Audit regulatory changes a step forward but more to do

Business leaders have given a cautious welcome to plans announced by the UK government to reform the audit process as part of a wider corporate governance strategy.

The plans will revamp the UK’s corporate reporting and audit regime through a new regulator, greater accountability for big business and by addressing the dominance of the Big Four audit firms.

Business secretary Kwasi Kwarteng announced the plans, which he said the reforms to improve the audit regime and corporate transparency will help prevent sudden large-scale collapses like Carillion and BHS, “which hurt countless small businesses and led to job losses”.

Additionally, the government announced it will review wider reporting burdens on large and small businesses including those from retained EU law.

In particular, the government will update the definition of micro-enterprises. “This threshold, the relic of an EU directive, could be forcing too many of Britain’s smallest businesses to spend time and money preparing accounts to a level of detail only needed for larger companies, distracting them from focusing on growth and creating jobs,” added Kwarteng. “Government will also consider the reporting requirements on smaller public interest entities to help attract high-growth firms, and review whether there are unnecessary restrictions on remunerating directors in shares.”

Under the move, the Financial Reporting Council (FRC) will be replaced by a new, “stronger” regulator, the Audit, Reporting and Governance Authority (ARGA), which will have tougher enforcement powers and funded by a levy on industry.

For the first time, the largest private companies, not just those listed on the stock exchange, will come under the scope of the regulator, reflecting the impact they have on the wider economy.

No extra regulations will be added to smaller businesses through the reforms: the focus is on the UK’s largest companies because so many jobs, suppliers and pensions depend on them. Unlisted companies with over 750 employees and with over £750 million annual turnover will come under scope of the regulator, a threshold set following consultation to ensure the reforms are as targeted as possible and minimise unnecessary burdens.

Directors at the biggest companies who breach their legal duties to be open with auditors, or lie about the state of their firm’s finances, will face sanctions such as fines, and the government will act to address ‘rewards for failure’ – where bosses pocket bonuses despite their company collapsing.

To curtail the unhealthy dominance of the ‘Big Four’ audit firms, FTSE350 companies will be required to conduct part of their audit with a challenger firm. The new regulator, ARGA, will also be given the power to make big audit firms keep their audit and non-audit functions operationally separate and to enforce a market cap if the state of the market doesn’t improve.

Reacting to the announcement, Matthew Fell, CBI chief policy director, said: “The UK’s world-leading reputation on corporate governance should be jealously guarded. And high-quality audits are important for maintaining investor confidence and broader public trust in business.

“These reforms strike a sensible balance between tightening regulation and maintaining the UK’s attractiveness as a place to invest and do business.”

Federation of Small Businesses (FSB) National chair Martin McTague added: “It’s good to see BEIS grasping the nettle on audit reform. As legislation is drawn up, the key to success will be making corporate Audit Committees directly responsible for reporting on payment and wider supply chain practice.

“When we were the first group to flag the ramping up of unreasonable payment terms at Carillion, six months before the company collapsed, nothing was done.”

He added: “Improving transparency at big corporates whilst easing unnecessary reporting burdens for small businesses is the right direction of travel.”

Peter Swabey, policy and research director, at the Chartered Governance Institute UK & Ireland, said: “The Institute has consistently argued, throughout the various reviews of the audit market, that there are three fundamental issues to be addressed. The expectation gap – the difference between the political, press and public expectation of the role of audit and what an auditor would perceive it to be. The delivery gap – the Financial Reporting Council has indicated that only 71% of audits reviewed last year did not require improvement or significant improvement; and the perceived capability gap between the ‘big four’ and the challenger audit firms.

“The Government’s plans go a long way to addressing these issues. Key amongst these is the creation of a new regulator for the audit profession, the Audit, Reporting and Governance Authority (ARGA) – with tougher enforcement powers; powers which the Financial Reporting Council sorely lacked.

“It is also encouraging to see the largest unlisted companies brought within the scope of this regulation as such companies have a significant impact on the wider economy and benefit from the privilege of limited liability.

Our key concern over the Government’s plans remains the practical one of the balance between the need to address the unhealthy market dominance of the ‘Big Four’ audit firms and the need to improve the quality of audit. It is not easy to see how this balance can be achieved.”

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