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.
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?
The proposed reforms do include substantial changes that are likely to significantly alter the way audit companies operate.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.
The devil will be in the detail as regards the carve up between the big four and challenger firms – it also remains to be seen how many of the latter will have the appetite to take on audits on a scale that have hitherto been the preserve of the big four.
What has not yet been established is just how this proposal will work in practice.The largest audit firms may already have plans in place in anticipation of this change and could even be some way there in terms of managing a process such as this by virtue of their familiarity with component audits.
But aside from the impact on the firms themselves, there is also a potential impact on the company being audited, who will now have to invest its time and efforts in liaising with not one but two sets of auditors. In some, and likely the most complex, cases this could be a considerable additional burden.
While some may look past this, it is likely these changes will not only affect the largest corporations in Britain and their audit firms, but also many advisers and SME owners and managers who work alongside, or indeed invest themselves in, FTSE 350 companies.
However, there appears to be very little within the proposed changes to bring greater simplicity and support to small businesses with regards the audits of their own accounts, although this is perhaps unsurprising given the aim of the reforms was to prevent large-scale scandals within some of the UK’s largest companies, while easing unnecessary reporting burdens for small businesses.
As the Financial Reporting Council has been under substantial media and political criticism for some time, it is perhaps not surprising that the government has in the end chosen to jump. But all changes should be made with audit quality in mind, and what may sound like a bright idea in theory does not always turn out as such in practice.
It remains to be seen what impact these proposals will have on audit quality in practice and the speed with which the new regulator will be established – it may not be in place until 2023 or 2024.
Louise Aumann is senior associate at Reed Smith
