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What is one criticism of Audits (or audit firms)made in this chapter and what reforms are suggested? To what extent to you think that these reforms would have positive effects if adopted in Australia? Can you foresee any complaints from Big 4 Audit firms if the suggested reform where madeWhat is one criticism of Audits (or audit firms)made in this chapter and what reforms are suggested? To what extent to you think that these reforms would have positive effects if adopted in Australia? Can you foresee any complaints from Big 4 Audit firms if the suggested reform where made
Read Chapter One “There’s No Business Like Accounting Business” in the Reforming The Auditing Industry Report (Sikka et al, 2018, pp9 – 18).
Your essay should cover the following:
Your essay should cover the following:
What is one criticism of Audits (or audit firms) made in this chapter and what reforms are suggested? To what extent to you think that these reforms would have positive effects if adopted in Australia? Can you foresee any complaints from Big 4 Audit firms if the suggested reform where made?
Students must reference at least 8 academic journals or reports (and 2 or more newspaper or professional accounting magazine articles). Students should also identify any other standards or references to the Code of Ethics for Professional Accountants.
Style and Format
- This assignment requires the student to complete an academic style essay (not a report).
- This assessment task must be word processed, in size 12 Times New Roman font using double-line spacing with a left margin of 2cm.
CHAPTER 1
THERE’S NO BUSINESS LIKE ACCOUNTING BUSINESS
The 2007-08 banking crash caused one of the biggest economic crises of modern times. Banks were bailed out by taxpayers at enormous cost. This ushered in austerity, cuts in public spending, rise in government borrowing, economic stagnation, wage freezes, erosion of people’s purchasing power and the resulting destruction of well-known high street names which has turned city centres into economic deserts. Amidst this economic turmoil, one group has increased its revenues and profits. That is the big four accounting firms – PricewaterhouseCoopers (PwC), Deloitte, Ernst & Young and KPMG. They audit almost all of the UK and the world’s major banks and leading corporations. They are paid millions to hold companies and their directors to account, but have delivered little.
TAKING AUDITS FOR A RIDE
Audit has been the making of the accounting firms. There are no state guaranteed markets for engineers, mathematicians, scientists, designers, biotechnology or telecommunications experts, but there is a state guaranteed market of external auditing reserved for accountants belonging to a select few trade associations. The sick are not required to consult a doctor and the injured are not compelled to hire a lawyer, but corporations, trade unions, schools, hospitals, local authorities, public bodies, housing associations and others are required by law to submit to an audit regardless of whether auditors deliver a worthwhile audit or not. Audit has given accounting firms easy access to senior management and has been used as a stall to sell many other services, including internal audit, risk management, executive remuneration, corporate governance, internal controls, regulatory compliance, mergers and acquisitions, legal work, pensions, restructuring, business turnaround, pre-share issue due diligence, interpreting accounting standards, tax avoidance and even laying golf courses, printing T-shirts and badges.
The big firm’s fingerprints are all over the Panama Papers1, Luxembourg leaks2, Swiss leaks3 and the Paradise Papers4 as they devise ingenious tax avoidance schemes on an “industrial scale5”. The sole purpose is to deplete the UK public purse with the consequences that the elected government cannot deliver the social investment mandated through the ballot-box. They exercise the ultimate veto on democratic choices. On many occasions courts have declared the tax avoidance schemes crafted by the firms to be unlawful, but no big firm has been investigated, fined or disciplined6. Despite scandals, failures and conflict of interests, the firms
1 https://www.icij.org/investigations/panama-papers/
2 https://www.icij.org/investigations/luxembourg-leaks/
3 https://www.icij.org/investigations/swiss-leaks/
4 https://www.icij.org/investigations/paradise-papers/
5 House of Commons Committee of Public Accounts, Tax avoidance: the role of large
accountancy firms (follow–up), 28 January 2015; https://publications.parliament.uk/pa/cm201415/cmselect/cmpubacc/1057/1057.pdf
6 Austin Mitchell and Prem Sikka, “The Pin-Stripe Mafia: How Accountancy Firms Destroy Societies”, Basildon: Association for Accountancy & Business Affairs, 2011.
