Risk & Economy » Audit » ‘Fourget’ choice

'Fourget' choice

Despite attempts to promote choice and competition, the Big Four still has a stranglehold on the audit market

Auditing is back on the agenda, though this time not because of a major audit
failure or the collapse of a Big Four firm. Not yet, anyway. But recent
proposals to encourage more competition for large company audits, increased
auditor liability and revisions to international auditing standards could all
have an impact on the market for business assurance services.

The debate about how to improve audit choice for larger companies rumbles on,
most recently stimulated by another report issued under the auspices of the
Financial Reporting Panel. The interim recommendations of the FRC’s Market
Participants Group form a package of suggestions directed at regulators,
accountancy firms, investor groups and companies. For example, companies, it is
suggested, could be required to give more information to shareholders on the
auditor reselection process. Similarly, boards could be forced to disclose any
contractual obligations to appoint certain types of audit firms.

Same difference
Could such recommendations make a difference to the rather limited auditor
choice available to large companies? “There’s no one thing in the
recommendations that will make a difference,” says Richard Everett, director of
group finance at Friends Provident. “Even taken collectively, I don’t think the
package of recommendations will make a significant difference in the short
term.” Nevertheless, he sees a benefit in keeping the debate about choice in the
audit market going.

Although not very concerned about the restricted choice of auditors for large
companies, Everett says: “The root of our concern is that the current situation
doesn’t give audit firm incumbents a particularly good incentive to improve
services, innovate or improve quality.” Friends Provident’s audit choice is
essentially limited to the Big Four. “It’s a very specialised area of audit and
the skills to do that are concentrated in the Big Four,” Everett says. “It would
take a bold move for the mid-tier to invest in these skills.”

Nevertheless, Everett believes large companies can make effective use of
mid-tier firms – if those firms promote themselves properly. “Speaking from
previous experience, in a different organisation we used a mid-tier firm for
some specialised gap filling within our finance function and that was working
extremely well. There are things firms could do for bigger companies, and that
way they could gain their confidence and build up relationships.” he says.

The lack of global presence remains a major stumbling block for mid-sized
firms which want to audit large companies. “We have had approaches from some of
the mid-tier firms suggesting they can provide services,” says Ken Lever, FD of
Tomkins. “The problem is that they don’t have the global reach of the major
firms.” That said, Lever is sceptical about the truly global nature of the
services offered even by the Big Four. “I think the only firm that did operate
truly internationally was Andersen,” he says.

Lever also suggests that the quality of personnel in firms outside the Big
Four may be more variable. “They do have some very good quality people, but the
consistency of quality across these firms tends not to be as great as in the
larger firms,” he says.

Like Everett, Lever suggests mid-tier firms could provide specialist services
to large companies. “They might look to concentrate on providing internal audit
or Sarbanes-Oxley services,” he says, “but they would have to buy in that
resource.”

Perceived quality
He also suggests that market perceptions still encourage large companies to go
with the Big Four. “A lot of what’s going on from an audit perspective is driven
by the demands of investors,” he says, adding that it is “no accident” that the
vast majority of the FTSE-350 have Big Four auditors. “It’s almost seen as the
wrong thing to do to have somebody other than the Big Four.” As Lever notes:
“Pioneers get arrows in their backs. Most audit committees are understandably
conservative. Most take persuading that there should be any change at all. But
why would they be anything other than conservative in their choice?”

If there are some lingering perceptions that quality may be better in the Big
Four firms, Trevor Dighton, CFO at Group 4 Securicor, would challenge that.
Baker Tilly used to be Securicor’s auditors, before it merged with Group 4. “We
were large for them in client terms, and we got a very good service,” Dighton
says. “The level of service and attention to detail you get from the second tier
could conceivably be better than from a large firm.”

