Memorandum by the Financial Reporting
Council (ADT 24)
1. INTRODUCTION AND
1.1 The Financial Reporting Council (FRC) welcomes
the opportunity to give evidence to the Economic Affairs Committee's
inquiry into Auditors: Market concentration and their role.
1.2 The FRC is the United Kingdom's independent
regulator responsible for promoting high quality corporate governance
and reporting to foster investment. The FRC and its operating
bodies have a number of responsibilities in relation to audit,
including policy, standards, monitoring and investigations. These
functions are carried out with the primary goal of improving audit
1.3 The FRC is concerned about the current concentration
in the audit market and we have expressed these concerns for some
time. Currently, the audit market is not delivering a fully competitive
environment, particularly for FTSE 100 and FTSE 250 companies
and in sectors such as banking and insurance. Choice and innovation
in the market are therefore less extensive than we would wish.
We are also concerned about the disruption and cost that would
arise in the event of a large firm leaving the market and a subsequent
reduction to three or fewer major players.
1.4 We have attempted to address these concerns
over the last five years but with no real change in the level
of concentration. A new analysis of the impact of the current
market structure is now warranted. It needs to take into account
the global nature of the audit market and seek the advice of competition
authorities here and overseas.
1.5 The FRC works unequivocally to enhance audit
quality, which enables investors to make sound judgments, and
thereby supports efficient capital markets. We believe that further
safeguards should be put in place to enhance audit quality. Specifically,
the regulatory framework which determines the relationship between
the FRC, audit firms and professional accounting bodies should
be strengthened to provide greater transparency, accountability
and independence in the public interest.
1.6 We particularly recommend that the FRC should
take on certain functions of the professional bodies and should
have a wider range of sanctions to address shortcomings in audit
quality and for use in disciplinary situations. For example, we
believe the FRC should have responsibility for the licensing of
auditors of public interest entitiesa task that should
be undertaken in addition to the general licensing of auditors
within the profession itself.
An unambiguously robust and independent regulatory
oversight of the audit profession would ensure a speedier response
to risks, an increased focus on audit quality and, ultimately,
enhanced market confidence in the role and value of audit.
1.7 The Government's decision to abolish the
Audit Commission should be used as a catalyst for greater competition
in the audit market. The Commission's in-house audit practice
is the fifth largest in the UK. Although this work is not in the
corporate sector and does not address the international coverage
issues, if secured by a non Big Four firm it would enhance their
scale and strength and so reinforce their ability to compete.
Conversely, if the work goes to the Big Four, the reverse will
2. CURRENT SCOPE
2.1 Audit gives confidence to investors and
supports effective capital markets. It provides independent assurance
to shareholders that the directors have prepared the financial
statements properly and that those statements provide a true and
fair view. Additionally, although not its primary purpose, the
existence of an audit acts as a deterrent to fraud.
2.2 Given its importance, audit must be done
well and investors must have justifiable confidence in its quality.
Audit quality is difficult to define and there is no agreed definition
of audit quality that can be used as a standard against which
actual performance can be assessed. The FRC has sought to address
this and to improve understanding of audit quality via its Audit
Quality Framework (AQF). The AQF identifies key characteristics
and drivers of audit quality to assist companies, audit committees
and other stakeholders to assess the effectiveness of audit and
2.3 Changes that affect the UK audit market
should not be made without consideration to the profession's competitive
strength and its strategic importance (as part of a successful
professional services sector) to the UK economy. Accounting standards
are based on international requirements and the largest audit
firms are members of international networks and serve many clients
with global operations. Any significant regulatory change that
would affect the structure of the auditing profession or the role
of audit needs to be considered on an international basis.
2.4 The Enron scandal and the subsequent collapse
of its auditor, Arthur Andersen, in 2001 led to worldwide concerns
about the quality and reliability of audit. In the UK, those concerns
were addressed by the introduction of independent monitoring of
public interest auditors, oversight and standards-setting to the
auditing profession, which had previously been self-regulating.
The FRC and its operating bodies were given responsibility for
this independent regulation in 2005.
2.5 The auditing profession in the UK has a
long history. Most of today's global firms have their origins
in UK-based practices. Today, the FRC and the UK profession provide
worldwide thought leadership on matters such as auditing standards,
ethics and governance.