describe themselves as independent auditors. As a consequence of the closeness of the ties and the capaciousness of the revolving doors, successive governments have indulged the firms by giving them liability protections and shielding them from the consequences of their failures7. This has diluted incentives to deliver good audits. Their partners have colonised HMRC8 and are permitted to write laws which ensure that they and their clients always win9. They advise government departments and promote accounting-think to promote more demand for their services10. They have colonised regulatory bodies. They hire legislators, former and potential ministers to advance their business interests11. Unsurprisingly, they have been highly influential in determining and preserving the rules of the game in which they are the most highly rewarded players. In 2007, the combined global revenues of the big four firms was $89 billion and by 2017 it reached nearly $142 billion12, a growth of almost 60%, making them the 56th largest economy13 and dwarfing the gross domestic product of countries such as Hungary, Kuwait and Ukraine. The rents from the state guaranteed market and revenues from services sold on its back have swelled the coffers of the UK arms too. In 2007, the big four firms had combined revenues14 of £6,354 million and by 2017 they reached15 £11,864 million, an increase of nearly 87% at a time when the UK economy hardly grew and workers’ share of GDP plummeted to all time low of 49.14%16. In 2017/18, the average profit per partner at Deloitte was around
£832,000; £712,000 at PwC; £677,000 at Ernst & Young, and £519,000 at KPMG (rising to £601,000 in 2018). This represents a return of around 200% on their capital17.
7 Prem Sikka, “Globalization and its Discontents: Accounting Firms Buy Limited Liability Partnership Legislation in Jersey”, Accounting, Auditing and Accountability Journal. Vol. 21, No. 3, 2008, pp. 398-426.
8 Prem Sikka, Michele Christensen, John Christensen, Christine Cooper, Tom Hadden, Deborah Hargreaves, Colin Haslam, Paddy Ireland, Glenn Morgan, Martin Parker, Gordon
Pearson, Sol Picciotto, Jeroen Veldman and Hugh Willmott, Reforming HMRC: Making It Fit For The Twenty-First Century, A Policy Paper Published by the UK Labour Party, 8 September 2016.
9 The Guardian, ‘Big four’ accountants ‘use knowledge of Treasury to help rich avoid tax’, 26 April 2013; https://www.theguardian.com/business/2013/apr/26/accountancy-firms-
knowledge-treasury-avoid-tax
10 Richard Brooks, Bean Counter: The Triumph of the Accountants and How they Broke Capitalism, London: Atlantic Books, 2018.
11 Austin Mitchell and Prem Sikka, 2011, op cit.
12 As per the firm’s annual reports available at 30 September 2018– Deloitte, $43.2 billion; PwC, PwC 41.3 billion; Ernst & Young, 31.4 billion; KPMG, 26.4 billion.
13 http://databank.worldbank.org/data/download/GDP.pdf
14 As per Accountancy Top 60 league table of UK accountancy firms: 2007; PwC, £1,980
million; Deloitte, £1,790 million, KPMG, £1,454 million; Ernst & Young, £1,130 million; https://www.accountancydaily.co/sites/default/files/Top60Survey2007.pdf
15 As per the firm’s annual reports available at 30 September 2018 – PwC, £3,764 million, Deloitte, £3,580 million; Ernst & Young, £2,348 million; KPMG, £2,172 million.
16Office for National statistics, GDP quarterly national accounts, UK: January to March 2018; https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/quarterlynationalaccou nts/januarytomarch2018
17 Richard Brooks, 2018, op cit.
THE SILENCE OF THE AUDITORS
An audit makes people feel comfortable that a competent party from outside is checking a company’s accounts and ensuring that the information is ‘true and fair’ and not misleading. Such hopes continue to be dashed by a regular parade of scandals, such as Carillion, BHS, Tesco, BT, Quindell, Autonomy, Rolls Royce, Cattles, Conviviality, Patisserie Valerie and many others. In each case, auditors collected large fees but delivered little of value and thousands of innocent people lost their jobs, savings, pensions and investments. To take just one example – Carillion entered liquidation in January 2018. It had about 43,000 employees (19,500 in the UK) and £7 billion of liabilities to 30,000 small businesses, most of whom will lose almost everything owed to them. The pension scheme deficit of £2.6 billion will force employees to lose some of their pension rights. Carillion had non-current assets of
£2,163m, and £1,571m of this was goodwill, which had not been amortised for years and this helped to overstate the profits which was a boon for executives collecting profit-related pay. For the period 2009 to 2017, Carillion’s debts rose by 297%, whereas the value of its long-term assets grew by just 14%. From December 2009 to January 2018, the total debt owed by Carillion increased from £242 million to an estimated £1.3 billion. In the five-and-half-year period from January 2012 to June 2017, Carillion paid out £333 million more in dividends than it generated in cash from its operations. None of this aroused any interest from auditors. KPMG audited the company for 19 years and always gave the company a clean bill of health.
