UK audit firms have come under increased scrutiny in recent years, following several high-profile failures. Audit firms missed red flags in the accounts of BHS (2016), Carillion (2018), Patisserie Valerie and Thomas Cook (2019) before each of their collapses, which has drawn attention to the shortcomings in audit diligence.
Some of these were laid bare in a 2023 report by the Financial Reporting Council, the industry’s regulator, following its investigation into KPMG’s audit of Carillion. Its pages contain references to jokes made by auditors about the poor quality of their work and a scathing indictment of the firm’s failure to adhere to “the most basic and fundamental audit concepts”.
There’s something fundamentally wrong with the audit mission
A lack of good auditing presents a serious risk. An auditor’s job is to verify the accuracy of a company’s financial records and provide a warning if it identifies any signs of financial distress.
Adam Leaver is an accounting professor at The University of Sheffield and director of the Audit Reform Lab think-tank. “Shoddy audit practices can wreak havoc on the economy,” he says. “They lead to fragile businesses, job losses and expensive government bailouts.”
Despite this, the Labour government is contemplating scrapping stricter audit rules for private companies, that were promised by the Conservatives, according to reports. This is part of the government’s wider plan to reduce regulatory barriers and drive economic growth. Leaver argues that such a move fails to acknowledge that financial transparency and accountability are just as important for economic stability and growth as less stringent regulation.
In turning a blind eye to a decade-long problem, he believes UK ministers are putting businesses at risk.
Audit practices are not fit for purpose
A recent study by Audit Reform Lab highlights the threat that poor audit practices pose. It found that, of the 250 publicly traded UK companies that collapsed between 2010 and 2022, auditors failed to raise the alarm in 75% of cases. Worse still, 38 of these firms declared dividends in their last set of accounts and 10 of those did so despite making a loss, which is a sign of insolvency risk.
Of the Big Four auditors, EY performed most poorly, having sounded the alarm for just 20% of collapsed firms. PwC provided warnings in 23% of cases, Deloitte 36% and KPMG 38%. Auditors outside the Big Four provided warnings for just 17% of collapsed firms.
This poor performance is also happening at a time of record partner pay at the largest UK accounting firms.
“There’s something fundamentally wrong about the audit mission,” says Leaver. The sector is plagued by conflicts of interest and poor regulation where auditors are often being paid by the very people they are supposed to be auditing.
The profession, Leaver continues, has become little more than a glorified form of compliance. Auditors are seen as policing the process of reporting rather than upholding accounting rules. The process has become overly procedural and compliance-focused, lacking critical analysis and professional judgement.
“Auditors should be taking a much more critical look at accounts, exercising scepticism and upholding company law, but they often fail to do so,” Leaver says. This lack of objectivity is partly the result of how accounting is still being taught. He adds: “If we were to build the worst possible system, you’d end up with the one we have today.”
A lack of action
Over the past few years, successive governments have emphasised the need to reform the audit sector to prevent business scandals and collapses. The idea of creating a new regulator with the power to clamp down on poor-quality auditing was first floated in 2018. The Labour party also included a draft audit reform bill in last summer’s King’s Speech.
These efforts, however, have been continually kicked to the curb. “It is a vicious cycle,” Leaver says. “We have a big government inquiry, they come up with some interesting solutions, we go through another round of discussions and everything gets watered down.”
Shoddy audit practices wreak havoc on the economy
This is partly because the sector is too complex, technical and tied up with multiple interests to be radically overhauled without significant cost, explains Leaver. It’s easy to delay reforms, especially when governments have had to deal with Brexit, the ongoing cost-of-living crisis, slow economic growth and a global pandemic.
“There’s also the problematic fact that the people you would naturally turn to for advice on audit reform are the audit firms themselves,” Leaver says. The absence of public interest is also part of the problem. He adds: “It is not intuitive to the public in the same way that tax avoidance is. It doesn’t have the same public resonance because it’s perceived as dull and technical.”
What is the solution?
Transforming the audit process to become more efficient and effective requires both structural and cultural changes.
Separating the audit function in large accountancy firms and making it a standalone business would remove any conflict of interest, Leaver says. Back in 2020, the Financial Reporting Council asked the Big Four firms – PwC, EY, Deloitte and KPMG – to separate their audit function from the rest of the business by June 2024.
KPMG has rejected the suggestion that splitting its business would boost audit quality. Both PwC and Deloitte have said they have no plans to break apart their businesses and EY did set out to do so, but ultimately called the project off.
Another “less controversial” solution, according to Leaver, is to change profit distribution rules. In the UK, when companies are revalued, it is counted as a profit. Firms can borrow against those revaluations and distribute them as they see fit, which can weaken businesses. “Changing the rules about what can or cannot be distributed would make it easier for auditors to say those profits aren’t real profits,” Leaver explains. “It would ease the pressure on auditors and there would be much less gaming going on.”
Tougher scrutiny of the auditors who sign off companies’ accounts is long overdue but the government and regulators face a difficult balancing act. A push for tighter standards risks stifling competition and squeezing smaller firms out of the market. And yet, any further delays in audit legislation, Leaver argues, risks weakening corporate accountability and eroding public trust.
UK audit firms have come under increased scrutiny in recent years, following several high-profile failures. Audit firms missed red flags in the accounts of BHS (2016), Carillion (2018), Patisserie Valerie and Thomas Cook (2019) before each of their collapses, which has drawn attention to the shortcomings in audit diligence.
Some of these were laid bare in a 2023 report by the Financial Reporting Council, the industry’s regulator, following its investigation into KPMG’s audit of Carillion. Its pages contain references to jokes made by auditors about the poor quality of their work and a scathing indictment of the firm’s failure to adhere to “the most basic and fundamental audit concepts”.
There’s something fundamentally wrong with the audit mission
