The Financial Reporting Council
announces its plans for the ‘Big Four’
to ring-fence their audit practices

6 July 2020

Following a number of high-profile corporate collapses in the last few years, audit quality has been the  subject of intense regulatory focus. In recent times, significant changes to audit regulation were proposed by Sir John Kingman; the CMA made recommendations around ‘operational split’; and, late last year, Sir Donald Brydon endorsed the CMA’s suggested approach in recommending the formation of a separate audit industry with its own governing principles.
 

Having considered the various suggested approaches and sought the views of the affected firms, the FRC has today announced its Principles for operational separation of the audit practices of the ‘Big Four’ firms (Deloitte, EY, KPMG and PwC) ("the Principles"). The Principles are wide-reaching, and will undoubtedly reshape the way in which the firms practise.

The Principles narrate two ‘FRC objectives’ and six ‘desired outcomes’. In summary, the objectives are:

  1. to improve audit quality by ensuring that auditors are focussed purely on audit, as opposed to being involved in any other part of the business which might influence the approach to the audit; and
  2. to improve audit market resilience by ensuring that the revenue of the audit practice is not subsidised by the rest of the firm. 

To seek to ensure that those objectives are met, the FRC’s ‘desired outcomes’ include:

  • the total amount of profits distributed to partners in the audit should not persistently exceed their contribution to the audit practice’s profits;
  • individual audit partner remuneration should be determined predominantly by their contribution to audit quality, taking account of the complexity and risk-profile of the audit; and
  • auditors should not be, nor considered to be, ‘consultants’, and should act only in the public interest and for the benefit of shareholders of audited entities, and wider society.

The specific Principles are detailed, and are aimed at facilitating the firms’ compliance with the objectives and desired outcomes. They include a requirement for partners and staff in the audit practice to spend the majority of their time working within that practice, as opposed to other aspects of the business. They also state that the audit practice is to produce a separate profit and loss account, to demonstrate its independence from the ‘consultancy’ aspects of the firm’s offering.

As part of its regulatory oversight, the FRC will expect regular management information to be provided by the Big Four, to allow it to assess whether the objectives and desired outcomes are being met.

The Big Four have all indicated that they are largely in support of the operational separation. On the positive side, it gives the firms a structure to follow which will hopefully lead to increased routine compliance reviews and fewer significant fines being issued after lengthy FRC enforcement proceedings. On the negative side, it places even greater focus on the specific role of an auditor, arguably making it a less attractive career path to follow, particularly given the shift in remuneration structure. 

The FRC is asking for implementation plans to be submitted by the Big Four by 23 October 2020, with the aim of rolling out the Principles by 30 June 2024 at the latest. It will be interesting to follow how this new regime will influence the number of enforcement cases brought by the FRC over the coming years, or indeed whether the regime will extend to other large firms which carry out Public Interest Entity audits.

Further information

For further information on issues raised in this blog post, please contact a member of our Regulatory team in confidence.

 

About the author

Julie Matheson is a Partner in the Regulatory team, specialising in defending professionals in the financial and legal fields.  She has particular expertise in defending accountants and accountancy firms in regulatory proceedings brought by the FRC, ICAEW and ACCA.

 

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