Individuals from the UK are prominent on international regulatory
bodies and in the global governance of the largest firms. The
UK's thought leadership provides a catalyst for international
developments and debate.
2.6 The audit profession's history and importance
to capital markets provide evidence of its strengths. The monitoring
work of the FRC's Audit Inspection Unit (AIU) also indicates that
the audits of most listed companies are performed to an adequate
standard. That assessment does not mean, however, that there is
no room for improvement. The number of audits requiring significant
improvement is too high at around 13% of those inspected. The
AIU's report on the 2009-10 round of inspections also noted that
four FTSE 350 audits, including two in the FTSE 100, required
significant improvement. Appendix B gives a detailed breakdown
of AIU inspection findings over the past two years. Whilst the
achievement of the highest AIU quality ranking for all audits
is probably unachievable at a proportionate cost, we believe that
a FTSE 100 audit requiring significant improvement should be a
rare and exceptional event. As noted above, we believe that strengthening
the FRC's powers to include a broader range of sanctions would
both incentivise audit firms to improve the quality of their work
and ensure there were more effective tools available to hold the
firms to account.
2.7 The AIU's inspections in 2009-10 confirm
that major firms have policies and procedures in place to support
audit quality. However, the number of audits requiring significant
improvement indicates that firms are not always consistently applying
their policies and procedures on all aspects of individual audits.
In addition, policies and procedures can only go so far in supporting
and encouraging desirable behaviours to deliver audit quality.
These must be underpinned by other incentives and support for
auditors to exhibit the right behaviours and appropriate sanctions
when they do not.
2.8 In considering behaviour and culture within
the firms, the AIU has identified a number of instances of firms
failing to apply sufficient professional scepticism in relation
to key audit judgements. This lack of scepticism may manifest
itself in a number of ways: over-reliance on management representations;
failure to investigate conflicting explanations; failure to obtain
appropriate third party confirmations; or seeking to obtain evidence
that corroborates, rather than challenges, judgements made by
2.9 Application of appropriate professional
scepticism is vital as, unless auditors are prepared to challenge
management's assertions, they will not be able to confirm, with
confidence, that a company's financial statements give a true
and fair view. The AIU therefore looks closely at the evidence
of scepticism during its inspections and, if concerned, will seek
an improved approach by the firm. The AIU also pays attention
to whether recruitment, appraisal and promotion policies reward
personnel for delivering high quality audits including displaying
appropriate scepticism in their audit work.
2.10 We believe that audit firms and the
profession should do more to promote auditor scepticism, for example
during recruitment, training and continuing professional development.
We have recently published a discussion paper
to promote debate on these issues within the profession.
2.11 In addition to our focus on scepticism
we also believe it necessary to remain vigilant about the potential
for conflicts of interest to arise when an auditor provides non-audit
services to their audit clients and for these to undermine audit
quality. The primary purpose of audit is to provide assurance
to shareholders. However, auditors are in practice selected by
a company's management and the appointment only ratified by shareholders,
who rarely show interest in the choice. Auditor independence rules
exist in part to minimise the risk that auditors become overly
influenced by client management, for example in the hope of winning
contracts for non-audit work.
2.12 The rules on auditor independence are set
through the Auditing Practices Board's (APB) Ethical Standards.
The APB has recently consulted on whether auditors should be subject
to further restrictions. It has concluded that there is not sufficient
evidence to warrant an outright ban on the provision of all non-audit
services to audit clients. Indeed all stakeholders, including
investors, generally opposed the suggestion. However, the APB
has concluded that some tightening of the standards is justified
and has recently published revised provisions for comment.
2.13 Audit quality is not driven by auditors
alone. Auditors report on the financial statements which have
been prepared under particular accounting standards. Those accounting
standards should facilitate the production of an accurate picture
of the company's financial health. If they do not, auditors cannot
be expected to rectify such deficiencies.
2.14 Corporate behaviour also plays a significant
role. Boards are stewards of investors' money and have a responsibility
for ensuring that the corporate culture and environment is one
which encourages open dialogue with their auditors at all levels.
Auditors and individual partners should not fear removal if they
challenge management assumptions.
