Options for change

A number of suggestions have been made to improve the audit market, ranging from slight alterations to major overhauls involving changes to the law and redrawing company structures. This section sets out some of the most likely options being discussed.

Enhanced role of, and communication by, the audit committee

This could include more communication between the audit committee and company stakeholders as well as regular dialogue between the audit committee and the external auditors. The audit committee could also be asked to go into more detail about their policies when selecting auditors, and explain their work.

Further consideration of the role of audit and the auditor report

At the moment, the role of the auditor is to provide an independent, professional, opinion on whether a company’s financial reports are “true and fair”, or not. However, the role of the auditor could be expanded to, for example, include reporting risks to the business, potential problems or any concerns the auditors have regarding the business, strategies, or models. The audit report could develop to include more explanations of how decisions had been reached, or highlight any matters in the Annual Report that the auditors feel are not consistent with the financial statements. There have even been suggestions that auditors might be asked to alert the authorities when a company is heading for trouble.

Reviewing restrictive covenants

Some loan agreements contain contractual obligations for a company to use a Big Four firm for audit (restrictive covenants). This is viewed as anti-competitive and it is likely that there will be moves to ban restrictive covenants.

Review of the provision of non-audit services

Currently, audit firms can provide both audit services and consultancy work. Policymakers have expressed concerns that this could compromise their independence. For example, if they are advising on financial planning as well as providing an independent audit this could be seen as a conflict of interest. If there is a suggestion that firms are offering audit services at a reduced rate in order to secure more lucrative consultancy work this could be seen as anti-competitive and also as prejudicing their independence. Unless auditors can prove that there are adequate safeguards in place to ensure their independence, they could be banned from providing both audit and non-audit services to the same company. Or “audit-only” firms could be set up, with other “consultancy firms” providing the non-audit services (see “Changes to the Audit Model” below).

Reviewing contingency planning in the event of a potential failure of a major audit network

Competition is already a concern with the Big Four occupying a large share of the market. If one of the Big Four were to leave the market or fail this would leave the “Big Three” and competition concerns would magnify. This is what happened when Arthur Andersen failed in the wake of the Enron scandal, (with the Big Five becoming the Big Four). As the Big Four audit most of the biggest UK companies, this would cause widespread disruption and uncertainty. Suggestions for addressing this potential issue include requiring the big audit firms to have contingency plans such as “living wills” and having plans in place that set out what would happen in the even that they left the audit market.

Reviewing the ownership restrictions on audit firms

Current rules mean that the majority of voting rights in audit firms must be held by qualified auditors. This makes it harder for them to expand or diversify, as it restricts their ability to raise capital (they cannot attract investors by offering equity). This has been seen as a barrier for smaller firms who want to take on larger audits and so contributes to reduced competition. It has been suggested that relaxing ownership rules might make it possible for more firms to have the resources to take on larger audits, improving competition.

Changes to the audit model

A number of regulatory changes have been explored by the various investigations into the audit market conducted by the European Commission, the House of Lords (UK) and the Public Companies Accounts Oversight Board (United States). One, or a combination of, the following changes has been suggested

Joint audit - Two accounting firms would share the responsibility for the audit of a major company. In the light of competition issues currently being debated, it is likely that at least one of them would have to be a non-Big Four firm. Both auditors would share their findings and reach a common position. This model currently operates in France.

Shared audit - More than one audit firm would be involved in the auditing of a major company, with a smaller audit firm taking a smaller proportion of the work, perhaps a subsidiary. Unlike Joint Audit, both auditors would not have unlimited liability for the whole company but would have proportional liability for their respective areas. It would also mean that the primary auditor could be rotated, with a secondary auditor retained where specific experience or expertise was necessary. This model is already used where companies have subsidiaries in other jurisdictions.

Mandatory rotation - Relationships between firms and auditors would be limited to a set term, after which the company would have to change auditors.

Mandatory tendering - After a set term, companies would have to go out to tender for audit services. Unlike mandatory rotation this would not necessarily preclude the current auditors winning the contract for a further period.