What has been the impact of the audit reform on mid-level accounting firms?
Business Secretary Kwasi Kwarteng recently told the UK that the government will reform its audit regime after numerous failings in corporate auditing were exposed. He says it is clear that the UK’s audit regime needs to be modernized with a package of “sensible and proportionate reforms”. He added that by restoring confidence in the corporate governance regime and encouraging âgreater transparencyâ, it will provide investors with âclarity and certaintyâ while protecting jobs across the country.
The reform was divided into three sections, focused on improving the audit market, strengthening investor and public confidence, and increasing the accountability of directors. As part of these changes, companies would be required to use small âchallengerâ firms to perform much of their annual audit in order to increase competition. In addition, the âBig Fourâ will also face a market share cap and a new regulator, the Audit, Reporting and Governance Authority (ARGA), currently being created to replace the Financial Reporting Council (FRC). .
In addition, to regain confidence in companies, new reporting obligations will be introduced. Audits may extend beyond financial results and ARGA will be supported by new legislation. Finally, executives of large companies could be held responsible for “serious failures”, with an emphasis also on increased transparency.
Lord Callanan, Minister of Corporate Responsibility, says audit failure is not an abstract problem, it has “real” consequences. âRogue auditors and administrators who have slept behind the wheel need to be held accountable. As part of our plans, we will endeavor to ensure that the new regulator is fully equipped to respond to where serious failures have occurred, âhe concludes.
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Impact of the reform on mid-level accounting firms
Julie Matheson, Kingsley Napley Accounting Consulting Partner, recently published a report detailing the impact the reform would have on mid-level accounting firms.
In its report, it estimates that 97% of audits of FTSE 350 companies are carried out by the four large firms. Matheson suggests that there are a few main proposals that will affect mid-level companies, one of them being the expansion of the Public Interest Entities (PIE) market; and the managed shared audit requirement.
According to the proposals, large private companies, companies listed on AIM and perhaps also third sector organizations can fall under the umbrella of PIE, she said. This could lead to up to 120 accounting firms to audit PIEs and therefore meet the regulatory requirements of the future ARGA. Matheson warns that if midsize and smaller companies choose to stay in the PIE market, they could be subject to an “extra level of control.”
However, she says that under the managed shared audit proposals, mid-level companies may have the opportunity to build on their skills and experience by getting involved in auditing FTSE 350 companies, which are currently dominated by the Big Four.
The Department of Business, Energy and Industrial Strategy (BEIS) says that the larger audit firm should include a smaller firm to do a small part of the audit, for example to audit a subsidiary. While the target is good, Matheson says some mid-level companies can “shirk” to avoid the increased “scrutiny” involved in audits of high-level companies.
Steve Gale, chief audit executive at Crowe UK, argues that another challenge that mid-level companies can overcome is that they will have to spend “time, energy and money” in securing insurance. that they have the necessary resources and infrastructure to support this.
He adds that one of the biggest obstacles to date for challenger companies has been the ârefusalâ of PIE’s audit committees to make appointments outside of the big four firms. He suggests that there are a number of reasons for this, including misconceptions about âexperience, expertise and resourcesâ within challenger companies. He also explains that there is also a lack of knowledge in some areas of audit firms outside of the Big Four.
Robert Holland, audit expert at Kreston International, says large companies will always tend to âplay it safeâ and use the Big Four by default, which means there aren’t enough players on the market. land, but that the reform could create more. opportunities for mid-sized companies to enter the market.
Commenting on the reform, Simon Hayden, partner at Perrys Chartered Accountant, believes that “these reforms alone will not create a level playing field”. However, he says anything that âdilutes the dominanceâ of the Big Four and opens up opportunities for other audit firms is to be welcomed. Potentially, these changes will benefit midsize audit firms the most. However, if they âgain a foothold in the auditâ of FTSE companies, it can open the door to smaller companies further down the food chain, he concludes.
How accounting firms can circumvent the challenges of reform
Holland suggests that some of the challenges the reform inflicts on mid-level accounting firms will be helped by the creation of the new regulator ARGA. The new regulator could help set better auditing standards and make a positive contribution to the global standard setting process. Matheson agrees with Holland’s point of view and suggests that ARGA will allow other companies to âstep upâ and perform FTSE 350 audits while âleveling the playing fieldâ.
According to her, one of the main objectives of the reforms was to ensure greater competition in the PIE market. To this end, companies will need to be reassured that any initial mistake in the skills development phase will not necessarily lead to “significant enforcement action” against them, she continues. Positive and constructive use of a firm’s relationship with ARGA would be a useful first step, as would a commitment to continue to focus on constructive engagement with firms, when breaches of standards. audit are observed, rather than presuming that this coercive measure will follow, adds Matheson.
Gale concludes that audit reform could present opportunities for mid-level accounting firms and management of large listed companies by helping them familiarize themselves with the capabilities of challenger audit firms while still being able to retain leadership. largest audit firm as the group’s lead auditor. He says that the challenger companies, meanwhile, would gain expertise and experience that are believed to be lacking and while increasing their presence and reputation in the market.