The 2007-08 banking crash showed that auditors delivered little of any social value. Some banks collapsed within days of receiving a clean of bill of health18. They had danger written all over them but the Nelsonian auditing firms saw nothing wrong. UK taxpayers provided £1,162 billion to support and rescue distressed banks, including
£532 billion to recapitalise Lloyds and RBS, and £106 billion to nationalise Northern Rock and Bradford and Bingley19.
Lehman Brothers had a leverage ratio of more than 30 to 1. With this leverage, a 3.3% drop in the value of assets would wipe out the entire value of equity and make the bank technically insolvent. About 80% of Lehman’s income came from speculative activities. No matter how clever, no one can win all the bets on financial horses, but that did not occur to auditors. Lehman Brothers received an unqualified audit opinion on its annual accounts on 28 January 2008 from Ernst & Young, followed by a clean bill of health on its quarterly accounts on 10 July 2008. By early August it was experiencing severe financial problems and filed for bankruptcy on 14 September 2008. The bank used an accounting gimmick codenamed Repo 105. Under this $50 billion scheme, Lehman sold assets just before its financial year-end for around 5% less than the balance sheet value, with an agreement to buy them back shortly into the next accounting period for the amount of sale plus interest. The resulting cash was used immediately to pay debt and thus show lower liabilities and improved leverage ratio. The US insolvency examiner said that “the only purpose or motive for the transactions was reduction in balance sheet … there was no
18 Prem Sikka, “Financial Crisis and the Silence of the Auditors”, Accounting, Organizations and Society, Vol. 34, No. 6-7, 2009, pp. 868-873
19National Audit Office, Taxpayer support for UK banks: FAQs, https://www.nao.org.uk/highlights/taxpayer-support-for-uk-banks-faqs/
substance to the transactions20”. Ernst & Young collected $31 million in fees in 2007 and knew that Repo 105 had been used for several years by Lehman. The insolvency examiner concluded that “… the firm’s outside auditor, was professionally negligent …”. A subsequent writ by the New York attorney general alleged that
“E&Y substantially assisted Lehman Brothers Holdings Inc. …now bankrupt, to engage in a massive accounting fraud, involving the surreptitious removal of tens of billions of dollars of securities from Lehman’s balance sheet in order to create a false impression of Lehman’s liquidity, thereby defrauding the investing public21”
Just before the crash, Bear Stearns had shareholder funds of $11.8 billion (£7.4 billion), assets of $384 billion (£240 billion), which could not easily be converted to cash, and a derivatives portfolio with a face value of $13.4 trillion (£8.4 trillion). It had a leverage ratio of over 35 to 1 and could therefore barely absorb a decline of around 3% in its assets. For nearly six years before its demise, almost all of the pre-tax profits at Bear Stearns came from speculative rent-seeking activities. It received an unqualified audit opinion on 28 January 2008 from Deloitte. However, by 10 March its financial problems hit the headlines and on 14 March, with state support from the US, it was sold to JP Morgan Chase.
Northern Rock’s financial statements for the year to 31 Dec 2006 received a clean bill of health from PwC on 27 February 2007. Yet a few weeks later depositors were queuing outside the bank trying to rescue their savings as concerns grew about the stability of the bank. The bank need soon racked up around £30 billion of emergency funding form the government22. In common with auditors of other banks, PwC also collected fee for consultancy. The House of Commons Treasury Committee expressed concern that “there appears to be a particular conflict of interest between the statutory role of the auditor, and the other work it may undertake for a financial institution23. A subsequent inquiry by the House of Lords Economic Affairs Committee24 accused bank auditors of “dereliction of duty”, “complacency” and basking in a culture of “box ticking” rather than delivering meaningful audits.
