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ICAEW hits back at claims of declining audit quality

Author: ICAEW Insights

Published: 29 May 2024

Fresh analysis criticises auditors’ work but omits an acknowledgement of recent changes to audit and the government’s failure to reform legislation.

Audit quality has increased since the 2018 collapse of Carillion, despite a recent report criticising audit performance, ICAEW has said.

New research claimed that audit firms failed to issue warnings before three out of four major UK corporate collapses since 2010. However, it didn’t acknowledge the government’s decision to halt urgent reforms to audit and corporate governance, or the role of company directors in corporate failures.

The Audit Reform Lab, part of the University of Sheffield, didn’t sufficiently highlight the role of government, which – after years of consultation and a series of in-depth reports by respected business experts – unceremoniously withdrew proposed corporate governance reforms late last year, citing companies’ concerns about extra reporting requirements. 

The Audit Reform Lab’s research found that of the Big Four auditors, EY performed worst – warning of going concern risks for just 20% of collapsed firms. PwC provided warnings in 23% of cases, Deloitte 36% and KPMG 38%. Auditors outside the Big Four performed even worse – providing warnings for just 17% of collapsed firms.

Since the 2018 collapse of Carillion, however, the accountancy profession has acknowledged past failings, with regulators and firms alike working to tighten processes and rules. Some firms have already separated audit services from consulting to avoid criticisms of auditors cosying up to clients. 

Furthermore, the Financial Reporting Council (FRC) has increased its fines on firms for audit failures. But little more can be done unless the government acts on the reforms urgently needed to hold company directors to account for corporate failures.

ICAEW CEO Alan Vallance said: “The FRC’s audit quality reports show the proportion of good audits increasing over the inspection cycles from 2018 to now. This contrasts with the conclusion of researchers at Sheffield University that there is an ‘appearance of declining quality’.

“Carillion’s collapse in 2018 marked a watershed moment, and since then regulators, the audit profession and others have delivered substantial and significant improvements.”

One of the main points in the research relates to going concern warnings. A crucial reform dropped was a new requirement to produce an annual Resilience Statement (RS), setting out how a company is managing risks and building or maintaining resilience over the short, medium and long term.

The RS was intended to replace the Viability Statement, which looked at whether a business was financially viable into the future.

Had the FRC previously known that the Resilience Statement was going to be pulled, the regulator would likely have consulted on changes to improve the existing requirements of the Viability Statement, experts say. But, for the moment, there is little the regulator can do given the government’s decision to drop the majority of the proposed reforms.

In agreement with the accountancy profession, however, the Audit Reform Lab is urging the government to introduce the proposed new audit regulator – the Audit, Reporting and Governance Authority (ARGA) – as a matter of urgency. 

“Until the culture of audit is reformed, and a new and more effective regulator is in place, partners at audit firms will continue to reap huge financial rewards, despite continued audit failures that harm business confidence and our economy more widely,” the report said.

Prof Adam Leaver said that audit reform is moving in the right direction but much more is needed to be done by all parties in the industry, including professional bodies and universities to better arm auditors with the “real world understanding”.

Leaver said: “I wouldn’t wish to diminish the impact of [recent changes] and they are very welcome. We’re supportive of them. Whether they go far enough remains to be seen.”

Vallance acknowledged that there is more to do, saying: “We have long called for legislative reform to underpin efforts to improve trust and accountability by reducing the risk of disorderly corporate failure and enhancing governance at major UK companies. At the core of this should be a strong statutory regulator and greater director accountability, alongside enhanced assessment of reliance and fraud risk. Such changes would reinforce the UK as a trusted location for foreign direct investment.”

Leaver also acknowledged that corporate frauds are perpetrated by company directors, and auditors are often blindsided. “We are on the side of auditors. A lot of audit reform is really about how you empower auditors through the education and training pathways.”

It is a demand Vallance has reiterated, saying: “We call on the next government to bring forward the necessary primary legislation as a priority.”

ICAEW on audit reform

In its Manifesto, ICAEW sets out its vision for a renewed and resilient UK, including the reforms that are needed to audit and corporate governance.

Manifesto 2024: ICAEW's vision for a renewed and resilient UK

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