The collapse of Carillion had a very wide-reaching impact – there were the: (a) 30,000 or so businesses that were reportedly owed upwards of a billion pounds, (b) the political nightmare it has caused the Conservative party, and now, according to Reuters, (c) the impact zone has widened to encompass the audit sector as a whole.
Fast-Track Investigation Launched Due to Audit Concerns
The Competition and Markets Authority (CMA), along with the Financial Reporting Council (FRC), has announced a joint fast-track investigation into the statutory audit market due to “recent poor results from reviews of audit quality”. It is stated that this has arisen because, “Unreliable numbers can lead to the wrong investment decisions, which in turn risk people’s jobs, their pensions or their savings”. The CMA points to Carillion and BHS as two clear, high-profile examples of where question marks are raised over the performance of the respective auditors, in relation to the scale of the problems that ensued with these organisations.
Do the Big Four Have Too Much of a Monopoly?
One of the leading questions in the investigation will be whether the ‘big four’, that’s EY, Deloitte, KPMG and PwC, have too much of a monopoly on the market; an ‘iron grip’ on the decision making process of most major organisations in the UK, and whether more should be done to encourage competition in the sector, for what seems to be perceived as a necessity to improve quality in the market.
A Tender Merry-go-Round
The Reuters article stated that “The CMA’s predecessor, the Competition Commission, recommended five years ago that Britain’s top 350 listed companies put their audit work out to tender at least every decade, but the result has been a ‘big four’ merry-go-round, with smaller rivals such as Grant Thornton and BDO making little headway”.
Andrea Coscelli, the CEO of the CMA, reportedly stated “Given the in-depth thinking already done by the CMA and the Competition Commission before it, we plan to move swiftly and to issue our provisional findings before Christmas”.
There are some who will say that this review is something that should have been done some time ago. After all, just taking one example from the CMA report, questions were raised back when BHS collapsed and that was a few years ago now. Earlier this year, the FRC fined PwC and individually the partner in question, Steve Denison, for ‘misconduct’ over the audit carried out on BHS in 2014. In 2015 Denison signed off BHS accounts as a going concern and the next day the whole business was sold for just £1. Just one year later, the company collapsed owing its own pension fund over half a billion pounds. PwC admitted that there were “serious shortcomings with the audit work”, apologising for their work falling “well below professional standards”.
The biggest collapse in the retail sector since Woolworths, 11,000 jobs lost, PwC fined and Mr Denison banned from audit for 15 years. But this goes deeper and further.
The Answer to the Question, ‘Why Now?’ is Carillion
The sheer scale of the problem this caused, and the collapse of Carillion seemed to be worryingly familiar as the company’s management and their auditors were subjected to a parliamentary inquiry. BEIS chair Rachel Reeves, MP for Leeds West, said that auditors, KPMG were also “guilty of failing to tackle the crisis” and had failed to “paint a true picture of its crippling financial problems”. In an article in Accountancy Age it was stated “While KPMG took a £29m pay packet as Carillion’s auditor for 19 years, the inquiry said that it “complacently” signed off “fantastical figures” and that “in failing to exercise professional scepticism towards Carillion’s accounting judgements over the course of its tenure as Carillion’s auditor, KPMG was complicit in them”.
Separately, Carillion’s board members were hauled over the coals. As reported by Accountancy Age, MP Frank Field criticised the board for scrapping an independent review in favour of having “KPMG, their pet rubber-stampers, to mark their own homework”. What apparently happened is that the newly appointed Carillion CFO, Emma Mercer, raised concerns about the state of the company’s accounts. Despite questioning the 2016 year-end position, it seems she felt that she was not being listened to by others. Initially this initiated a 3-tier review; a Carillion internal review, a KPMG review and a sub-committee review. This was later scrapped. KPMG quite surprisingly stated that there was not “an intent to deceive, but rather was due to incompetence, negligence or sloppy accounting.” Incompetence, negligence or sloppy accounting? These are not statements you expect from one of this country’s leading audit firms.
The CMA and FRC Investigation
The FRC has already expressed concerns about the concentration of audit work at the top end of the market, with the organisation’s CEO, Stephen Haddrill, stating that “there should be more competition in the major accounting and audit area”. They have pledged to work with the CMA on their investigation, as well as conducting their own investigation into the audit in Carillion’s case.
Going forward the CMA proposes to review five areas of the audit market:
- The scope and purpose of audit as well as the standards auditors must live up to,
- The ‘principal-agent’ problem that leads to a misalignment of incentives,
- A lack of pressure for quality due to a lack of choice in the marketplace,
- The need for more medium sized players in the market to make any change at the top possible, and finally
- The regulation of audit in the UK.
Key Observation: Informal Insights Built on Strong Relationships are of the Highest Value
What do you do if you don’t perceive you can rely on statutory audit information to establish the appropriate financial health of your key strategic service partners? We wrote some time ago about how your Intelligent Client Team (ICF) can gain ‘live’ insights into both the operational and financial health of your strategic partner. Statutory accounts often only provide an indication of a supplier’s financial health. You can also have better visibility with a publicly traded supplier, as quarterly accounting practices often give a good indication of the relatively current financial strength of the supplier.
However, an appropriately resourced ICF team, that has the skills and capabilities to gain these insights from the supplier ‘off-the-record’, can help you develop advance notice of any potentially adverse financial circumstances, which you can further discuss with the supplier to work with them and mitigate any potential service disruption, much earlier.
Photo Credit: iStock, z_wei