Tuesday 23 February 2021 4:39 pm

Regulator gives green light on Big Four plans for audit separation

The Financial Reporting Council (FRC) has given the go ahead for the Big Four firms to press on with the next stage of separating their audit divisions from the rest of the business.

The Big Four – Deloitte, EY, KPMG and PwC – were asked by the regulator to submit their plans for operational separation of their audit practices by 23 October 2020.

The FRC has since reviewed the plans with each of the firms, and today said it was “content” for the Big Four to move on to the next stage of implementation.

Read more: UK directors to face fines in major overhaul of audit rules

Last summer the FRC asked the Big Four firms to separate their audit units from the rest of their business by 2024.

Auditors have come under increased regulatory scrutiny in recent years, with corporate failures at Carillion retailer BHS led to three government-backed reviews that recommended a shake-up of audit. 

The FRC has set out 22 principles that will guide what operational separation will look like. They include, for example, the creation of an independent audit board at each of the Big Four firms, that is required to provide oversight of their audit practice.

One of the principles also states that transactions between the audit practice and the rest of the firm should be conducted and priced on an ‘arms-length’ basis, nor should the audit practice receive fees for introducing business to other parts of the firm.

But both the audit separation process, and the FRC, have been criticised for not going far enough toward reform.

Atul Shah, an professor at London’s City University, said of the FRC’s update: “The Big Four have become too big to regulate. Here again they are defining how they will be ‘operationally separate’ with lots of nice sounding words like ethics and independence.

“The last forty years of accounting regulation have taught us one thing: do not trust the Big Four with either audit quality or independence. Once again we are placing trust on those whose record has been so damaging to our economy and society. Welcome to more audit failures. Self-regulation usually means no regulation.” 

The industry is still waiting on a delayed BEIS report, which will give greater clarity on the role of the Audit Reporting and Governance Authority, a newly created body that, in theory, will have sharper teeth and will take over regulating the audit sector.

Read more: Challenger audit firms prep for forced audit separation

Where are the Big Four up to?

The Big Four have each created, or plan to imminently create, a board or body that will provide audit oversight at the firms.

EY is currently recruiting two new independent non-executives for a majority-independent audit board, which will be in place by 1 July 2021.

Hywel Ball, EY’s UK chair, said his firm was making “good progress” towards implementing plans for the operational separation of its UK audit practice.

“We continue to engage with the FRC on the application of the principles for operational separation. In some instances, we are going beyond what the principles require. For example, over 95% of the revenues generated by our proposed audit business are restricted to services directly required to support the audit – higher than the 75% minimum required by the FRC,” he added.

Read more: BEIS audit reform proposals coming ‘in next couple of weeks’

Deloitte in September launched its independent Audit Governance Board, which became effective at the start of the year.

Stephen Griggs, managing partner for Deloitte, explained: [The board] has responsibility for providing independent oversight of the UK audit practice, with a focus on the policies and procedures for improving audit quality and ensuring the FRC’s objectives and desired outcomes for operational separation are met.

“We believe the majority of the changes to our business can be made ahead of the 2024 deadline, and continue liaising with the FRC on implementing further measures.” 

Read more: Regulators remind auditors to pay attention to Covid measures on corporate reporting

KPMG was the first of the four to announce the discontinuance of non-audit services to FTSE 350 companies it audits, and to create a separate audit board.

“We are well advanced in our work to achieve operational separation and are committed to working with the FRC to help shape the future for a profession which delivers high quality audits, acts in the public interest and supports successful and attractive capital markets. We have already adopted many of the updated principles,” said John Holt, KPMG’s head of audit.

PwC too has created a separate audit body, chaired by Philip Rycroft, who was recently permanent secretary at the Department for Exiting the European Union.

Kevin Ellis, PwC’s chairman and senior partner, said: “We will continue to engage constructively with the FRC over the coming months on the complexity and detail ahead of the June 2024 deadline for implementation of the principles.”