Auditors: Market concentration and their
role
CHAPTER 1: Introduction
1. In 1849 a Select Committee of the House of
Lords inquired into Audit of Railway Companies. Its report
is credited with helping establish the audit profession; certainly
by 1872 the Great Western Railway had an external auditor (Mr Deloitte)
and an audit committee.[1]
2. Much has changed since then. Audit is long
established as essential to the working of publicly-listed companies.
Today's investors confirm that it still provides indispensable
assurance: "Audit and accountancy are absolutely fundamental
to the integrity of our capital markets and the good governance
of our companies."[2]
3. Medium and large companies and banks are obliged
by law to have their annual financial statements audited by qualified
auditors. Financial statements are drawn up by companies' managements
and directors. They are a snapshot of a company's position at
a given moment and of the results of operations over the past
period. The auditor's report and opinion are published with the
financial statement and provide reasonable assurance that the
company's financial statements are true and fair and free from
material misstatements.
4. Audits are usually carried out by accountancy
firms. There are many in the United Kingdom and elsewhere. But
large company audit is mostly in the hands of the "Big Four"
international networks: Deloitte, Ernst & Young, KPMG and
PricewaterhouseCoopers. Their dominance of the market raises concerns
about competition and choice in the provision of a service their
clients have no choice but to buy. Since most of the Big Four
began here, and London is a leading financial centre, it is right
for a British parliamentary Select Committee to look into these
concerns, although measures proposed to address them need to take
account of the global nature of the audit market.
5. Since statutory audit is concerned mainly
with companies' financial statements for the past period, it is
largely backward-looking, though it includes a view that the company
remains a going concern. This limitation is not always understood.
Auditors' endorsements of financial statements are sometimes taken
as forecasts of good financial health. Misunderstandings on these
lines help form an "expectations gap". Critics who do
understand its role also question whether statutory audit meets
all today's needs and advocate more emphasis on the going concern
statement, the forward-looking element in an audit report. We
have heard other suggestions for widening its scope, usually at
some cost.
6. Audit is shaped by the accounting standards
underlying companies' financial statements. In recent years, United
Kingdom Generally Accepted Accounting Principles (UK GAAP) are
being replaced by International Financial Reporting Standards
(IFRS), which it is intended will be adopted globally and help
encourage international trade and investment. But critics say
IFRS is lowering the quality of audit by reducing scope for the
exercise by auditors of prudence, scepticism and judgment in favour
of a rules-based, box-ticking approach. They also question the
ability of regulators to maintain standards.
7. Concerns about market concentration and about
the scope, relevance, quality and regulation of traditional audit
were exacerbated by the financial crisis of 2007-09 when bank
audits were seen to fail to give warning of imminent collapse,
and seem simply to have monitored compliance with the law rather
than prudence. There is a striking contrast between the generally-recognised
high quality of the Big Four's audit work and their failure to
spot systemic risk in banks. Questions have arisen in particular
about communication between the auditors and regulators of banks.
8. All these concerns would become much more
acute if for any reason the Big Four were reduced to a Big Three.
As things stand, only three of the Big Four audit large banks
in the UK; withdrawal from the audit market of one of the Big
Four could in the worst case reduce the number of bank auditors
to two.
9. In this report we examine and make recommendations
on these complex and sometimes intractable issues, recognising
that they are also being looked at by other bodies, national and
international.
10. We are grateful to all our witnesses for
their written and oral evidence to the inquiry.
1 The Minute (quoted in Tricker, R I, (1978): The
Independent Director-The Role of the Audit Committee, [Tolley],
p56) read:
'Report of the Audit Committee
'The auditors and Mr Deloitte attended the Committee and explained
the various matters connected with the Finances and other departments
of the railway, which explanations were highly satisfactory.
'The Committee consider the Auditors have performed their arduous
duties with great care and intelligence and therefore confidently
recommend that they be continued in office.
Benjamin Lancaster
Chairman
Paddington Station
22nd February, 1872' Back
2
Q 404 (Mr David Pitt-Watson, Hermes Investments). Back
| 
