U.K. regulator orders Big Four to separate audit practices by 2024
08 Jul 2020

A U.K. regulator on Monday told the country’s biggest professional services firms to draw up plans for separating their audit businesses by Oct. 23 and for the work to be completed by mid-2024.

The Financial Reporting Council—the U.K.’s accounting and audit watchdog—said it aims to reduce potential conflicts of interest and boost the quality of audits in the U.K. as the country embarks on its future outside of the European Union.

The measures come after a string of corporate failures, including at construction giant Carillion PLC, coffee chain operator Patisserie Holdings PLC and travel company Thomas Cook Group PLC.

The FRC listed 22 principles the “Big Four”—Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers—will have to adhere to by June 30, 2024. Under the principles, the Big Four will have to ringfence their audit practices and ensure that audit partners spend the majority of their time on audits.

Audit practices will need to publish their own profit and loss statements, separate from the overall firm’s, and make sure there are no material, structural cross-subsidies from other parts of the business, the FRC said.

Audit partners’ pay will be based on their contribution to audit practice profits, the FRC said. The regulator also is asking professional services firms to be more transparent about their audit businesses and for audit professionals to demonstrate ethical behavior and professional skepticism while conducting their work.

The FRC is adopting recommendations made by other regulators, lawmakers and accounting experts in previous years, though not one proposing that audit practices be funded by audit fees only.

The regulator also stopped short of ordering a full, structural breakup that would have required audit entities to be spun off into separate legal entities.

“Operational separation of audit practices is one element of the FRC’s strategy to improve the quality and effectiveness of corporate reporting and audit in the United Kingdom following the Kingman, CMA (Competition and Markets Authority) and Brydon reviews,” said FRC Chief Executive Jon Thompson.

The changes don’t apply to smaller audit and accounting firms.

The Big Four in recent years have generated a growing part of their revenue with nonaudit services, including consulting, and have offered them to many of their audit clients. Even though the firms have taken steps to stop selling nonaudit services to audit clients, concerns around conflicts of interest and financial dependency of audit practices remain.

Monday’s announcement is part of a broader effort to overhaul the structure and oversight of the U.K. audit sector. The FRC is set to become part of a new statutory regulator called the Audit, Reporting and Governance Authority, which will be equipped with a bigger toolbox to rein in audit firms.

The Big Four, academics and industry representatives welcomed the changes but said more actions are needed to improve the quality of audits in the U.K.

By Nina Trentmann, The Wall Street Journal, 6 July 2020

Read more at The Wall Street Journal

RiskScreen: Eliminating Financial Crime with Smart Technology

You can claim CPD minutes for this content, by signing up to our CPD Wallet