In the Big Audit model—by which the world’s large public companies engage the international networks of the Big Four to provide financial statement assurance for their use and that of the capital markets—the Big Four had collective 2018 worldwide revenue exceeding $143 billion. How confident can investors be that the Big Four have provided a level of assurance commensurate with these fees?

In the United States, because the incidence of financial malfeasance is a trailing economic indicator, the resilience of the securities indices has meant a period of relative quiet. Further muting the rhetoric is the somnolent attitude of the major American regulators, notably the wholesale turnover of the members and senior staff of the PCAOB that has made it essentially a high-salaried housekeeper.

What should be expected? Recent disclosures about Under Armour’s revenue recognition and Mattel’s accounting for taxes have put PricewaterhouseCoopers and the profession back under the spotlight; the next outbreak of corporate chicanery—inevitable but on an unpredictable timetable—will only turn up the wattage.

U.K. Developments

Public perception and attitudes vary across the globe. The United Kingdom, where the modern audit function was invented in the mid-19th century, differs considerably from the United States. There, the environment has been aflame for two years, bracketed between the collapse of Carillion in January 2018 and that of travel services giant Thomas Cook in September 2019. Pending for mid-January release is a report from Donald Brydon, former head of the London Stock Exchange, on his broadly conceived Independent Review into the Quality and Effectiveness of Audit, a mission launched by the government’s Secretary for Business.

In December 2018, a committee charged by Parliament and headed by City grandee John Kingman issued its report, adopted by the secretary, recommending wholesale restructuring of the Financial Reporting Council (FRC), the country’s audit regulator. Kingman characterized the FRC as a “ramshackle house built on weak foundations,” and his report proposed it be supplanted by a new Audit, Reporting, and Governance Authority (ARGA). Two other reports in April 2019 are also in the mix, from the Competition and Markets Authority (CMA) and Parliament’s select Business, Energy and Industrial Strategy Committee (BEIS).

On the regulatory and professional oversight front, implementation of Kingman’s lesser ARGA recommendations, which do not require legislation, has proceeded apace. More consequential restructuring and broadened agency authority will depend on unblocking the country’s Brexit-based legislative paralysis.

Meanwhile, the headline proposals with the highest potential impact on accounting firms themselves are as follows:

  • Two from the CMA: first, required “joint audits” for most of the FTSE 350 companies—that is, two audit firms, of which one would be a non–Big Four challenger, would share engagement execution and responsibility. Second, the Big Four would undergo an “organizational split” between their audit and other practices, including separate management, governance, and financial statements, and would forego cross-practice profit sharing.
  • The BEIS committee, endorsing the CMA’s joint audit proposal, would go further—full legal separation of the Big Four’s audit practices, enforced reduction or caps on their dominant share of the large-company market, and shortened limits on the duration of audit engagements.

What would be the effects? An “organizational split” would appear to be within the large firms’ capacity to adjust, as they already display separate branding and identities for their audit and other practices and operate in compliance with country-specific limitations on ownership and licensing.

At the same time, such a moderate step would allow the firms to retain the specialized resources necessary to meet the demands of large and complex audits in such areas as transfer pricing, valuation, actuarial, IT and cyber risk, data analytics, and financial instruments.

As for the proposals for enforced large audit access for smaller firms, the advocates have yet to come to grips with the market reality: the challengers simply lack the scope and scale to carry out such a program. The Exhibit makes the point, showing the 18 international networks with global 2018 revenue above $500 million. The graph illustrates the smaller firms’ limitations in geographic scope, availability of personnel, and financial resources necessary for investment and risk acceptance—factors that would prevent them from advancing into the FTSE 350 market as well as impair their “joint audit” capability. It is no criticism of those firms’ claims to quality of performance that their capacity is simply not equal to the challenge, within the CMA’s proposed 10-year time span, to obtain and deploy the resources needed either to tender for or actually perform at that scale, when engagements would increase in number and complexity each year, and their work would be exposed beyond the United Kingdom to include the United States and other markets with their regulatory and litigation risks.


Firms with Global Revenue over $500 million in 2018

What are the prospects? From an interview given by the new chairman of the FRC, Simon Dingemans, it seems reason may prevail—at least unless more aggressive politicians seize control of the process. Dingemans was quoted on November 6 as vigorously negative on joint audits, which he said “lead to duplications, confusion of responsibility and extra costs for no obvious added value.” In the same interview, his measured approval of “organizational split” implies that he would not be ready to take the more disruptive steps of legal separation or stripping away the Big Four’s nonaudit capabilities.

No Calm in Sight

As the Danish physicist Niels Bohr observed, “predictions are hazardous—especially about the future.” At the very least, it is safe to say that the regulatory environment in the United Kingdom will not settle down any time in the near future. Professional developments there will bear watching with care and concern.

Jim Peterson, JD is a lawyer, writer, and teacher based in Chicago, Ill.