Challenger audit firms are readying themselves for audit separation, a requirement not yet expected of them, but one they see as inevitable in the future.
Last summer audit regulator the Financial Reporting Council (FRC) ordered the Big Four firms – Deloitte, KPMG, PwC and EY – to separate their audit units from the rest of their business by 2024, in what would be a “major step in the reform of the audit sector”, according to the watchdog’s chief Sir Jon Thompson.
Although audit separation was targeted at the Big Four, challenger firms BDO, Grant Thornton and RSM have confirmed they have been working behind the scenes on what audit separation would look like for them, on the assumption they will have to follow suit in the future.
Scott Knight, head of audit and assurance at BDO, is working on the assumption that the FRC will ask challenger firms to submit plans for audit separation this October, a year after the Big Four submitted their plans.
Even if it did not become a regulatory requirement for challenger firms, Knight said the market would likely force challenger firms to follow their larger competitors.
He said the Big Four would use the separation of their audit divisions to their advantage when pitching for new business.
“They will say, ‘you get the best quality audit where they are operationally separated, and the FRC are aware of this, and that’s why they pushed us down this path – to remove any kind of influence. We are operationally separated – but other firms you’re talking to might not be,’” he said, adding: “Of they’ll do that – I’d do that if I was in their shoes.”
Audit firms have come under increasing pressure in recent years following accounting scandals including the collapse of Patisserie Valerie, BHS and Carillion.
The FRC’s audit separation plan hopes to quash conflict of interest issues among the major players, so audits “do not rely on persistent cross subsidy from the rest of the firm”.
At present, the watchdog relies on voluntary compliance by the Big Four, but the body is set to be replaced by a new, more powerful regulator called the Audit, Reporting and Governance Authority (ARGA), which will have more power to shake up the sector.
A BEIS consultation on audit separation, which will give more detail on the powers of ARGA, is expecting is the coming weeks.
Doesn’t make sense for challenger firms
Mazars global head of audit David Herbinet also expects market forces to push challenger firms into audit separation. He said work was underway at Mazars to be ready for such an outcome.
“We don’t think the regulator will demand it,” he said. “But if tomorrow we want to compete on equal footing with our peers, we expect it will be required.”
He continued: “I think [audit separation] makes sense for the Big Four because, when audit becomes such a small part of your business I think it’s good to create a structure that pays more attention to that part of the business, and that’s really what separation does.
“But for Mazars it doesn’t really make sense because we’re an audit-centric organisation. Audit is nearly 50 per cent of our business worldwide, with the Big Four you’re getting to less than 20 per cent sometimes, so we don’t really have the same dynamics, the internal pressures, the same culture, and so forth.”
Grant Thornton has also been working on audit separation plans behind the scenes.
Fiona Baldwin, head of audit at Grant Thornton, said: “Whilst we are not, as yet, required to present our plans for operational separation to the regulator, we have been working on the practicalities of adopting the principles and are continuing to engage with the FRC, our people and our clients on the benefits of the proposals should they become applicable to us.”
We are committed to improved audit quality across the entire profession, along with strengthened independence, improved competition and choice in the market; and believe the proposals set out by the FRC are a step in the right direction.”