HBOS received a clean bill of health from KPMG even though one of the bank’s senior employees raised red flags25. Auditors would not listen. In 2008, the government spent £37 billion to bail out the bank. In 2017, a HBOS bank branch manager and a number of his associates were convicted of loan fraud going back more than a decade. Some of the details are provided in a document codenamed “Project Lord Turnbull Report” and published by the All Party Parliamentary Group
20 US Bankruptcy Court Southern District of New York, (2010). In re Lehman Brothers Holding Inc., Report of Anton R. Valukas, 11 March 2010; http://jenner.com/lehman/VOLUME%203.pdf.
21 http://amlawdaily.typepad.com/032312e%26ycomplaint.pdf; accessed 20 January 2014.
22 The Guardian, MPs tackle PwC over Northern Rock role, 4 December 2007; https://www.theguardian.com/business/2007/dec/04/northernrock
23 House of Commons Treasury Committee, The run on the Rock, January 2008, p. 115
24 House of Lords Select Committee on Economic Affairs, Auditors: Market concentration and their role, March 2011.
25 Atul Shah, The Politics of Financial Risk, Audit and Regulation: A Case Study of HBOS,
London: Routledge, 2018
on Fair Business Banking26. Anthony Stansfeld, Police and Crime Commissioner for Thames Valley, estimates that more than £1bn could have been involved:
“The fraud was denied by Lloyds Bank for 10 years, in spite of it being apparent that senior members of the bank were aware of it at least as far back as 2008. It resulted in a great number of companies being ruined, and the lives and livelihoods of their owners and those that worked with them being destroyed.
“They were pursued for their personal guarantees, and lost their houses and possessions as the bank and its lawyers pursued them for all they owned. Families were split up, marriages ruined, and suicides resulted”27.
Yet no questions have been asked of auditors. The FRC did not examine audit failures exposed by the banking crash. Auditing firms know that regulators, especially the financial sector regulators, place reliance upon auditors but the neither the Financial Conduct Authority (FCA) nor the Prudential Regulation Authority (PRA) has brought any action against the firms for worthless audits. Other countries are not so accommodating. For example, the US Federal Deposit Insurance Corporation (FDIC), a government corporation providing deposit insurance to depositors, sued Grant Thornton for failing to discover fraud at a bank and secured damages of $24 million28. The FDIC also sued PwC for alleged negligent audits of Colonial Bank29. In July 2018, the judge said that PwC “did not design its [Colonial Bank] audits to detect fraud” and awarded $625 million to the FDIC30.
UK reforms have been minimalist and grudging. The audit industry has more or less carried on as before and scandals persist. In early 2018, Carillion collapsed and the chair of the House of Common Business, Energy and Industrial Strategy Committee said:
“Carillion’s annual reports were worthless as a guide to the true financial health of the company31”.
26 All Party Parliamentary Group on Fair Business Banking, Statement on release of draft Project Lord Turnbull Report – 21 June 2018, http://www.appgbanking.org.uk/statements/statement-on-release-of-draft-project-lord- turnbull-report/
27 Statement from the Police and Crime Commissioner – Fraud, 19 January 2018;
https://www.thamesvalley-pcc.gov.uk/news-and-events/thamesvalley-pcc- news/2018/01/statement-from-the-police-and-crime-commissioner-fraud/
28 Grant Thornton, LLP v. FDIC, No. 1:2000cv00655 – Document 645 (S.D.W. Va. 2010); https://cases.justia.com/federal/district-courts/west- virginia/wvsdce/1:2000cv00655/136/645/0.pdf?ts=1428387676; also see
https://www.courtlistener.com/opinion/219065/grant-thornton-llp-v-fdic/
29 http://online.wsj.com/public/resources/documents/PWC_rulingpdf.pdf?mod=article_inline
30 Reuters, PwC must pay FDIC $625.3 million over bank’s collapse: U.S. judge, 2 July 2018; https://www.reuters.com/article/us-at-t-directv-now/pwc-must-pay-fdic-625-3-million-
over-banks-collapse-u-s-judge-idUSKBN1JS2CB
31https://www.parliament.uk/business/committees/committees-a-z/commons-select/work-
and-pensions-committee/news-parliament-2017/carillion-shareholders-17-19/; 19 February
2018.