2.15 Audit committees have primary responsibility
for the appointment, reappointment and removal of external auditors,
and should also review annually the effectiveness of their audit
arrangements including the experience, expertise, resources and
independence of the audit firm. Audit firms report to us that
strong and effective audit committees are a powerful driver of
audit quality and that there has been an improvement in the overall
effectiveness of audit committees in recent years.
3. WIDENING THE
3.1 Despite enhancements in the regulatory environment
and in overall audit quality there remains evidence of an expectation
gap between the actual scope of an audit and public perception
of the information an audit should reveal. This gap was particularly
evident in much of the commentary following the financial crisis,
with many people querying how a bank could have received an unqualified
audit report, only to collapse a few months later.
3.2 In recent months there have been suggestions
from various market participants, including some audit firms,
that there would be value in widening the scope of audit and in
extending reporting requirements beyond shareholders to include
bodies such as regulators.
3.3 In June 2010 the FRC and FSA published jointly
a discussion paper
on the contribution the auditor could make to prudential regulation.
The paper suggests a number of recommendations, which are intended
to contribute to better supervision of banks and financial institutions.
3.4 The European Commission plans to publish
a Green Paper on audit in the autumn and is currently consulting
on the role of audit as part of its recent Green Paper on corporate
governance. Early feedback suggests that auditors could validate
a wider range of risk-related information on financial institutions
and engage more closely with supervisory authorities. Although
focused on financial services, there is no reason why such an
extended audit approach could not be applied across other sectors.
3.5 For its part the FRC has recently launched
a project to examine the lessons from the financial crisis and
other market developments as they impact on corporate reporting,
accounting and auditing of non-financial services companies. To
assist with this, the FRC has appointed an advisory group consisting
of senior figures from business and the accountancy profession.
A discussion document will be published later this year, covering
various matters including whether the role of audit should be
extended. Our consultation is likely to cover the following topics:
Greater transparency on the level of
assurance provided by the audit;
Enhanced reporting of the auditor's views
on matters arising from the audit, such as values involving significant
Assurance on the directors' narrative
Reporting on risk/company's business
Cost-effectiveness of any changes;
Safe harbour against liabilities arising
from any extra work.
3.6 We will be able to provide further information
about this work, including an indication of our early conclusions,
in oral evidence to the Committee. We believe it is particularly
important to ensure that responsibility and accountability rest
in the right place between management, the Board and its audit
committee, and the auditor. We would be happy to provide a written
update later in the autumn if that would be helpful to the Committee.
4. MARKET CONCENTRATION
4.1 The market for the audits of the UK's largest
companies is highly concentrated. The "Big Four"
audit 99% of the FTSE 100 and 95% of the FTSE 250. Similar levels
of concentration are seen in most other developed countries.
4.2 There are a number of reasons for this concentration,
which are explored in more detail in Appendix A. However, we believe
that market perception is the main barrier to the expansion of
non-Big Four firms into the audit market for large public interest
entities. Appendix C shows current levels of concentration in
the London main market and in AIM. It is notable how few of the
smaller fully listed companies use a non-Big Four auditor in comparison
to AIM companies. There appears no other obvious explanation for
the difference in concentration between these markets. Mid-tier
firms may not have the resources to audit the very largest companies,
but they are quite capable of auditing a far broader range of
companies than is currently the case.
4.3 We believe the economic impact of such a
concentrated audit market should be investigated. The investigation
should be charged with identifying the causes and effects of market
concentration, for example on audit fee levels, as well as identifying
catalysts for greater competition.
4.4 Negative features of the current market
The potential for moral hazard as the
largest firms consider they are "too big to fail" and
judge that governments and regulators will be reluctant to take
enforcement action against them if that action had the potential
to result in the firm leaving the market. At the FRC we would
not moderate our actions to protect a firm from failure but it
is of concern that some believe such a risk exists.
Lack of choice for large companies, particularly
those in certain industries (such as banking and insurance) where
only two or three firms are judged to have the appropriate expertise
to act as auditor. If the company uses another large firm for
other services, such as corporate finance, it may find itself
without an effective choice of auditor in the short term due to
Lack of innovation in audit, with all
large firms offering a virtually identical product.
Regulatory restrictions on the scope of audit, independence rules
and the format of the audit report offer only a partial explanation
for this lack of innovation.
Little indication that the large firms
attempt to distinguish between themselves, or to compete, on quality.
