Why the big four auditors are under intense scrutiny – an update

Following the collapse of the company Carillion in February this year the role of its auditors came under the spotlight and investigations were promised, notably by the FRC (Financial Reporting Council) and the CMA (Competition and Markets Authority).

The reason for this was that the business had won several large public sector contracts, among them to build two hospitals, and also because its collapse put a number of subcontractors and jobs in jeopardy. However, primarily it was because its financial health was revealed to be considerably shakier than the directors had suggested.

The company’s annual audit had been carried out by KPMG, one of the “big four” auditors, and in March 2017 it had expressed no concern over reported profits of ￡150m, even though four months later these proved to be illusory. Perhaps they may have been reassured by the company's 'internal auditor', Deloitte, which might also be looked into since it may have involved helping 'massage' numbers for KGMG to report on.

The role of the auditor is ”to provide an independent opinion to the shareholders on the truth and fairness of the company’s financial statements,” according to The Institute of Chartered Accountants in England and Wales (ICAEW), one of the bodies appointed to approve and register auditors. Auditors’ reports, filed at Companies House, are used by suppliers and other interested parties to make decisions about their involvement with a company.

Not surprisingly, when the FRC, published the results of its annual inspections of the big four auditors in June it singled out KPMG for an “unacceptable deterioration” in the quality of its work.

But it also found that the overall quality of the audit profession is in decline and that only half of KPMG’s FTSE 350 audits. were deemed satisfactory. In fairness it should be said that the FRC scores for the others in the big four had also declined. Deloitte scored 79%, down from 82% last year, EY fell from 92% to 82% and PwC was down from 90% to 84%.

It also fined PwC (Price Waterhouse Cooper) ￡6.5 million for its failings in auditing of retailer BHS two years before its collapse. 

The calls for a radical overhaul have been growing as there seem to be so many accounting scandals, such as the recent problems with Patisserie Valerie. The calls reflect public concern about a conflict of interest since these businesses also earn massive fees from their clients for consultancy work.

Earlier this month KPMG announced that it will no longer do consultancy work for the UK's biggest companies if it is also auditing them.

So when will there be some answers on the big four auditors?

According to a report in CityAM last week there are now five investigations either pending or on the go.

The CMA investigation following Carillion was expected to reveal its findings before the end of the year but it has recently announced that it is also intending to study the entire auditing market to see whether the big four were crushing competition from smaller firms.

Sir John Kingman, the chairman at Legal & General, was tasked by the government this summer with reviewing the operations of the FRC, whose outcome may strengthen its powers. The FRC is also reviewing itself separately from the Kingman investigation.

Shadow Chancellor John McDonnell has commissioned Professor Prem Sikka, an academic at the University of Sheffield, to review the sector and make recommendations with this report due by year end.

Finally, the Beis (Business, Energy & Industrial Strategy Select Committee) leader Rachel Reeves (Labour) has announced that it will review both the Kingman and CMA reviews, probably starting in January.

It will take a while before all the results are in and revealed but it looks like time is running out for the big four and they can expect changes to regulation, to their ability to carry out both audits and consultancy, and possibly, some hefty fines at the end of it all.