Carillion – a watershed moment for the profession

Michael Izza was very much in demand by the media for the profession’s reaction to the recent Select Committees’ report on Carillion.

He outlined his strong view that the whole issue of Carillion was a watershed moment for the profession and that there are lessons to be learned to restore public confidence in audit. He spoke on BBC Radio 4’s Today programme, engaged in a debate in City AM and was widely quoted elsewhere.

The Work and Pensions and Business, Energy and Industrial Strategy (BEIS) Committees issued their report into the collapse of Carillion on 16 May 2018. The report placed responsibility for the collapse of Carillion on the board and senior leadership of the company describing its business model as “an unsustainable dash for cash”. But it also drew attention to the audit profession and shed light on areas in need of improvement, including a ‘’failure to exercise professional scepticism’’ and a ‘’crisis of confidence in the audit profession’’.

Michael has been clear and strong - if these problems are not fixed and trust rebuilt then there may not be an audit profession in 20 years’ time unless we act now to sort out the problems. The specific challenges to be addressed are:

Restoring Public Trust

The expectation gap that has developed means the profession needs to do more to demonstrate the value of audit, and evolve it to better address the needs of wider society – investors, employees, pensioners, suppliers and customers.

When carried out correctly and with the proper integrity, audit encourages investment and business growth – it is a fundamental part of a well-functioning economy. However, if trust in the profession is eroded, then the contribution that the vast majority of audits make to maintaining confidence in business, will be undermined.

Technology can help us to communicate with stakeholders and we need to explore how we can use it.

Increasing Competition in the Audit Market

ICAEW has long supported increased competition in the audit market, and we believe that the best way to do this is to make it more appealing to new entrants by removing the barriers to entry.

The changes to auditor independence requirements resulting from the new European Audit Reforms were designed to improve audit quality and restore investor confidence, as well as increase competition in the market. However, two years on from the EU statutory audit directive, the number of firms registered for Public Interest Entity (PIE) audits has fallen from 51 to 32. Some measures such as joint audits, shared audits, market share caps have all been examined and rejected, so it may be time to think about these again. Other areas to explore could be changes to liability rules, looking at fee structures, or a completely new look at the scope and purpose of audit – asking how it can evolve to meet the needs of businesses today.

The Select Committees’ report gave attention to the issue of competition in the audit market, recommending that:

‘’the Government refers the statutory audit market to the Competition and Markets Authority, and that the terms of reference of that review should explicitly include consideration of breaking up the Big Four into more audit firms’’.

Breaking up the Big Four would create additional smaller firms, but there is no guarantee that these smaller firms would want to take on big audits. Many smaller firms have cited the cost of regulation, the long timeframe for reviewing audits, and unlimited liability as some of the reasons they are reluctant to enter the audit market. Grant Thornton, the UK’s fifth largest accountancy practice has recently announced that it will withdraw from auditing FTSE 350 companies due to the “competitive landscape”. The answer lies in removing barriers to entry, which the Financial Reporting Council (FRC) needs to start addressing.

Improving Regulation

Regulators have rightly faced serious questions about the strength of their powers and their ability to act in a timely manner and ICAEW agrees with the report’s recommendation that ‘’all directors who exert influence over financial statements should be investigated, not just those with accounting qualifications’’.

ICAEW wants to ensure that the oversight regulator of our profession is able to focus on clearly-defined areas of responsibility, with the powers it needs to hold boards of directors and the profession accountable, whilst not straying into areas where it is not needed or where its competence could be limited.

The worst possible outcome from the select committees’ report on Carillion would be a return to business as normal which would result in the same issues being raised after the next corporate collapse. We need to make sure that public confidence in audit is safeguarded and enhanced.