4.6 Our most immediate concern is that the highly
concentrated market for audit services, and a litigious market
(especially in the US), poses a risk that one of the Big Four
could fail. Such a failure may be unrelated to audit; all of the
large firms operate other lines of business, some of which, such
as corporate finance, are inherently risky and could have significant
adverse impact on their reputation with clients and prospective
clients. In addition, as the large firms are all members of international
networks, the event would not necessarily have to take place in
the UK. Whatever the nature and cause of the event, the subsequent
collapse of public confidence in the stricken firm could quickly
result in an exodus of clients and senior personnel, effectively
destroying the business.
4.7 A large firm leaving the market would result
in severe disruption to capital markets in the UK and globally,
as investors lose confidence in the financial statements of the
firm's audit clients. In the longer term, the difficulties around
lack of choice and independence conflicts identified above would
be exacerbated. Additionally, if the event were audit-related,
the remaining firms may become reluctant to audit companies in
high risk industries and may even begin to withdraw from certain
sectors of the market. At a minimum, a market with three or fewer
large firms is likely to require a significantly more intrusive
regulatory environment and therefore cost.
4.8 However, we do not believe that the Big
Four should be preserved at all costs, and regulators and legislators
should not be afraid to take action against a Big Four firm if
it is warranted. We would certainly not wish to preserve a firm
from commercial failures. We would prefer to see action after
failure to prevent the market becoming dominated by just three
4.9 In 2006 the FRC and the then DTI commissioned
Oxera to produce a study
on the UK audit market. Following the publication of the Oxera
study, the FRC consulted on a discussion paper seeking stakeholder
views on mitigating risks arising from market concentration. Respondents
to the discussion paper had a clear preference for market-based
solutions to these risks and to assist in the identification of
such solutions the FRC created the Market Participants' Group
(MPG) which issued 15 recommendations
aimed at reducing risk and increasing choice in the audit market.
4.10 The FRC has been monitoring the implementation
of these recommendations and published the most recent Progress
Report in June 2010. The majority of the recommendations have
been implemented but to date this market-based approach has had
minimal impact on market concentration.
4.11 Taking into account the evidence the FRC
has received to date, we do not believe that purely market-based
solutions have had, or will have, a significant impact on concentration
and choice, and that there is a need for regulatory solutions.
In June we committed to publishing by the end of 2010 an analysis
of the work done so far on the Audit Choice project, together
with suggestions for further action. However, given the initiative
planned by the Committee we will defer this until we have seen
4.12 Furthermore, in light of the decision to
abolish the Audit Commission, the Government should use the opportunity
afforded by this change to open up competition to non-Big Four
accountancy firms to take on work currently conducted by the Audit
5.1 The FRC welcomes this inquiry and looks
forward to playing a part in the solution to the current problems
caused by a highly concentrated audit market.
5.2 The FRC believes it has a significant role
to play in driving up audit quality and encouraging a more competitive
audit market. Currently, the FRC's work shows that audit quality
is of an acceptable standard, although a significant minority
of audits remains unsatisfactory. With increased powers and a
tiered sanctions regime, the FRC could be more effective at holding
the profession to account and improving standards.
5.3 Consideration should be given to extending
the current scope of audit. However, any changes must be examined
carefully to assess their cost-effectiveness and impact on the
5.4 Concentration in the audit market limits
choice and poses a substantial risk to capital markets. Market-led
solutions have not proved effective and therefore regulatory solutions
should now be considered.
5.5 Given the AIU's inspection findings, the
FRC is mindful that any efforts to improve choice must not be
at the expense of quality.
5.6 The FRC stands ready to work with the Committee
to identify and implement practical and workable policies that
will improve audit choice and quality for the good of the capital
APPENDIX A: CALL FOR
Q1 Why did auditing become so concentrated
on four global firms? For example, do economies of scale make
it too difficult for smaller firms to compete?
A1 There are many reasons for the dominance
of the UK audit market by the Big Four and these are explored
at length in the Oxera study
referenced in the main body of our submission. However, some of
the most important include:
The desire for the largest and most complex
global companies to use an audit firm with a strong international
Difficulty for new or growing audit firms
to raise sufficient capital to expand into the market for the
The ability for audit firms to achieve
sufficient scale to absorb the cost of investment in new or emerging
The increased size and complexity of
companies being audited.
