Shared and joint audits: are two auditors better than one?
The audit market for larger listed companies in many jurisdictions, including the UK, is dominated by four audit firms - the ‘Big Four’. These firms are significantly larger than the ‘challenger’ firms. Governments and regulators are considering whether to mandate shared or joint audits in an attempt to increase audit quality, competition and choice.
The Competition and Markets Authority (CMA) has proposed that FTSE 350 companies either appoint joint auditors, with one being a challenger firm, or appoint a challenger firm as their sole auditor.
What are shared and joint audits?
- In shared audits, one firm is appointed to perform the audit of the group accounts and, usually, some of the components, while another firm, or firms, audits the other components, representing a significant share of the total group.
- In joint audits, two or more firms are appointed to take joint responsibility for the entire group audit.
What experience is there of shared and joint audits?
Shared audits used to be common but, over time, companies have migrated to being audited by one audit firm. This is primarily a consequence of the development of audit firms’ international networks. Where shared audits still exist, it is due to auditor rotation requirements.
Some jurisdictions currently mandate joint audits and in others they are performed voluntarily. In Belgium, South Africa and some other African jurisdictions they are mandated for financial services companies. In France, joint audits are mandated for larger listed companies, banks and political parties, but involvement of a challenger firm is not mandated. Joint audits were once common practice for financial institutions in the UK.
What are the big issues?
Many larger firms believe that the additional costs associated with shared and joint audits are likely to be significant for the entities and audit firms, especially for joint audits, because of the duplication of work involved. Conclusions from academic and other analyses on the effect of joint audits on audit fees have ranged from no significant differences to increases in excess of 25%. The CMA has suggested that the additional costs incurred by listed companies could be offset by a lower cost of capital.
In many jurisdictions, joint auditors have joint and several liability. If one firm is unable to pay its share of any damages awarded as a result of a negligently performed audit, the other firm would be liable for the full amount. Governments seem unlikely to change these arrangements, which are intended to protect investors.
Big Four and challenger firms provide accounting, tax, legal and consultancy services that prevent them from acting as auditor. Sometimes, there may be only one alternative among the Big Four if an audit committee wants to change auditor. A sufficient number of challenger firms would need to participate in the market, and there would need to be an incentive to give up non-audit services they provide to companies they wish to audit.
Making a success of shared or joint audits
- Challenger firms would need to gain the confidence of those investors who have put pressure on listed companies to choose Big Four firms.
- "Catch-22" situations in which challenger firms are unable to demonstrate that they have the experience to bid for larger engagements without first having gained that experience, would need to be overcome.
- Implementation would need to be phased over time as existing audits come up for tender.
- Audit committees would need to prepare well in advance of their next audit tender, identifying able and willing challenger firms, and addressing conflicts arising from non-audit services.
- Joint and shared audits would require more planning and entail additional risk for Big Four firms as well as challenger firms which would need to be balanced with additional fees.
- Challenger firms would need to consider to what extent they were willing to invest in tendering for audits and in gearing up for first year audits if they were successful.
- Government and audit regulators would need to consider support for challenger firms and listed companies, and establish a process to determine whether there was a positive effect on competition and choice, and on audit quality, over time.
- They would also need to consider whether, were reforms to prove successful, they could do away with compulsion and allow companies to revert to appointing a single firm of auditors if they wish.