UK audit reform proposals ‘long overdue’

The UK government has set out how it intends to revamp the UK’s corporate reporting and audit regime through a new regulator, which should lead to greater accountability for big business and address the dominance of the main audit firms.

It is a response to last year’s whitepaper, which set out proposals to strengthen the UK’s framework for major companies and the way they are audited. 

The reforms to improve the audit regime and corporate transparency should prevent sudden large-scale collapses like Carillion and BHS, which hurt countless small businesses and led to job losses.

Additionally, the government has announced it will review wider reporting burdens on large and small businesses including those from retained EU law.

Minister for Corporate Responsibility Lord Callanan said:

Collapses like Carillion have made it clear that audit needs to improve, and these reforms will ensure the UK sets a global standard.

By restoring confidence in audit and corporate reporting we will strengthen the foundations of UK plc, so it can drive growth and job creation across the country.

Regulator proposed

The Financial Reporting Council will be replaced by a new, stronger regulator – the Audit, Reporting and Governance Authority – with tougher enforcement powers and funded by a levy on industry.

For the first time, the largest private companies – not just those listed on the stock exchange – will come under the scope of the regulator, reflecting the impact they have on the wider economy.

Unlisted companies with over 750 employees and with over £750 million annual turnover will come under scope of the regulator, a threshold set following consultation to ensure the reforms are as targeted as possible and minimise unnecessary burdens.

Directors at the biggest companies who breach their legal duties to be open with auditors, or lie about the state of their firm’s finances, will face sanctions such as fines, and the government will act to address ‘rewards for failure’ – where bosses pocket bonuses despite their company collapsing.

Large businesses will have to be more transparent about their profits and losses – not dishing out dividends while on the brink of collapse – while also providing more information to investors and the public about what they have done to prevent fraud, which company metrics have been independently checked and about the risks their company faces.

To curtail the unhealthy dominance of the ‘Big Four’ audit firms, FTSE350 companies will be required to conduct part of their audit with a challenger firm.

The new regulator, ARGA, will also be given the power to make big audit firms keep their audit and non-audit functions operationally separate and to enforce a market cap if the state of the market doesn’t improve.

New climate and risk reporting measures

Currently, companies do not have to state how they assure non-financial information in their annual reports. However, under the new regime, large corporates will have to set out how thye assess the quality and reliability of this information that lies outside of financial statements - including on climate, risk and internal control.

Dr Roger Barker, director of Policy and Governance at the Institute of Directors, said it was welcome news but added: “There are several things that we would have liked to have seen included in the reforms.

“Firstly, we would have liked to have seen ARGA take on a ‘purpose objective’ as part of its remit – whereby it would oversee reporting and governance in relation to a company’s stated business purpose.

“Secondly, the reforms could have helped take forward the objectives of the Better Business Act campaign – by emphasising the need for a more balanced stakeholder approach to business decision making rather than prioritising the interests of shareholders.”

He urged the government to expedite legislation for the formation of the new audit regime regulator.

“It is understandable that the Government is limiting its expansion of Public Interest Entity to a smaller group of large private entities than first envisaged, given the need to minimise additional regulatory burdens on business in a challenging economic environment.

“We remain sceptical about requiring large audit firms to conduct audits in partnership with challenger firms. This is a step into the unknown, and the new audit regulator will need to keep the viability of this approach under close review.”

Concern over ‘glacial pace’ of reform

John Wood, chief executive of the Chartered Institute of Internal Auditors, also welcomed the proposals and commitment to publish a draft Audit Reform Bill, but said the changes were long overdue.  

“We strongly support putting the audit regulator on a statutory footing with the legal powers it needs to do its job properly, and believe this aspect of reform should now be delivered as soon as possible.

”However, despite the announcement made today we remain very concerned about the glacial pace of audit reform and believe that an Audit Reform Bill must now be accelerated.

”The Government must stop kicking the can down the road on audit reform and get on and pass the legislation that is now urgently required to prevent any more unnecessary corporate collapses linked to audit and governance deficiencies.”   

Breaking the audit monopoly

Meanwhile, Peter Swabey, policy and research director, Chartered Governance Institute, UK & Ireland, said: 

“The Institute has consistently argued, throughout the various reviews of the audit market, that there are three fundamental issues to be addressed:

• The expectation gap – the difference between the political, press and public expectation of the role of audit and what an auditor would perceive it to be;
• The delivery gap – the Financial Reporting Council has indicated that only 71% of audits reviewed last year did not require improvement or significant improvement; and
• The perceived capability gap between the ‘big four’ and the challenger audit firms.

“The Government’s plans go a long way to addressing these issues. Key amongst these is the creation of a new regulator for the audit profession, the Audit, Reporting and Governance Authority (ARGA) – with tougher enforcement powers; powers which the Financial Reporting Council sorely lacked.

“It is also encouraging to see the largest unlisted companies brought within the scope of this regulation as such companies have a significant impact on the wider economy and benefit from the privilege of limited liability.

“Our key concern over the Government’s plans remains the practical one of the balance between the need to address the unhealthy market dominance of the ‘Big Four’ audit firms and the need to improve the quality of audit. It is not easy to see how this balance can be achieved.”

”While the UK’s reputation for corporate governance is strong, a robust audit market is essential to building trust and maintaining the UK’s reputation as a good place to do business and the Institute’s focus is on the governance issues raised by recent audit failures rather than the impact of specific accounting decisions.”