Monday 6 July 2020 3:49 pm

‘Utterly inadequate’: Experts slam watchdog’s Big Four audit split

The audit watchdog’s move to force the Big Four accountancy firms to ring-fence their audit units has been condemned as a “cosmetic exercise” by industry experts.

The Financial Reporting Council (FRC) today announced that the Big Four — PwC, Deloitte, KPMG and EY — must separate their audit and non-audit businesses by 2024 to ensure audits “do not rely on persistent cross subsidy from the rest of the firm”.

Read more: Watchdog orders Big Four to separate auditing units by 2024

Auditors have come under sustained criticism in recent years for repeated failures to prevent company collapses, including Carillion and BHS, and for mixing audits and more lucrative non-audit work for the same clients.

Three government-backed reviews have called for shake-ups to the sector, but no legislation mandating change has yet been introduced.

The FRC said today it was asking the Big Four to agree to operational separation based on a set of principles it has discussed extensively with them. 

PwC, Deloitte, KPMG and EY all released statements welcoming the regulator’s announcement. Maggie McGhee, executive director at the Association of Chartered Certified Accountants, said the FRC had “acted decisively in support of audit quality and the public interest”.

Of the Big Four, EY and KPMG called for changes to corporate governance such as improved director accountability.

But Prem Sikka, an accounting expert and emeritus professor at Exeter Business School, told City A.M. the FRC’s plans were “utterly inadequate”.

Sikka, who authored a report on the audit industry for the Labour Party in 2018 calling for a state-backed audit body, said more needed to be done to address the sector’s problems. 

“What we need is a complete structural — not an organisational — split, where audit is the only thing that the accountancy firms must do and consultancy has to be in a legally separate organisation,” he said. 

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“It’s not the case that you can have both under one roof but separated by some imaginary Chinese walls,” Sikka continued. “There is absolutely nothing in this statement which would improve the accountability of auditing firms.”

Sikka also criticised the FRC, which has previously been branded as “toothless” by MPs over its handling of the BHS scandal and is due to be replaced with “a more forceful regulator”, the Audit, Reporting and Governance Authority (Arga). 

“I think this is just a cosmetic exercise [the FRC] are going through to appease public opinion. It is not really the reform which is needed and therefore it will fail,” he added. 

Darren Jones MP, chair of the business, energy and industrial strategy committee, said: “My committee has been clear in previous inquiries that reform of the audit sector is overdue”.

“It is welcome the FRC have taken some further steps on the path to reform by coming forward with these plans. But when reform is so sorely needed, why are the Big Four firms allowed four years to enact these changes?”

“There are also questions about how far an operational split along these lines will be able to tackle conflicts of interest and whether it will go far enough to provide the tough, professional challenge and scepticism needed to deliver genuinely high-quality audits in the public interest,” Jones said.

Atul Shah, an audit specialist and visiting lecturer at City University, criticised the FRC’s plans as “toothless”.

Read more: Audit shows Wirecard’s core business ‘has been lossmaking for years’

Shah said that a break up of the Big Four was the only way to tackle what he described as “systemic professional failure” within the audit industry, with a “total split off between auditing and non-audit activities”.

“The reality is that these firms are very big, very powerful and highly conflicted. So we not only need to break them up, but we need to downsize them as well to reduce their power and to actually enforce them much more rigorously and strongly in terms of audit quality,” he said.