A report by parliamentary committees32 concluded that in
“failing to exercise professional scepticism towards Carillion’s accounting judgements over the course of its tenure as Carillion’s auditor, KPMG was complicit in them”.
In April 2016 BHS33 collapsed. It had been audited for a decade by PwC. The firm had a long-standing relationship with its CEO, Sir Philip Green, and provided auditing and consultancy services to BHS and its parent company. The audit partner responsible for the overall quality of the audit, supervision of the audit team and issuing the audit report spent just two hours on the job to conclude that BHS was a going concern, the very heart of the audit failure. He appeased directors by backdating his audit report34.
Auditors have failed to draw attention to frauds, fiddles, massaged profits and inflated balance sheets even when the ‘red flags’ have been evident. Directors are complicit in such shortcomings, but if they could be relied upon to come clean no society would spend vast sums on external audits.
REGULATORY INACTION
Despite a steady stream of scandals, the structure and regulation of audit market has remained unchanged. Auditing firms dominate the FRC and through it, collude with company directors to formulate accounting and auditing rules which they then pretend to independently apply and attest (see chapter 2). The wording in audit reports obfuscates auditor responsibility. The routine statement is that financial statements give a true and fair view because they comply with extant accounting standards. There is no mention that the big companies and the audit industry collude to manufacture accounting standards, or that this mechanical approach to audits has enabled auditors to abdicate responsibility for assessing the appropriateness of company accounting practices. After all, auditors are paid to give an informed opinion on financial affairs of businesses.
Fee dependency and conflicts of interests arising from the sale of non-auditing services have continued. The threat of lawsuits could act as a pressure point, but it is almost impossible for any individual stakeholder to sue audit firms or the audit partner responsible for negligence as the firms enjoy too many liability concessions.
The UK accounting regulator, the Financial Reporting Council (FRC) admits that
“Across the Big 4, the fall in quality is due to a number of factors, including a failure to challenge management and show appropriate scepticism across
32 House of Commons Business, Energy and Industrial Strategy and Work and Pensions Committees, Carillion, May 2018; https://publications.parliament.uk/pa/cm201719/cmselect/cmworpen/769/769.pdf
33 House of Commons Work and Pensions and Business, Innovation and Skills Committees, BHS, London: House of Commons, July 2016.
34 SKY News, Banned BHS auditor ‘spent two hours signing off retailer’s accounts’, 21 June 2018; https://news.sky.com/story/banned-bhs-auditor-spent-two-hours-signing-off-retailers-
accounts-11411768
their audits, poorer results for audits of banks. There has been an unacceptable deterioration in quality at one firm, KPMG. 50% of KPMG’s FTSE 350 audits required more than just limited improvements, compared to 35% in the previous year35”.
No firm has been barred from securing new business or shut-down. The regulatory response is to levy puny fines and business-as-usual continues. The audit industry, together with the Institute of Chartered Accountants in England and Wales (ICAEW), has long used strategies for organising reforms off the agenda. Rather than reflecting upon its own failures, it routinely blames others for audit failures. Producers of goods/se2018)rvices do not blame their failures on consumers for expecting higher quality products/services or duty of care, and they try to meet social expectations. In sharp contrast, the audit industry castigates people for expecting higher quality audits, ethical conduct and a duty of care (the technical jargon is the ‘expectation gap’36) and this was evident in response to the Carillion scandal37. Its stale response has been to tweak accounting/auditing standards, codes of ethics, and disciplinary arrangements, all under the control of the auditing industry38. When that does not work, high profile individuals are enrolled to produce soothing reports to say how audit would be transformed in the future39. This way, public opinion is massaged, journalists and legislators are disarmed, reforms are postponed and auditing drifts from one crisis to another and fees keep rolling in. No questions are asked about whether profit-seeking auditing firms, the private police force of capitalism, are capable of delivering good audits, and how the current accounting/auditing standards have become tools of stagnation. Risks of audit failures have been transferred, as evidenced by BHS and Carillion, to suppliers, employees, pension scheme members, taxpayers and local communities, but the auditing industry are oblivious to the massive social and economic consequences. There is little evidence to show that corporate governance models and values are standardised, yet the emphasis is on developing standardised approaches to audits. Rather than transforming audits, regulators have been devoted to securing compliance with outdated and failed models of audits. Unsurprisingly, the FRC, the auditing regulator has been described as “chronically passive”, “timid”, “useless” and “toothless40”.
