audit regulator the Financial Reporting Council added: “The FRC supports the government’s proposals to enhance the quality of corporate governance, corporate reporting and audit which would be underpinned by a strong and effective regulator.
“High standards of audit, corporate reporting and corporate governance are vital to reinforcing the UK’s position as a key global centre for investors and businesses.”