AFTER the failure of giants such as BHS and Carillion sparked public outcries in recent years, the Government has unveiled long-awaited proposals to shake up the financial reporting and audit regimes which may do little to mollify some critics.
The White Paper on Restoring trust in audit and corporate governance published last week underlined the importance of what may sound like academic issues.
Minister for Corporate Responsibility Lord Callanan noted: “Audit failure isn’t an abstract problem, it has real life consequences. Thousands of jobs have been lost in the wake of collapses like Carillion, and many more lives impacted, while wider confidence in big business is undermined.”
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The paper follows three high-profile reviews which all highlighted big concerns about the system under which companies’ accounts are vetted by independent experts, whose opinions are relied on by a range of stakeholders.
Corporate grandee Sir John Kingman in 2018 noted serious failings in the regime under which the performance of auditors is monitored by the Financial Reporting Council, which some say is toothless.
In a report published last year the FRC found a third of the audits completed by the seven biggest firms fell short of the quality expected.
In 2018 a study by the CMA identified serious competition issues in the market for large company audits, which is dominated by the Big Four: Deloitte, EY, KPMG and PwC. It said legislation should be introduced to require the Big Four to share audits with smaller firms and to separate their audit and consulting operations to help avoid potential conflicts of interest.
The following year Sir Donald Brydon, a Scottish chartered accountant who chaired the London Stock Exchange, raised big questions about the purpose of audits that are limited to the checking of historic accounting information, which do not consider bigger picture issues.
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The Government appears happy that the paper released last week, which runs to 232 pages, is a carefully considered and comprehensive response to the concerns raised by all three reviews. It declared that the proposals would ensure the UK’s markets are at the cutting-edge of global best practice.
The proposals cover a range of areas.
They could result in directors being required to take much greater responsibility for ensuring the accounts they publish provide a meaningful picture of the state of firms’ affairs and for related internal controls. Directors may have to do more to ensure fraud is detected. Companies could be required to introduce sanctions, such as bonus clawbacks, for directors that approve dividend payouts when there is a risk the companies they run face insolvency.
Auditors will also be required to take account of a much wider range of information in reaching their judgements. A new regulator, the Audit, Reporting and Governance Authority, will have power to look at the actions of auditors and directors and be able to require corrective action is taken relatively quickly.
The Government stopped short of recommending joint audits should be compulsory for FTSE 350 firms but said smaller players should be given some of the work involved under a “managed shared audit” requirement. The Big Four could also face a cap on their market share of FTSE 350 audits if competition in the sector does not improve.
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The press release accompanying the white paper includes positive comments from Sir John Kingman, the CMA and Sir Donald Brydon. But there are big concerns about whether the Government is doing enough or acting at the pace required.
Sir Donald noted: “The need for progress on these reforms remains urgent.”
The Government said that in light of the current challenges to the UK economy, the consultation period concerning the proposals will run for 16 weeks. Any legislation could be months off.
The Institute of Directors said the prospect of increased responsibilities could put people off sitting on boards and suggested the Government take a less legalistic approach to director behaviour. British Chambers of Commerce warned about potential cost implications.
However, it looks like the regulations proposed would only apply to directors of firms that are large enough to be classed as Public Interest Entities. The implications of the reforms for SMEs are unclear.
The additional responsibilities for directors proposed are less onerous than those imposed on US executives under the Sarbanes Oxley Act in 2002.
Labour peer, Lord Sikka, emeritus professor of accounting at the University of Essex, noted the Government was only suggesting tweaking the corporate governance code in respect of executive pay. Compliance with the code is voluntary and can’t be enforced by the courts.
Lord Sikka, a longstanding critic of the audit market, was scathing about the white paper proposals in respect of the Big Four.
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In an article on the Labour Hub website, he said the auditing market should be opned up to a much wider range of players. He also suggested the managed shared audit proposal would compromise the independence of the junior firms concerned.
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