BEIS Committee publishes recommendations for the Future of Audit

In the latest in a series of reviews into the future of audit, The Business, Energy and Industrial Strategy (BEIS) Committee has issued its report and recommendations for the reform of the UK audit market.

Referring to the audit failures exposed in the aftermath of the global financial crisis, the BEIS Committee report states that the previous audit reforms, i.e. mandatory audit firm rotation and restrictions on the provision of non-audit services, have been ineffective in either increasing competition or delivering acceptable audit quality. They believe that the time has come for radical change.

BEIS Committee recommendations

Some of the key recommendations are listed below.

The scope of audit

• The detection and investigation of potential fraud must be a priority within any audit.
• The Brydon review should consider broadening the scope of audit to cover the whole of the annual report and adopt a more forward-looking approach.

The audit product

• The Financial Reporting Council (FRC) should mandate the ‘graduated findings’ approach to auditor reporting. This approach requires the auditor to express an opinion on key judgements and estimates in the accounts by describing them on a range from cautious to optimistic, in order to provide a greater insight into the audit process.
• The introduction of greater transparency and insight into the audit process should encourage greater engagement from investors.
• Consideration should be given to requiring companies to publish the audit report at the same time as the preliminary results are announced.
• If there are barriers to auditors taking on more responsibilities and reporting on them candidly (such as unlimited liability and skills issues), these should be removed.

Capital maintenance

• The UK Government and the FRC should produce clear concise guidance on the issue of distributable profits including a definition of what counts as realised profits for the purposes of distribution.
• Companies should be required to disclose their distributable profits in the financial statements split between realised and unrealised profits.
• A solvency system should be introduced and complement the revised capital maintenance regime.

Separation of audit from non-audit

• The report recommends, at the very least, an economic split between the audit and non-audit sections of the firms.
• A review of the above operational split should be conducted after a period of three years whereupon, if no improvements in transparency, culture or independence have occurred, a full structural split of the Big Four UK firms into separate audit and non-audit businesses should occur.

Fees

• The FRC and its successor should require greater reporting on audit fees which might include the number of audit hours, staff mix and charge-out rates.
• Auditors should also report on instances where additional work has been undertaken but they have been unsuccessful in obtaining an increase in their fees.

Independence, challenge and professional scepticism

• Greater emphasis should be placed on professional scepticism by audit committees in their auditor selection process rather than referring to ‘cultural fit’ as criteria.
• Greater oversight of audit committees to encourage more challenge and address any potential bias in favour of specific firms.
• The frequency of audit rotations should be reduced to seven-year, non-renewable, terms.
• The current rules in relation to the receipt and giving of hospitality should be tightened and also be applied to prospective audit clients with audit firms to publish details of all hospitality in full.

Competition, choice and resilience

• Joint audits should be piloted at the upper levels of the FTSE 100 combined with a market share cap for the remainder of the FTSE 350.
• These joint audits should include a Big Four firm and a challenger firm; they should not include two Big Four firms.
• Consideration to be given to the introduction of additional safeguards for the audits of banks.
• A segmented market cap should be introduced to enable challenger firms to obtain a proportion of FTSE 350 audits.

Regulation of audit

• The new regulatory body, ARGA, should make use of the available sanctions and, whilst it should be proportionate, it should also be prepared to imposing tough sanctions in the worst cases.
• The consideration being given to the introduction of a UK-styled version of the US Sarbanes-Oxley approach on internal controls is welcomed as a significant step towards improving the reliability of financial reporting.
• All directors, regardless of their professional qualification, should be held to account and liable to any regulatory sanctions.
• Audit Quality Reviews should move beyond process-driven box ticking and offer a robust appraisal of the opinions offered in audits and on the quality of the analysis and evidence used to drive those opinions.