The Carillion Anniversary – Has anything changed in Audit as a result.

This time last year, Carillion made headlines as the company announced its collapse due to a massive £1.5 billion debt. It was reported that some 47,000 people were employed by Carillion at the time; majority of which were employed within the UK.

The collapse raised many questions, but also put the spotlight on KPMG; the company’s auditor for the past 19 years.

This isn’t the first time we have been here. The Big 4 firms (PwC, Deloitte, EY and KPMG) have all had their fair share of audit failures over the past number of years. For instance, PwC came under fire after the scandal at Tesco in 2014. The FRC only finalised its probe into the PwC audit mid 2017.

Following the Tesco / PwC issue, the FRC imposed a rule which limited the amount of time a firm can be the auditor of a company. This is in addition to requirements stated in the Auditing Standards which limit the length of time an individual Partner can be in charge of an audit. This saw a minor shake up, with a number of companies needing to change auditors as a result.

So, what has been done to fix this?

Fast forward a few years (with multiple FCR audit performance reviews in between), and here we are again. The construction giant has collapsed, fingers are pointed at KPMG, EY and Deloitte for their roles in the event, and the FCR has had a knee jerk reaction saying all big firms should partner with a smaller firm.

Understandably, the business community has come out stating that such a move would only cost businesses more, increase the work load of employees, result in unclear roles and responsibilities, and increase the time taken to complete the review.

Arguing on behalf of the audit firms, such an approach would result in bad client / firm relationships, result in the loss of business knowledge and IP (such as audit methodologies), and result in an possible disjointed and incoherent audit approach – particular for the first year of the audit.

One key person who should be blamed for the collapse is the FRC. It is part of their role and responsibility to monitor audits and large firms, yet on more than one occasion (and as proven by history), poor audit practices have now become the norm and the FRC responds with a knee jerk reaction. The FRC is not proactive in addressing potential situations – at all.

I am not saying the firms, (and in the case of KPMG and Carillion) are not to blame, but it is easy for the FRC to wait for something to blow up and deal with the situation at hand, as opposed to proactively preventing it.

It is no secret about audit firms in the UK. Graduates are hired who may or may not have an accounting degree. They are often pushed through crash course training sessions before being sent out to the field to complete an audit. Graduates are lead by a Manager, who, depending on the training and guidance they have received, could be passing on good or bad traits. The Manager, bound by tight timeframes, restrictive audit budgets, and team resourcing that may be a mix of good team members, is under a huge amount of pressure. A simple Google of ‘life of an internal auditor’ or search for relevant hash-tags on Twitter will show that this situation is very much real.

So how do we fix this?

Simply forcing firms to work together is not going to prevent this issue from occurring again. If anything, it would likely result in more errors.

I believe the FRC, through consultation with Professional Groups, accounting firms and, should consider the development of mandatory floors.

Starting with a trial and proper investigation to determine its feasibility and impacts, businesses should be categorised based on either one or a combination of annual turnover, assets or employee numbers. This category then sets a minimum price floor that a firm can charge a client. The price floor should also be reflective of a resourcing floor. As an example (and the numbers used here are very very rough):

A large national company with revenue of £500 million may be classed as a ‘Large National Business’. A price floor of, for argument sake, £300,000 may be set, meaning no accounting firm can provide services for less than this amount. Further, the price floor set means the firm must allocate 1x Partner, 1x Manager, 1x Assistant Manager, 2x Accountants and 1x Graduate / Junior Accountant. An effort of time should be set per person (e.g Partner must perform 8 hours per week).

Financial Report Council – Developments in Audit – October 2018

Whilst the numbers used above are purely to illustrate an example, the setting of minimum floors would ensure that audits are appropriately resourced, and any timeframe or budget constraints are removed. The FRC can easily monitor this, with audit firms and companies being required to submit a statement signed by both parties demonstrating the requirements have been upheld. This would then allow the FRC to fine firms and Partners found breaching the mandatory requirements.

The minimum price floors imposed on accounting firms, whilst potentially increasing revenue for firms, should allow firms to invest in better on job training, formalised classroom training and in-house audit quality review programs. It would be expected that an investment in these areas by firms would mean audit quality results as reported by the FRC, would begin to improve. The 2018 audit quality results showed that the % of audits rated good or requiring limited improvements has decreased and is almost back to the same level as 2014/15 (coincidently when the Tesco scandal occurred). Are we on track for more audit issues and business collapses?

This is only one potential way of resolving an issue, but I suspect it would be better received than the current approach thrown around by the FRC.

At the end of the day; businesses are responsible for their own success or failure, however audit firms need to shape up and improve their audit quality, and the FRC needs to be more proactive in how it monitors audit quality and prevents similar situations in the future.

Failure to fix this issue quickly will only result in more issues, and at the current rate, another one will happen soon.