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Lukewarm response to revamp of audit regime

Will the latest overhaul of the audit regime help restore trust in big business? Only time will tell, writes Graham Hambly of PQ Magazine 

The government has finally unveiled its long-awaited revamp of the UK’s corporate reporting and audit regime. They have promised a new regulator, greater accountability for big business and are addressing the domination of the ‘Big 4’ accountancy firms.

The Minister for Corporate Responsibility, Lord Callanan, said: “Collapses like Carillion have made it clear that audit needs to improve, and these reforms will ensure the UK sets a global standard.”

However, the Financial Reporting Council’s Sir Jon Thompson said: “The Government’s decision not to pursue the introduction of a version of the Sarbanes-Oxley reporting regime is, the FRC believes, a missed opportunity to improve internal controls in a proportionate, UK-specific manner. We know that well-run companies contribute to a stronger, healthier economy overall.”

The FRC will now be replaced by a new, stronger regulator – the Audit, Reporting and Governance Authority (ARGA) – with tougher enforcement powers and funded by a levy on industry. Work on this has already begun, with the government acting to enable the regulator to ban failing auditors from reviewing large companies’ accounts.

To curtail the unhealthy dominance of the ‘Big 4’ audit firms, FTSE350 companies will be required to conduct part of their audit with a challenger firm. The new regulator, ARGA, will also be given the power to make big audit firms keep their audit and non-audit functions operationally separate and enforce a market cap if the state of the market doesn’t improve.

For the first time, the largest private companies – not just those listed on the Stock Exchange – will come under the scope of the regulator, reflecting the impact they have on the wider economy.

Small businesses not impacted by the reform

No extra regulations will be added to smaller businesses through the reforms: the focus is on the UK’s largest companies because so many jobs, suppliers and pensions depend on them. 

Unlisted companies with over 750 employees and with over £750 million annual turnover will come under the scope of the regulator, a threshold set following consultation to ensure the reforms are as targeted as possible and minimise unnecessary burdens.

Directors to be held accountable 

Directors at the biggest companies who breach their legal duties to be open with auditors, or lie about the state of their firm’s finances, will face sanctions such as fines, and the government said it will act to address ‘rewards for failure’ – where bosses pocket bonuses despite their company collapsing.

Large businesses will have to be more transparent about their profits and losses too – not dishing out dividends while on the brink of collapse – while also providing more information to investors and the public about what they have done to prevent fraud, which company metrics have been independently checked and about the risks their company faces.

Corporate collapses have had major impact

The government said that previous corporate collapses have had a significant impact on individuals and the economy:

  • 9,000 redundancies were made, 555 retail stores closed and 1,286 companies and government entities owed money following the collapse of Thomas Cook.
  • 11,000 jobs put at risk by the collapse of BHS.
  • 7,000 suppliers and contractors impacted by the collapse of Carillion.

Meanwhile, the Department for Levelling Up Housing and Communities also unveiled plans to strengthen the local audit framework in response to Redmond Review. This includes establishing ARGA as the system leader for local audits, which will ensure councils and local bodies are delivering value for money for taxpayers.

‘Who can forget the BHS audit?’

Following the announcement, Lord Sikka, Emeritus Professor of Accounting at the University of Essex, said: “Who can forget the BHS audit, where a PwC audit partner spent two hours on the audit and 31 hours on consultancy? 

“The audit team was effectively led by a person with only one-year’s post-qualification experience and most of the audit was deficient. To appease directors, a PwC audit partner also backdated the audit report.

“The government’s proposed reforms will not prevent any of the above. There is no reform of auditor independence, liability, transparency or public accountability. In the absence of effective pressure points, audit failures will continue. 

“The government has missed an opportunity to restore confidence in audits and corporate governance.”

‘Half-hearted’ and ‘lop-sided’ action

ICAEW CEO Michael Izza was not too impressed, either: “Taking these measures as a package with the draft audit reform bill outlined a few weeks ago, the government’s approach has a half-hearted and lop-sided feel to it. Lessons from Carillion and other recent company failures have been ignored, with little emphasis now on tightening internal controls and modernising corporate governance.

“If ministers really think this is enough to restore public trust in business or reinforce the UK’s position as a leading global destination for investment, their confidence is misplaced.

“We support government’s ambitions to increase choice and improve quality in the audit market, but the challenge will be to achieve this while sustaining and growing capacity in the sector. The new regulator, ARGA, will be key to this – which is why it is a great pity that we will have to wait years for it to be established.”

Government has ‘copped out’

Richard Murphy, Professor of Accounting Practice at Sheffield University Management School, a chartered accountant and economic justice campaigner, added: “This is a missed opportunity. Audit failure is evidence of market failure. The government is clearly not willing to embrace the idea that market failure is possible.

“As a result, the need for regulation to protect people from market abuse is not recognised and auditing is left to reform itself, by and large. In a telling sentence on page 90, it is said that ‘the Government will leave the market – companies, directors, investors – to shape the development of an enhanced wider assurance services market in the coming years’. In other words, the government has copped out. That’s the most succinct summary of these reforms that I can offer.”

Murphy then outlined the big issues that audit reform had to address:

  • That IFRS accounts are not fit for purpose, being too subjective and splitting the reporting of income over up to three statements, meaning that no one can really tell what is going on. This has not been addressed, meaning that auditors are still auditing garbage. The ‘garbage in, garbage out’ rule still applies as a result.
  • Environmental reporting, which is the biggest challenge facing both business and society. The new resilience statement does nothing to address this because it only extends audit risk appraisal from the short term to the medium term, and the environment is a long-term risk. As a result, these reforms duck the biggest audit issue that we face.
  • Audit failure, most of which resulted from the payment of excessive dividends by quoted companies. This could have been tackled by requiring that groups disclose their distributable profits, as distinct from those that are generated from unrealised revaluations or by intragroup transactions. The government has ‘avoided’ this issue, only requiring that group parent companies disclose distributable reserves in their own accounts, and recommending that group consolidated accounts refer to the matter, but not mandating it, which means that every auditor will ignore it. Audit failures will continue as a result.
  • The audit profession has been left untouched. If it was responsible for the market failure that current audit disasters suggest, the government has not tackled this problem.

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