Alex Peal
Alex Peal
Joint Managing Partner for James Cowper Kreston in the UK

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Alex is joint Managing Partner for James Cowper Kreston in the UK, and an Audit and Assurance partner acting for many owner managed organisations and individuals. He has a specialist knowledge of the film industry and also is a member of the Kreston Global Audit Group.

How is audit reform affecting the profession?

September 22, 2022

After several high-profile failures and large company collapses in recent years, the audit sector has found itself under heavy scrutiny.

In fact, 2021/22 saw a record amount of fines issued by the Financial Reporting Council (FRC) totalling £46.5 million – almost triple the £16.5m issued in the year before.

The ripple effect of large company collapses has taken its toll on public trust in audit and corporate governance, particularly when it comes to the performance of the UK’s four largest audit firms.

As the Government implements new audit reforms and the market slowly shifts away from the Big Four, smaller audit clients can also expect to see some impacts as a result of these changes.

Where does audit reform stand now?

Earlier this year, the Government published a set of wide-reaching reforms to the audit sector, which aim to tackle the dominance of the Big Four, reduce the risk of sudden company collapses, and ultimately restore some trust in the profession.

These include replacing the FRC with a new Audit, Reporting and Governance Authority (ARGA).

ARGA will have a number of new powers compared to the old regulator, including the ability to ban failing auditors from reviewing large companies’ accounts, sanction directors of large companies for breaches of duty, and oversee professional bodies’ regulation of the accountancy profession.

The reforms also bring more large private companies within scope of the regulator, redefining public interest entities as those with more than 750 employees and £750 million in annual turnover.

A gradual shift from the Big Four

Another key reform means FTSE 350 companies will be required to conduct part of their audit with a challenger firm outside of the Big Four – a move intended to improve competition in the market.

A recent report from the FRC shows this shift is already happening to some extent. While in 2017, Big Four firms audited 96.8% of FTSE 250, that percentage had dropped to 89.2% by 2022.

And when it came to the UK market outside of those largest firms, the Big Four’s share had reduced from 74.2% to 28.2% over the same period of time.

So while the Big Four remains dominant over the UK’s largest companies, smaller companies are now seeing a much broader choice in the audit market, and are increasingly likely to work with a challenger firm.

What does the reform mean for smaller audit clients?

In theory, this increased competition should mean you see higher-quality work as an audit client, with rivalry between auditors encouraging enhanced services and lower fees.

The reality would appear to be that firms are spending more time on audits which does improve quality. However, this also comes at a cost because firms have realised that they need to increase fees to a level commensurate with the work that they are doing. Therefore, audit fees have actually risen rather than fallen.

In addition, because firms are spending more time on audits, without an increase in the total number of auditors there will be a reduction in capacity in the audit market. This can be seen in the market, and it has made it hard for some companies and particularly not for profit entities to find auditors willing to quote for work.

Another key change for smaller audit clients to look out for is the loosening of reporting requirements.

At the same time as it published its consultation response in May, the Government also announced plans to update the definition of micro-enterprises, with the aim of reducing the reporting burden on smaller businesses.

Micro-enterprises are currently defined as those which employ fewer than 10 people and have a turnover or annual balance sheet below €2 million.

The Government believes this threshold could be “forcing too many of Britain’s smallest businesses to spend time and money preparing accounts to a level of detail only needed for larger companies”.

It also says it will consider the reporting requirements on smaller public interest entities, and review the current restrictions on remunerating directors in shares.

Broadly speaking, the Government has been keen to emphasise that smaller businesses will see no extra regulations under the reforms – its focus is instead on the UK’s largest companies.

Get in touch to talk about how changes to the audit market could affect you.