35 Financial Reporting Council, Big Four Audit Quality Review results decline, 18 June 2018; https://www.frc.org.uk/news/june-2018/big-four-audit-quality-review-results-decline
36 Prem Sikka, Anthony Puxty, Hugh Willmott and Christine Cooper, “The Impossibility of Eliminating the Expectations Gap: Some Theory and Evidence”, Critical Perspectives on
Accounting, Vol. 9, No. 3, 1998, pp. 299-330
37 Economia, Bill Michael: on KPMG and the profession, 8 February 2018;
https://economia.icaew.com/en/features/february-2018/bill-michael-on-kpmg-and-the- profession-carillion-profile
38 Prem Sikka and Hugh Willmott, “The Power of ‘Independence’: Defending and Extending
the Jurisdiction of Accounting in the UK”, Accounting, Organizations and Society, Vol. 20, No. 6, 1995, pages 547-581.
39 Tony Puxty, Prem Sikka and Hugh Willmott, “Mediating Interests: The Accountancy Bodies’ Responses to the McFarlane Report’, Accounting and Business Research, Vol. 27,
No. 4, 1997, pp. 323-340.
40 House of Commons Business, Energy and Industrial Strategy and Work and Pensions Committees, Carillion, London: House of Commons, May 2018,
https://publications.parliament.uk/pa/cm201719/cmselect/cmworpen/769/769.pdf.
THE NEED FOR REFORM
Some commentators have openly said that “the conventional audit is probably no longer worth paying for41”. During the course of our investigation many people have asked us why in view of the regularity of their failures and involvement in bribery, corruption, tax dodging, price-fixing and other predatory practices42, accounting firms are permitted to conduct audits at all. Even by the feather-duster standards of the FRC, some 27% (19% in 2017) of the audits are substandard43. Imagine if that routinely applied to the production of cars, aeroplanes, medicine or food. The producers would be sued and shut-down and governments would step in. But that does not happen to auditing firms. They continue to be defended by regulators and governments, and, in a so-called ‘free market’ economy enjoy the protection of a state-guaranteed market for auditing. A study examined the stakeholder value generation by big accounting firms and rated it as “junk” and said that there was:
“little evidence of effective risk management with inadequate understanding and capability to monitor governance, cultural and human capital risk factors. This applies to both external audit services, which are not fit for purpose in this respect, and internal risk control systems within each individual firm.
… the core business model itself is neither societal in nature nor reconciled and integrated with its business model44”.
Audit is a trust engendering technology and has been grievously abused. Even the City folk are saying that auditors have had their “heads in the sand” and must provide a far more rounded view of companies’ health than the current statutory “truth and fairness” opinions45. The mantra in the auditing industry is that it needs to restore trust in audits, something that has been banded around for nearly fifty years, but the industry has been remarkably unable or unwilling to do so. The writing is on the wall and alternatives to audit firms and current conceptions of audits need to be considered. Audits by accounting firms are a means to an end – which is to secure accountability of big business and protect stakeholders – including customers, employees, pensioners and shareholders – from sleaze by preventing publication of misleading financial statements and perpetration of financial abuses, fraud and fiddles. Some say that this is the last chance saloon and legislators must soon call time. The industry has organised its own accountability off the political agenda. There are tomes of auditing standards, but hardly anything on auditor accountability
41 London Evening Standard, It’s still the human element that counts, 23 January 2008 (http://www.standard.co.uk/news/its-still-the-human-element-that-counts-6672357.html; accessed 27 January 2014)
42 Richard Brooks, 208, op cit; Austin Mitchell and Prem Sikka, 2011, op cit.
43 Financial Reporting Council, Report and Financial Statements for the Year Ended 31 March 2018; https://www.frc.org.uk/getattachment/4f46c7dd-f0b7-43d6-96c9-
c52136281a18/FRC-Annual-Report-and-Financial-Statements-2018.pdf
44 Paul Kearns and Stuart Woollard, Auditing the “Big 4” Accounting Firms – Preliminary
Report, The Maturity Institute, 23 October 2017; http://www.hrmaturity.com/wp- content/uploads/2017/11/Big-4-Project-Preliminary-Reportv.8.pdf
45 Financial Times, Scope and quality of audits needs reform, say City chiefs, 22 October 2018; https://www.ft.com/content/c3edd6e6-d3c3-11e8-a9f2-7574db66bcd5
to stakeholders. Parliamentary committees have rightly called for a break-up of the big four firms46 in order to reduce their power and ensure that they cannot hold governments and regulators to ransom. This needs to be accompanied by reforms to enhance transparency, audit quality and public accountability of the industry.