Now Group 4 Securicor is audited by KPMG, which Dighton says is “great”.
During the tender process which KPMG won, all Big Four firms and Baker Tilly
were invited to compete. However, in future Dighton suspects that the choice may
be limited to the Big Four. “We do have a very broad international footprint,”
he says. “We are in 100 countries.” Dighton finds it hard to see how the second
tier can close the gap in the near future, whether by organic growth or merger.
“There’s such a big gap between number five and number four,” he says.

Audit fees
But audit choice aside, how about audit fees? “They are quite high,” Dighton
says. “I would be concerned if they went up much more. It could be something to
worry about, with the dominance of the big players.”

Fees have gone up, driven partly by the change to International Financial
Reporting Standards. Unfortunately for FDs, some further fee rises may be on the
horizon if Ernst & Young’s fears about the impact of the new criminal
liability risk facing auditors are realised. Under the recent Companies Act it
becomes an offence for auditors if they “knowingly or recklessly cause a report
to include any matter which is misleading, false or deceptive in a material
particular”.

As Gerald Russell, a senior partner at E&Y, points out, the term “reckl
essly” is not that well understood in law. “We are worried this has the effect
of criminalising negligence,” he says. “It may make auditors become more
circumspect, which may mean they have to spend more time on certain areas.
Auditors faced with criminal sanctions will spend a lot of time on the minutiae
of accounts, and time is money.” Even now, with the reams of disclosure required
under IFRS, auditors are having to spend more time on such detail and less time
on considering the business itself. “More time is being spent on the accounts
package, rather than kicking the tyres,” Russell says.

Separately, it is unclear whether revisions currently being made to
International Standards on Auditing (ISAs) as part of the International Auditing
and Assurance Standards Board’s clarity and improvements project might also
translate into higher audit fees – or at least auditors trying to negotiate fees
up. What is clear is that the future clarified ISAs will be more specific than
their predecessors that have already been adopted in the UK. Although the UK’s
Auditing Practices Board has been trying hard to stem the tide of rule-based
standards, there is only so much one body can do in an international context.
Securities regulators internationally appear to support greater specification in
ISAs.

What happens for the UK’s auditors depends on the European Commission’s
endorsement – or otherwise – of the clarified ISAs. With the IAASB around
half-way through its clarity project and aiming to finish by 2008, this is
something for auditors, and their clients, to keep an eye on for the future.

FDs on their auditors
In the middle of May, we asked Financial Director readers what they
thought of the audit market and, indeed, their own auditors. Their responses
give much cause for concern.

Respondents to our survey came from across British industry – from businesse
s with turnover of less than £25m up to those with turnover in excess of £1bn.
Nearly half said they were audited by a Big Four firm, while about a third are
audited by a mid-sized/national firm.

On almost every issue, companies that are Big Four clients scored their
auditors lower than did those who use mid-sized or local firms. When asked,
‘What value do you attach to the audit over and above compliance with statutory
requirements?’, 60% scored their auditors at five out of 10 or less – and that
figure rose to 69% for Big Four clients.

The responses almost exactly mirror the results we found when we conducted a
similar survey in 1999 – and in some cases, companies are even more disenchanted
with their auditors than they were eight years ago.

Back then, for example, the single biggest gripe among clients of the then
Big Five was the quality of junior staff: 51% of them cited this as a problem
they had with their auditors. Today, 55% of the Big Four clients make the same
complaint.

But fees have leapfrogged up the table of complaints: in 1999, 44% of all
companies and 42% of Big Five clients had problems with their auditors’ fees;
today, 54% of all companies and 61% of Big Four clients cite fees as problem.

One consolation for auditors is that quality of service is less of an issue,
though still around a third of respondents today are unhappy with the service
provided by their auditors. “I’m not sure I would use ‘service’ and ‘auditors’
in the same sentence,” said one FD. “Auditors often talk about adding value to
my business, in reality they are an inconvenience and have so little commercial
understanding that they cannot hope to offer me anything extra,” said another
FD.

The full survey report will be available soon. To receive a copy, send an
email with the words “Audit survey” in the subject field and your name, company
and job title to [email protected] and it will be sent to you as
soon as it becomes available.

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