The idea of splitting the auditing and non-auditing (consulting/advisory) businesses of firms was mentioned in a report by a United Kingdom Parliamentary Committee following the collapse of Carillion in January 2020. The UK regulator (the Financial Reporting Council, FRC) later asked the largest UK firms to operationally split up their auditing and non-auditing businesses by 2024. Furthermore, it was recently reported that the Big 4 firm EY is also considering a worldwide split of its auditing and advisory businesses. This article explores the considerations, advantages and disadvantages of splitting firms.
In the UK it was found that the driving motives behind non-auditing functions are often poorly aligned with the culture of objectivity, professional scepticism and challenge required by auditors. So, while regulatory monitoring is forcing firms to be cautious, creating distinct businesses does appear to be the most reliable solution.
There is one problem, though. How do you create appealing businesses out of both when one (namely the newly founded standalone auditing practice) is likely to be viewed as inferior?
- Those within auditing tend to jump ship to better paid and less risky careers all the time. In South Africa, for example, the number of auditors registered with the Independent Regulatory Board for Auditors (IRBA) to provide assurance has declined by 8% from 2017 to 2022 (from 3 024 registered auditors to 2 782 registered auditors).
- Regulatory investigations that are pending against audit partners who are accused of getting it wrong could last for years.
- Although the underlying economics of the large firms are unclear, there is a popular belief that consulting in fact subsidises auditing. Or, at the very least, the ability to share costs means that audit fees are lower than they would be for a separate firm, regulators have found.
Splitting the auditing and non-auditing businesses of firms should −
- Eliminate undue influence by the non-auditing business on the auditing business
- Eliminate tensions between the two very different cultures within the auditing and non-auditing businesses of firms
- Reduce conflicts of interest for the auditing business
- Improve the independence (both in fact and appearance) of the auditing business, and
- Increase the transparency in relation to the financial performance of the auditing business
- In theory, splitting should also −
- Improve audit quality
- Better protect the public’s interest
- Restore the reputation of and trust in the audit profession
- Provide more stability and credibility to the investment market
- The loss of a wide range of in-house expertise and competencies may lead to increased costs for the auditing business. The auditing business would have to pay external experts when required.
- The loss of a multi-disciplinary model and diverse talent may stifle innovation within the auditing business.
- It may be more difficult for the auditing business to attract and retain talent without offering an in-house career in consulting as an option.
- Separation won’t eliminate all the conflicts of interest. The greatest issue is often the way in which clients appoint the audit partners who are meant to be their watchmen. Undue influence by clients (creating a self-interest threat to independence) is still a very real possibility.
- If, in fact, the standalone auditing practice is not financially feasible, splitting may lead to even more time and fee pressures. This in turn may have a detrimental impact on the professional scepticism exercised by auditors and the quality of audits performed by the practice, thereby defeating the purpose of splitting.
Having a feeling of déjà vu? Indeed, we have been here before. In the early 2000s, after the Enron scandal, firms like PwC and Ernest & Young sold their consulting businesses and yet, twenty years later, here we are again.
It would therefore appear that splitting can only work if auditing is made more attractive, both financially and culturally. This is the only way in which the auditing profession can attract the best and brightest (ie the right) people, who will do the work better and also see audit as a long-term career as opposed to a stepladder.
But how can the auditing profession be made more attractive?
The following could be considered to make the auditing profession more attractive:
- By implementing the World Bank’s recommendations to regulate the full reporting chain and not just the auditors. This includes the directors, audit committees and senior executives. The aim is to improve overall financial reporting and controls throughout the entire financial reporting ecosystem and to ensure that all role-players take responsibility for high-quality reporting. This in turn should reduce the auditor’s risk.
- By considering limiting or capping the auditor’s liability and including the relevant cap in the audit engagement contract. The liability of auditors should be both fair and realistic. Currently, the extent of exposure of auditors to unlimited liability to a wide range of potential claimants far exceeds that of any other group of professionals. Under proportionate liability, defendants are compelled to pay only in relation to their involvement in any misconduct. Any penalty must be appropriate and should not be lethal and destructive, both to the specific auditor in question or to the entire auditing firm which might have been wrapped up in one individual’s unlawful or negligent behaviour.
- By setting fair minimum charge out rates per hour, the purpose being to make the stand-alone auditing practice financially feasible.
- By expanding the statutory function of auditors beyond reasonable assurance on financial statements to also offer assurance on companies’ sustainability (environmental, social and governance) disclosures, thereby ensuring opportunities for growth within auditing firms.
- By considering the appointment of auditors by an independent body, thereby eliminating any undue influence by clients during and after the appointment process.
A list of sources is available on request
Michelle Vermeulen, Project Manager: Assurance at SAICA