In Brief

Around the turn of the century, the largest public accounting firms featured fast-growing advisory services divisions. Tension within these firms, and stricter regulations in the form of the Sarbanes-Oxley Act (SOX), led to divestitures and significant changes in firms’ mix of revenues. The landscape has again shifted, as advisory services have once again expanded and, in some cases, eclipsed traditional assurance work. This article illustrates these trends, describes the contemporary reaction from selected global regulators, and ponders the potential impact on the audit profession.

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When it comes to the Big Four public accounting firms, there is a delicate balance between advisory services, regulatory requirements, and auditor independence. This dynamic has historically been the driver behind notable changes in the profession. Recently, Carmine De Sabio, Ernst & Young (EY) CEO, attempted to separate advisory services to alleviate pressure from regulators but failed to separate its advisory service from assurance services, primarily due to the partners’ inability to reach a consensus on how to separate the firm’s tax practice, distinguishing between assurance and advisory allocations (“EY Split Paused Amid Partner Infighting Over Fate of Tax Experts,” Financial Timeshttps://tinyurl.com/4r2kyhts). Secondly, as part of the strategy to mitigate the overwhelming influence of the Big Four, the United Kingdom introduced new rules mandating that public interest entities engage auditing firms that are Big Four competitors or allocate a segment of the audit work to such competitors (“Audit regime overhaul to help restore trust in big business,” Gov.UK, https://tinyurl.com/4pjxze55). Finally, in September 2023, PricewaterhouseCoopers (PwC) U.S. unveiled plans to curtail specific categories of advisory consulting services, which had contributed annual revenues of $50 to $100 million. Per a spokesperson for the firm, the adjustment was made partly in response to stakeholders’ concerns about conflicts of interest (“PwC to Limit Consulting Services It Offers to U.S. Audit Clients,” https://tinyurl.com/2s4zbdjr).

To better understand this shifting landscape, the authors examined the growth of advisory service at the largest public accounting firms, analyzed why the growth of advisory services causes internal tension with assurance services, and forecasted firm and regulatory consequences based on historical and current events. Working within the new legislative constraint under the Sarbanes-Oxley Act of 2002 (SOX) that prevented selling advisory services to audit clients, firms focused on selling advisory services to non-audit clients, with tremendous success. This business model change has renewed tension between firms’ assurance and advisory divisions, fueled by the increase in audit firms’ violation of independence rules. Countries are initiating mandates that separate advisory services from assurance services in order to manage the consequences of this new business model. As accounting firms push the boundaries, and historical events such as the collapse of Arthur Andersen fade, it remains necessary for the profession to safeguard independence in fact and in appearance.

Growth of Advisory Service Surpasses Audit Revenue

The data used to analyze the revenue trends for the accounting firms were compiled from surveys published by Accounting Today in its annual “Top 100 Accounting Firms” from 2000 to 2022. The survey instrument requests firms to provide data on their net U.S. revenues and fee split as a percentage of total revenues. Total revenues (U.S. public and private clients) are disaggregated into three sources: assurance, tax, and advisory services. Starting with the 2002 survey, a fourth revenue source, “other,” was introduced to account for additional services such as financial planning, litigation support, valuation work, payroll, and benefit plan administration. In this article, the term “advisory services” includes “other” to provide consistency over time.

Big Four revenue trends.

Because the Big Four—Deloitte, PwC, EY, and KPMG—provide audit service for approximately 90% of U.S. publicly held companies, this analysis focuses specifically on their revenue trends. Exhibit 1 shows the past 23 years of revenue for the Big Four firms. Over this period, audit revenue declined while advisory service revenue increased. Overall, the revenues of the Big Four have increased from $28 billion (2000) to $79 billion (2022); this represents a 183% increase over 23 years. The increase in overall revenue was interrupted by a decrease in total revenues from 2004 to 2006, during which time the firms (except for Deloitte) sold off their advisory service practices. The 2008 financial crisis contributed to the leveling off of revenues from 2009 to 2010. Contributions to revenue from advisory services were the lowest (14%) in 2005, while assurance and tax services were 62% and 24%, respectively. This sharply contrasts with 2022, when advisory service revenues were 51%, and assurance and tax service revenues were 27% and 22%, respectively.

