The accounting watchdog in the UK has told Deloitte, EY, KPMG, and PwC to split their audit and consulting businesses in the next four years. This is in a bid to improve corporate reporting following a string of high-profile accounting scandals.
The Financial Reporting Council said in a statement Monday that the Big 4 firms have until October 23 to submit a plan for implementing ‘operational separation’, which will need to be completed by June 2024. According to the Financial Reporting Council, the objective of the operational separation by the Big Four is to ensure that audit practices are focused on the delivery of high-quality audits in the public interest and do not rely on persistent cross-subsidy from the rest of the firm.
This move is singlehandedly the biggest shake-up of the audit industry in decades. The FRC said the big four should focus on the delivery of high-quality audits in the public interest. Audits shouldn’t depend on financial support from the rest of the firm.
The Reason For The Separation
So, this new development was triggered just weeks after Germany’s Wirecard filed for insolvency following the discovery of a $2 billion hole in its accounts. The scandal attracted public criticism and raised questions over how the payments company’s auditor, EY, could have missed the accounting irregularities for so long and led to fresh scrutiny of the sector. Investors rely on auditors for assurance that a company’s accounts provide a true reflection of its earnings.
Furthermore, a lot of discrepancies that hovering around the operations of the auditing giants has led to this new development. Also, strings of corporate failures, including Carillion and BHS, which led to three government-backed reviews that recommended wide-scale reforms.
The spokesperson for the FRC made it clear that Monday’s announcement is unrelated to Wirecard saga. He said the regulators had already planned to publish the guidelines — the outcome of several independent reviews into the quality and effectiveness of auditing and corporate reporting.
Regulators say that the companies’ lucrative advisory arms create a conflict with their auditing divisions as it encourages auditors to be restrained in order to protect consulting opportunities.
“Today the FRC has delivered a major step in the reform of the audit sector,” FRC CEO, Jon Thompson said in a statement, adding that the regulator plans to introduce “further aspects of the reform package over time.”
Under the new principles, the finances of audit divisions must be ringfenced with a separate profit and loss account. Also, firms will have to introduce an independent audit board to oversee the practice.
The Big Four Revenue From Consulting
The Big Four (PwC, Deloitte, KPMG, and EY) now generate the majority of their revenues from consultancy practices, with only around 20% coming from auditing. The new principles seek to address concerns that the growth in consultancy revenues has reduced the focus on audit quality. FRC figures show that audit fees accounted for only about a fifth of the Big 4’s £10.95 billion ($13.7 billion) in combined fee income in the United Kingdom in 2018.
While this might come as a shock to many, the parties involved, Big 4 firms have welcomed the announcement. They stated that this will help to restore confidence in the sector.
What’s your take on this? Do you think they should be regulated?
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