Regulatory decisions permitting the Coopers
& Lybrand/Price Waterhouse merger.
The collapse of Arthur Andersen.
Market perception or the "IBM factor";
there is evidence that listed companies are often reluctant to
choose a non-Big Four auditor for real or perceived reputational
reasons. On occasion this perception we are told is backed up
by contractual obligations, for example clauses in loan covenants
which specify that the company may only engage certain auditors.
Q2 Does a lack of competition mean clients
are charged excessive fees?
A2 Competition theory would suggest that high
market concentration and limited tenderingboth of which
are features of the audit market for listed companieslead
to higher fees.
When audit tenders do take place there is usually
strong price competition and in many cases the new audit fee is
substantially lower than the previous fee. However, relatively
few tenders take place.
Analysis by Oxera suggested that the Coopers
& Lybrand/Price Waterhouse merger had led to a 12% overall
increase in audit fees. A number of other academic studies
support the view that consolidation in the audit market has increased
the level of audit fees. Oxera's conclusions were however disputed
by some of the large firms and, given the FRC's focus on quality,
this issue was not pursued further.
Q3 Does a narrow field of competition affect
objectivity of advice provided?
A3 We do not believe that concentration in the
market has affected audit firms' objectivity directly. However,
audit firms also provide a number of other services, eg tax and
consulting, and the reputation firms have earned through their
audit work has led to concentration in these other markets as
well. It is therefore the degree of concentration and market dynamics
for non-audit services that creates the actual and perceived risks
to auditor objectivity which the Ethical Standards are designed
Q4 Alternatively, does limited competition
make it easier for auditors to provide unwelcome advice to clients
who have relatively few choices as there is less scope to take
their business elsewhere?
A4 Strong audit firms contribute to audit quality.
Strong audit firms provide a safeguard against the risks associated
with providing unwanted advice. No one audit client is so significant
to the overall long term success of a major firm that it is worth
risking its reputation for. The challenge for major firms is in
balancing the risks of the short term impact of the loss of a
major client with the longer term reputational impact of not providing
unwelcome advice when necessary. This is risk is greater in relation
to the significance of individual clients to the reputation and
profile of individual partners within major firms and various
safeguards have been established to mitigate against this.
contribute also to quality because they have the capital to invest
in the training, systems and expertise necessary to deliver high
quality and effective audits.
Q5 What is the role of auditors and should
it be changed?
A5 As noted in paragraph 2.1 of our main submission,
the purpose of audit is to provide independent assurance to shareholders
that the company's directors have prepared the financial statements
properly, and that those statements provide a true and fair view.
In paragraphs 3.13.6 we set out the arguments for enhancing
the scope of audit and the role of auditors. There is much to
recommend such an enhancement, but any changes must be cost-effective
and must not put the UK at a disadvantage when compared to other
major capital markets.
Q6 Were auditors sufficiently sceptical when
auditing banks in the run-up to the financial crisis of 2008?
If not, was the lack of competition in auditing a contributory
A6 See paragraphs 2.92.11 of our submission
for our comments on scepticism. The FRC has not seen any evidence
that concentration in the audit market contributed directly to
the financial crisis.
Q7 What, if anything, could auditors have
done to mitigate the banking crisis? How can auditors contribute
to better supervision of banks?
A7 As noted in paragraph 3.3 of our main submission,
in June 2010 the FRC and FSA published jointly a discussion paper
on the contribution the auditor could make to prudential regulation.
The paper suggests a number of recommendations, which are intended
to contribute to better supervision of banks and financial institutions:
Meetings between the FSA and the auditors
of high impact financial institutions should occur more frequently
and at an earlier point in the audit process.
Enhanced engagement between auditors
and the FSA should result in an increase in statutory and voluntary
reports by audit firms to the FSA.
Further information-sharing between the
FSA and parts of the FRCincluding the Audit Inspection
Unit, Financial Reporting Review Panel and Accountancy & Actuarial
Q8 How much information should bank auditors
share with the supervisory authorities and vice versa?
