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FRC audit separation plans a ‘pragmatic’ response

7 July 2020: ICAEW has welcomed the FRC’s plans for the separation of Big Four audit practices from the rest of their operations but warned that in isolation it will do little to improve audit quality.

Following the Financial Reporting Council’s (FRC) announcement that it expects Deloitte, EY, KPMG and PwC to separate their auditing divisions from the rest of their operations by June 2024, ICAEW Chief Executive Michael Izza called the move a “pragmatic response” to the calls for greater clarity around the independence of auditors.

However, while the plans provide a useful framework for how to run an audit firm, Izza also commented that they will “do little” to improve quality or choice in the market.

“The audit profession is clear on the need for reform and changes are already underway,” continued Izza. “We want to see a more reliable core audit, and we are working with government to make this happen.

“It’s also vital that key recommendations from the Brydon and Kingman reviews – including the establishment of a strong new regulator, formal oversight of company directors and a renewed focus on internal controls – are implemented at the earliest opportunity.”

High-quality audits ‘in the public interest’

In a statement accompanying its separation plans, the Financial Reporting Council (FRC) said the measures were intended to “ensure that audit practices are focused above all on delivery of high-quality audits in the public interest” and that audit divisions should not rely on “persistent cross-subsidy from the rest of the firm”.

A list of “desired outcomes” published by the FRC called for the total amount of profits distributed to audit partners to not “persistently exceed” the contribution to profits made by the audit practice. It also stated that auditors should be “protected” from internal influences that could divert their focus away from audit quality, encouraged ethical behaviour, openness, teamwork, challenge and professional scepticism among auditors, and also called on them to act in the public interest and work for the benefit of shareholders of audited entities and wider society.

FRC chief executive Sir Jon Thompson said that by setting out the principles the watchdog had “delivered a major step in the reform of the audit sector” 

“The FRC remains fully committed to the broad suite of reform measures on corporate reporting and audit reform and will introduce further aspects of the reform package over time,” continued Thompson.

Following discussions with the firms, the FRC said it expected them to set out plans to improve their profession by October this year. The FRC will then publish an annual assessment of whether firms are delivering the objectives and outcomes of operational separation. 

The move to separate audit from other areas within Big Four firms comes in the wake of three government-backed reviews into the profession. One of the reviews led by Sir Donald Brydon called for the creation of a “standalone audit profession” supervised by the successor body to the Financial Reporting Council – the Audit, Reporting and Governance Authority (ARGA) – an endeavour in which Brydon believes bodies such as ICAEW should play a leading role.