Auditors: Market concentration and their role - Economic Affairs Committee Contents

Memorandum by the Financial Reporting Council (ADT 24)


  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 quality.

  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 entities—a 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 be true.


  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 auditors.

  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.[1] 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 client management.

  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[2] 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.


  3.1 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[3] 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 judgements;

    — Assurance on the directors' narrative reports;

    — Reporting on risk/company's business model;

    — 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.


  4.1 The market for the audits of the UK's largest companies is highly concentrated. The "Big Four"[4] 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 include:

    — 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 independence restrictions.

    — Lack of innovation in audit, with all large firms offering a virtually identical product.[5] 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 firms.

  4.9 In 2006 the FRC and the then DTI commissioned Oxera to produce a study[6] 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[7] 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 its conclusions.

  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 Commission.


  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 UK's competitiveness.

  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 market.

September 2010


  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[8] 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 network.

    — Difficulty for new or growing audit firms to raise sufficient capital to expand into the market for the largest companies.

    — The ability for audit firms to achieve sufficient scale to absorb the cost of investment in new or emerging markets.

    — 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[9]"; 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 tendering—both of which are features of the audit market for listed companies—lead 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[10] 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 to address.

  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.

  Strong firms[11] 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 3.1—3.6 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 factor?

  A6 See paragraphs 2.9—2.11 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 FRC—including the Audit Inspection Unit, Financial Reporting Review Panel and Accountancy & Actuarial Discipline Board.

  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 been proposed.

  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 or mitigated?

  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,[12] 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 the auditor.

  In its most recent Annual Report[13] 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 alternatives.

  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 enhanced?

  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 effectively.

  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 TOTAL

Firm typeNo.% No.%No. %No.%
Big 46055.5 3835.210 9.3108100.0
Other major firms825.0 1856.26 18.832100.0
Smaller firms418.2 731.811 50.022100.0
Overall total72 6327 162

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.


AuditorFTSE 100 FTSE 250Fledgling/ Small Cap Aim
Number of Companies100 2504131012
%% %%
PricewaterhouseCoopers40 27.32211.6
KPMG2322.2 2215
Deloitte2026.6 19.110.8
Ernst & Young16 18.717.97.8
BDO12.4 3.913.7
Grant Thornton01.6 9.218.4
PKF00 14
Baker Tilly00 17.3
Horwath Clark Whitehill0 001
Others00.2 4.110.4
Non Big Four Share1% 4.4%19.2%54.7%

  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.

1   The UK is the first major jurisdiction to introduce a governance code for large audit firms, including the appointment of independent non-executives. Back

2   "Auditor scepticism: raising the bar", APB/POB, 2010. Back

3   "Enhancing the auditor's contribution to prudential regulation", FRC/FSA, 2010. Back

4   The "Big Four" audit firms are Deloitte, Ernst & Young, KPMG, and PricewaterhouseCoopers. Back

5   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

6   "Competition and choice in the UK audit market", Oxera, 2006. Back

7   "Choice in the UK audit market: final report of the Market Participants' Group", FRC, 2007. Back

8   "Competition and Choice in the UK audit market, Oxera, 2006. Back

9   "No one gets fired for buying IBM". Back

10   For example Basioudis & Ellwood (2005); Beattie, Goodacre, Pratt & Stevenson (2000). Back

11   Not just the Big Four, but a number of other large firms. Back

12   For example: the IFAC Code of Ethics; SEC independence rules. Back

13   "2009/10 Annual Report", AIU, 2010. Back

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