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European audit market battles concentration and quality issues

5 February 2021: The European Commission’s second audit market monitoring report highlights persistently high levels of market concentration and several ongoing issues with audit quality, writes Susanna Di Feliciantonio, ICAEW’s Head of European Affairs.

Focused on statutory audit services for public interest entities (PIEs), the report covers the period 2015 to 2018 and is primarily based on data collected by national oversight authorities, including the UK. The report takes stock of changes to the European audit market several years after the implementation of the 2014 audit reform package. 

While acknowledging some challenges with the consistency and comparability of data, the report considers market concentration, risks associated with audit quality deficiencies and the performance of audit committees. It also sets out some next steps, leading towards a broader evaluation of EU audit rules. 

A shrinking market, but growing revenues

Between 2015, when the first market monitoring report was published, and 2018, the EU audit market has been characterised by continued contraction. This has led to 10% fewer sole practitioners and 3% fewer statutory auditors employed by audit firms. The number of registered audit firms fell by 6% and the number of firms auditing PIEs dropped by 35%. The number of PIE statutory audits shrank by over a third. The figures reflect the fall in the number of entities classified as PIEs, following changes to the PIE definition adopted by most EU countries.

The total turnover of EU firms auditing PIEs is reckoned to be about €40bn in 2018, with revenues from statutory audits increasing by 6% from 2015 to over €12bn. Around two-thirds of turnover originated from non-audit revenues – mostly to non-audited entities. Unsurprisingly, the overall figures vary significantly between EU countries, with audit firms in Germany and the UK accounting for 65% of total EU turnover. 

Big Four maintain a hold over the PIE market

The Commission finds ‘persistently high market concentration’, with the Big Four holding an average market share across the EU of 70% of all PIE audits. In only seven countries are the Big Four not the largest four firms (Latvia, Hungary, Czech Republic, Slovakia, France, Portugal, Poland, Greece, Romania and Bulgaria). The concentration is even more marked when it comes to revenue, with the Big Four accounting for around 90% of the PIE audit market. Changes in the individual shares of the Big Four were however visible over the period assessed.

Common audit quality deficiencies

Audit oversight bodies appear to have increasingly focused on PIE audit engagements, despite an overall decrease in the number of inspections. Across the EU, common issues continue to be identified. Deficiencies associated with internal quality control systems relate to ethics, independence, engagement quality control review (EQCR), monitoring of high-risk entities, lack of audit evidence and documentation. Inspections of audit engagement files also flagged up several issues, including risk assessments, materiality and sampling, internal control testing, audit quality and evidence, and group audits.

While many of the identified shortcomings remain under the spotlight of oversight bodies, the Commission notes that no sanctions were applied nor were any systemic risks detected. Mitigation measures that were put in place were mostly concentrated around the areas of ethics and independence, risk assessment and ECQR, internal control system analysis as well as fair value measurements and fraud procedures. 

Pointing to the fact that the same issues appear to arise repeatedly, suggesting that they might be structural, the Commission will consider ways to improve the consistency of quality assurance, investigations and sanctions regimes across EU countries. The possibility of making inspection reports more publicly accessible, potentially by digitalising or tagging them, will be also explored. 

Still lacking data on audit committees

Data on the performance of audit committees remains limited, with oversight bodies taking different approaches to monitoring – often basing their information on self-assessment exercises conducted by audit committees themselves. What data there is suggests that audit committees are broadly meeting the requirements set out in EU law on composition, independence, interaction with administrative and supervisory bodies as well as oversight of the audit function. 

Selecting the external audit appears to be more problematic, with only 87% of audit committees claiming that they are responsible for the procedure – and only 16% inviting more than one firm to tender, contrary to the existing legislative provisions. Shortcomings were also identified concerning the role of the audit committee in examining requests for the provision of non-audit services.

The Commission notes the need for greater monitoring of audit committees, particularly with regard to their interactions with external auditors, the organisation of tender process and approval of non-audit services.

Next up: an evaluation of the EU audit framework

The findings of the market monitoring report will be further bolstered by a study launched by the Commission to assess the effects of EU audit rules on the statutory audit market, alongside reflection on the effects of the COVID-19 pandemic on the audit sector. Given the likely relevance of some of the issues identified in the report, the Commission will also consider potential ‘lessons learnt’ with the Committee of European Audit Oversight Bodies (CEAOB). The various initiatives will all feed into a forthcoming evaluation of the EU audit framework, likely to focus on the issues of transparency, audit quality and competition. 

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