Carillion: The audit industry's existential question

Carillion sign on a UK construction site Image copyright Getty Images

We've heard it all before - for decades in fact. After every big corporate failure, fraud or scandal, up goes the cry: where were the auditors? The latest angst - of course - concerns the collapse of Carillion.

MPs last week lambasted auditor KPMG and, more broadly, slammed the audit market as a "cosy club incapable of providing the degree of independent challenge needed".

Policymakers want the competition watchdog to look again at whether the Big Four firms - KPMG, EY, PWC and Deloitte, which audit 99% of the FTSE 100 and 96% of the 250 index - should be broken up.

And to consider whether arms doing audit work should be separated from those carrying out other consultancy or professional services.

What's interesting about this latest round of soul-searching is that the audit firms appear to be active participants.

So much so, in fact, that Newsnight has been told that the industry is on the hunt for a big name to lead an independent review of the market.

The brief, though, wouldn't be to look at how the market should be structured, or how firms should manage conflicts of interest.

Instead, the sector is chewing over a more fundamental question: what should audit actually be?

This shift is important. In the world of audit, it's radical stuff.

Pyrrhic victories

Traditionally, auditors saw themselves as offering assurance, predominantly to shareholders, that the accounts presented a "true and fair" view of the company's position.

But that doesn't necessarily mean the same thing to the profession as it does to the public, politicians, employees and customers who end up judging the results in a case like Carillion.

For many years, criticism of the audit industry was met with two arguments. First, that those berating the sector just didn't understand audit. And second, that any proposed changes risked imperilling audit quality with unspecified but terrible consequences.

These were rolled out to counter reforms proposed by the last competition inquiry into the sector in 2013 - and against European Union audit reforms, which included mandatory rotation of audit firm for public companies and limits on non-audit work.

Past victories in resisting change perhaps feel rather pyrrhic, given where the sector now finds itself.

If audit is seen as the last line of defence against fraud or as an important arbiter on a company's likely long-term health, it is time to tackle those expectations head on.

Fix and break up?

It's clear that previous attempts to shake up the market simply haven't worked.

The Big Four have become even more dominant in the business of auditing large, listed companies.

Hopes that other firms would break into that elite club have proved unfounded.

Grant Thornton - which ranks fifth by fee income and with more than 4,500 people in the UK is hardly a minnow - this year it said it would stop bidding for new audit contracts.

And while the growth in non-audit fees from audit clients has slowed (and some in the industry would be happy with an outright ban on this work), the importance of lucrative non-audit work to the firms as a whole has only grown.

It is natural to seize on the idea of break-ups of the biggest firms as a remedy: it's a concrete solution that satisfies the clamouring that something must be done.

The trouble is it isn't clear it would work - at least not on its own.

Would a smaller firm, with more competitors, really be more minded to challenge a big client on questionable numbers or assumptions?

Would smaller, audit-only UK firms mean higher-quality vetting of the big, multinational companies that make up the FTSE 100?

And would changing the market's structure make it less likely that the public, investors and politicians end up feeling short-changed come the next corporate car crash?

Other measures - like requiring joint audits, implementing market share caps, rethinking fees, looking at more regular tendering, or incentivising new entrants - would also be worth considering.

Largely dismissed in the past, industry sources say that now everything is on the table.

Opening up the audit process is also certainly merited: Despite some progress, shareholders often get little decent insight into a process that is supposedly done for their benefit.

What is audit again?

But none of this helps if auditors' view of what their job entails doesn't match the public perception of what they're meant to be doing.

Hence the industry's desire for a credible big hitter to look at just that.

This is part overdue evolution and part self-preservation. And it comes as technology opens up the scope of what an audit can feasibly check and investigate.

After years of telling its critics they don't understand audit, the profession appears to be having second thoughts: perhaps, after all, they were the ones that misunderstood.

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