This report puts forward reforms which are likely to be opposed by the big firms, accountancy trade associations and their corporate beneficiaries, but wiser souls will know that the industry can’t continue to short-change society. As KPMG chairman47 put it: “We are an oligopoly — that is undeniable …I can’t believe the industry will be the same [in the future]. We have to reduce the level of conflicts and . . . demonstrate why they are manageable and why the public and all stakeholders should trust us”.
This report is organised in 12 further chapters.
Chapter 2 provides a background to the UK accounting industry. It shows that the big four accounting firms dominate the market for external auditing. It provides details of the regulatory system for external audits and shows that regulators are effectively captured by the auditing industry.
Chapter 3 argues that audit industry needs to be restructured and that financial auditors must act exclusively as auditors, as is the norm in almost all other sectors. The firms must be restructured and focus exclusively on audits and with no possibility of engaging in the sale of non-auditing services to anyone as the lure of consultancy fees has constantly undermined auditor independence and quality of audits.
Chapter 4 considers the possibility that the current big four firms could decline to big three. The biggest threat is likely to be the reckless pursuit of profits by accounting firms, including willingness to engage in predatory practices and “criminal wrongdoing”. The firms have also used their size to hold UK government to ransom. The only way forward is to expand the number of suppliers in the audit market, especially at the top-end of the market.
Chapter 5 recommends that a state appointed body should directly conduct real-time audits of financial enterprises. This would increase the number of suppliers and also facilitate greater competition in the audit market.
Chapter 6 calls for expansion of the supply of auditing services through abolition of barriers to entry and a mandatory system of joint audit for all large companies.
Chapter 7 calls for the creation of an independent body to appoint and remunerate auditors of large companies. It also calls for the big four firm share of the audits of businesses with turnover above £200 million and a balance sheet total of over £2 billion to be capped at 50% of the market.
46 House of Commons Business, Energy and Industrial Strategy and Work and Pensions Committees, Carillion, May 2018; https://publications.parliament.uk/pa/cm201719/cmselect/cmworpen/769/769.pdf
47 Financial Times, Big Four accountancy firms plan for forced break-up, 16 May 2018; https://www.ft.com/content/6c07f5d8-591b-11e8-bdb7-f6677d2e1ce8
Chapter 8 calls for compulsory change of audit firms after five years unlike the current term of twenty years. It also requires that audit tenders for a client or a portfolio of clients be published.
Chapter 9 argues that poor audit quality is the outcome of a corrosive organisational culture which receives little public exposure. Under intense time budget pressure, members of audit teams resort to irregular auditing practices and even falsification of audit work. It raises questions about the composition of audit teams, offshoring of audit work and reliance by auditors on work which is not performed by staff under their control and supervision. Such practices are part of profit maximisation by firms but are not disclosed. The chapter puts forward a number of suggestions for public exposure of the injurious culture of the firms and to thereby create pressures upon the firms to address the damaging impact of their flawed organisational culture.
Chapter 10 argues that the incidence of audit liability can act as an important pressure point for firms to improve audit quality, but UK liability laws are weak. It calls for changes to empower stakeholders.
Chapter 11 argues that the financial and transparency reports published by the big firms are very economical with information. One reason for that is that the firms have effectively been making their own rules. This must end.
Chapter 12 notes some of the regulatory failures in financial reporting and auditing, sanctions against failing firms, lack of urgency by the regulators and failure to eradicate poor practices. It concludes that the current regulators are unfit-for- purpose and need to be replaced. It recommends that all accounting principles/standards must be set by parliament and an independent Companies Commission can fill in the details. It recommends that auditors duties must be stated in the Companies Act and auditors must have duty to detect/report fraud and irregularities and actively consider whether the reporting entity is a going concern. Auditing standards would be set by the Companies Commission.
Chapter 13 concludes the report
