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

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
Paddington Station
22nd February, 1872' 

2   Q 404 (Mr David Pitt-Watson, Hermes Investments). Back

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