Impact of govt's audit reform remains to be seen

Louise Aumann

Louise Aumann

Amidst an ever-growing number of headlines on audit quality, the government has published its response to a consultation on audit and corporate governance reform. 

Importantly, within the response there lie details of the powers of the soon-to-be-unveiled Audit, Reporting and Governance Authority (ARGA).

From the big four through to smaller competitors and the companies themselves being audited, the saga of creating ARGA has been of burning interest for some time now.

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The launch of this new body is supposed to mark a watershed moment regarding audit quality, strengthening some existing audit requirements and expanding the scope of various obligations.

But now we have detail to hand, can it be said that the reforms will actually improve audits, not just relating to the UK’s largest businesses, but right across the board?

It has to be said that a seeming sigh of disappointment has – perhaps unfairly – greeted the publication of the response, with suggestions that the plans have been watered down and the government has bowed to pressure.

It is understandable why some might feel this way, not least when it comes to the change in the number of companies expected to fall within the definition of a public interest entity (PIE).

The reforms set out that unlisted companies with more than 750 employees and £750mn annual turnover are to now be classed as a PIE, which is currently estimated to be around 600 companies. This is far less than the 4,000 additional companies some observers and business bodies expected to be added to the PIE regime.

Equally, those who hoped the UK might copy the US by making directors personally liable for internal controls over financial reporting may be feeling slightly disappointed. The reforms do give the regulator the ability to investigate and sanction directors of large companies, but for breaches of duties around corporate reporting and audit only.

However, when taken in the round the proposed reforms do include substantial changes that are likely to significantly alter the way audit firms operate, particularly with regards to the audits of FTSE 350 companies. The proposals will require FTSE 350 companies to either appoint an auditor outside the big four or to allocate a certain portion of their audit to a smaller firm.

The idea behind this move is to bolster the competition of the audit market, while avoiding replication of the substantial efforts that are required to audit a FTSE 350 company. However, what has not yet been established is just how this proposal will work in practice.

With the big four having to hand over part of an audit to a smaller firm, the two sets of firms are going to have to find a way to work together and make this proposal work. This is not only going to cause headaches from a division of labour and audit methodology perspective, but also raises significant questions regarding liability for the audit in question and where exactly that will lie.