A8 The FRC/FSA paper mentioned above discusses
this point in some detail. Currently, supervisors meet with the
auditors of "high impact" financial services firms (such
as banks) at least annually. There is evidence that auditors have
not always shared all relevant information with supervisors and
there have been occasions where, for example, both the FSA and
the audit firm have been pressing management on a particular judgement,
but neither was aware of the other's concern. Where there is a
concern, the default for both the auditors and the supervisors
should be to share information unless there are legal or regulatory
impediments to them so doing.
Going forward, the FSA proposes more frequent
meetings between auditors and supervisors and also that they be
held earlier in the audit process. Trilateral meetings between
auditors, supervisors and the bank's audit committee have also
Q9 If need be, how could incentives to provide
objective and, in some cases unwelcome, advice to clients be strengthened?
A9 Several incentive factors may encourage auditors
to display scepticism and to deliver unwelcome advice when necessary.
At firm and at office/business unit level, no single client should
represent a disproportionate amount of revenue. In addition, the
firm's management should show a proper concern for reputation
and exposure to litigation and should set an appropriate "tone
from the top".
On an individual level, firms should ensure
that their recruitment, appraisal and promotion policies reflect
and reward personnel who display appropriate scepticism in their
audit work. Firms should be aware of the risks arising from individuals'
long association with a particular client.
Regulators such as the FRC provide an incentive
to firms to provide such advice due to the reputational risks
associated with the transparency of the FRC's findings from audit
monitoring and inspection. This incentive could be enhanced by
a wider range of sanctions for use where examples of poor quality
are identified and in disciplinary situations, allowing proportionate
action to be taken whilst retaining the nuclear option of withdrawal
of a firm's audit licence.
Q10 Do conflicts of interest arise between
audit and consultancy roles? If so, how should they be avoided
A10 As noted in paragraph 2.12 of our submission,
there is the potential for conflicts of interest where auditors
provide consultancy or other non-audit services to their audit
clients. UK Ethical Standards, along with similar rules elsewhere
in the world,
contain prohibitions on certain activities, such as auditing ones
own work, acting in a management capacity or acting as advocate
for an audit client. Other services may not be prohibited, but
are recognised as a threat to independence which can be mitigated
by the application of appropriate safeguards, such as restrictions
on who may undertake particular work or review by partners or
firms independent of the audit.
Increased transparency also mitigates this risk,
for example through disclosure in the audit client's accounts
of the type of non-audit services provided by and fees paid to
In its most recent Annual Report
the AIU highlighted its concerns over whether firms too readily
identify safeguards to mitigate threats to their objectivity and
the effectiveness of those safeguards. In particular the AIU recommended
that firms must embrace the principles underlying ethical standards
and accept they should not provide non-audit services to audit
clients when appropriate safeguards do not exist.
Q11 Should more competition be introduced
into auditing? If so, how?
For the reasons set out in the main body of
our submission, the FRC believes that the audit market would benefit
from greater competition. This is not a simple thing to achieve
in the short to medium term. Market-led solutions have not been
effective to date and there may be a need to consider regulatory
However, we would stress that any effort to
reduce the degree of concentration in the market must not be at
the expense of audit quality.
Q12 Should the role of internal auditors
be enhanced and how should they interact with external auditors?
The internal audit function is intended to provide
management with a degree of assurance on internal controls. There
is, therefore, some overlap between internal and external audit.
Analysis of the credit crisis has identified
concerns about the quality of information about risk and internal
control on which boards base their decisions, and raised the question
of how boards can get assurance that they are receiving the information
they need at the appropriate time. One way in which this might
be done would be through an enhanced role for internal auditors.
This is an issue on which the FRC will be consulting as part of
its review of its existing guidance on risk management and internal
control, which is due to begin later in 2010.
In recent months some audit firms have offered
clients a new service, which includes as part of the external
audit service certain functions traditionally associated with
internal audit. We understand that combining certain internal
and external audit functions can be attractive financially to
the client. However, there is a risk that auditors offering both
services can find themselves in breach of independence requirements
by auditing their own work and/or acting in a management capacity.
The AIU and APB have looked into one high-profile example of this
(Rentokil plc) and believe that the service as described is compatible
with existing independence rules. We will keep developments in
this area under review.
Q13 Should the role of audit committees be
The main role and responsibilities of audit
committees are set out in some detail in the UK Corporate Governance
Code and accompanying FRC guidance. The issue is less whether
the role should be enhanced but whether it can be carried out
more effectively. As noted the overall effectiveness of audit
committees is considered to have improved in recent years, and
the FRC is hopeful that the recent changes to the UK Corporate
Governance Code will lead to further improvements.
The FRC is currently consulting on guidance
to audit committees that is intended to improve transparency of
a company's policies in relation to the provision of non-audit
services, in parallel with the consultation on the Ethical Standards
referred to in the main submission.
Audit committees also have a responsibility
for assessing the effectiveness of their audit arrangements and
the FRC provides information to assist in this process. However,
from an initial review of 57 sets of accounts for the financial
year ended 31 December 2008 (including 23 FTSE 100 companies)
it was not evident that audit committees had either complied with
FRC guidance or made use of the Audit Quality Framework or of
the additional information on audit quality which we have made
available. It is unclear to us whether audit committees require
further guidance and information to discharge this responsibility
Q14 Is the auditing profession well placed
to promote improvement in corporate governance?
External auditors have a role to play in those
aspects of corporate governance relating to financial reporting,
in particular risk management and internal control. Listed companies
in the UK are required under the UK Corporate Governance Code
to issue an annual internal control statement. Under the UKLA's
Listing Rules auditors are required to review this statement,
and the FRC's Auditing Practices Board issues guidance on how
this should be carried out. It is for consideration whether this
role should be enhanced.
The case for auditor involvement in other aspects
of corporate governance is less compelling. It would not be appropriate
to ask the auditor to opine on issues such as the composition
of the board, for example, which are rightly a matter for the
board and shareholders and on which the auditor has no particular
competence. As noted in paragraph 3.5 of our submission, there
may, however, be an argument for auditors to verify the accuracy
of some disclosures.
|Good with minor improvements required
||Acceptable but with improvements required
||Significant improvements required
|Other major firms||8||25.0
The table above shows the results of AIU inspections over the
last two years, broken down by the size of firm and the AIU's
grading of the audit.
The "Big Four" are Deloitte, Ernst &
Young, KPMG and PricewaterhouseCoopers
"Other major firms" are those firms outside
the Big Four which are subject to a full scope AIU inspection.
There are five such firms: Baker Tilly, BDO, Grant Thornton, Horwath
Clark Whitehill and PKF
"Smaller firms" include all other firms
which audit between one and ten public interest entities. Individual
audits conducted by these firms are subject to AIU review but
monitoring of firm-wide procedures is delegated to the monitoring
units of the recognised supervisory bodies.
There is a fourth category of firm which makes up
the bulk of the 8,000 firms registered for audit in the UK. These
firms do not audit any public interest entities and are reviewed
solely by the monitoring units of the recognised supervisory bodies.
APPENDIX CMARKET CONCENTRATION BY INDEX MAY 2010
| Auditor||FTSE 100
||FTSE 250||Fledgling/ Small Cap
| Number of Companies||100
|Ernst & Young||16
|Horwath Clark Whitehill||0
|Non Big Four Share||1%
Based on Hemscott Corporate Advisers Rankings Guide with
the agreement of Hemscott, a Morningstar company. Figures include
companies treated as FTSE constituents by the London Stock Exchange.
Table shows percentages except where otherwise stated.
The UK is the first major jurisdiction to introduce a governance
code for large audit firms, including the appointment of independent
"Auditor scepticism: raising the bar", APB/POB,
"Enhancing the auditor's contribution to prudential regulation",
FRC/FSA, 2010. Back
The "Big Four" audit firms are Deloitte, Ernst &
Young, KPMG, and PricewaterhouseCoopers. Back
The only recent example we have seen of innovation in the audit
product is the "extended audit" service offered to some
large companies such as Rentokil plc. Back
"Competition and choice in the UK audit market",
Oxera, 2006. Back
"Choice in the UK audit market: final report of the Market
Participants' Group", FRC, 2007. Back
"Competition and Choice in the UK audit market, Oxera,
"No one gets fired for buying IBM". Back
For example Basioudis & Ellwood (2005); Beattie, Goodacre,
Pratt & Stevenson (2000). Back
Not just the Big Four, but a number of other large firms. Back
For example: the IFAC Code of Ethics; SEC independence rules. Back
"2009/10 Annual Report", AIU, 2010. Back