Exhibit 1

Big Four Revenue Sources

Advisory revenue.

Exhibit 2 shows that Big Four advisory service revenues grew from $11 billion (2000) to $40 billion (2022); this represents a 274% increase over 23 years. Revenue from advisory services was temporarily constrained by the enactment of SOX, which prohibited auditors from providing advisory service to assurance clients. In response, the Big Four sold off their advisory service practices one by one, except for Deloitte, which did not do so due to market conditions. Deloitte’s failure to divest may have provided an example of how advisory services may be sold to non-audit clients without violating SOX. Therefore, as the non-compete agreements with their former advisory arms expired, the other three firms began to replicate the success of the Deloitte business model. Advisory service revenue doubled from 2010 to 2015 and has continued to increase rapidly since then, leading to a concern about the impact of advisory services on public accounting firms (Alyssa Schukar, “Big Four Accounting Firms Come Under Regulator’s Scrutiny,” Wall Street Journal, March 15, 2022). Since 2014, total advisory revenues have exceeded total assurance revenues for the Big Four by 50% or more and growing. Deloitte is the clear leader in advisory revenue, followed by PwC, EY, and KPMG.

Exhibit 2

Big Four Advisory Service Revenues, by Firm

Assurance revenues.

Big Four assurance revenues increased from almost $11 billion (2000) to more than $21 billion (2022); this represents an approximately 100% increase in revenue over 23 years. Although assurance revenue has generally increased, it decreased twice during our analysis period. There was a decrease in 2002, when firms adjusted to resource constraints that led to dropping some clients to the non-Big Four due to SOX requiring additional audit work and disruptions resulting from engagements that were formerly Arthur Andersen (AA) clients. Assurance fees decreased again in 2009 due to several factors, such as a pent-up response to increasing assurance fees, competitively priced assurance engagements, the financial crisis of 2008, and PCAOB Auditing Standard 5. This new auditing standard decreased the billing hours needed to comply with SOX Section 404, which relied on the work of internal auditors and others. (See R. Mithu Dey and Lucy Lim, “Assurance Fee Trends from 2000 to 2014,” American Journal of Business, vol. 33, no. 1/2, 2018, pp. 61-80.)

Tax revenues.

Big Four tax revenues increased from $7 billion (2000) to $18 billion (2022); this represents a 168% increase over 23 years. During this period, several major pieces of tax legislation were enacted [e.g., the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the American Jobs Creation Act of 2004 (AJCA), the Patient Protection and Affordable Care Act of 2010, and the Tax Cuts and Jobs Act of 2017] that may account in part for the growth in tax revenues.

Divestitures.

Around 2000, AA, EY, KPMG, and PwC divested their advisory services practice due to management tension between audit and advisory partners, the opportunity to unlock value, and pressure from regulators. Arthur Andersen was the first to divest. A formal profit-sharing agreement between AA and Andersen Consulting (AC), both under the parent company of Andersen Worldwide, had become untenable, as AC grew faster than AA. The conflict, as reported in the press, lasted for about three years, from December 1997 to August 2000, when AC finally split off with its advisory service practice, becoming Accenture, paying AA $1 billion and foregoing the rights to the Andersen name (Ken Brown, “Andersen Consulting Wins Independence,” Wall Street Journal, Aug. 8, 2000).

EY was the second to divest when it sold its advisory group for $11.1 billion to French IT firm Capgemini in February 2000, at the very peak of the Nasdaq stock market boom (John Tagliabue, “Cap Gemini to Acquire Ernst & Young’s Consulting Business,” New York Times, Mar. 1, 2000). A year later, in 2001, KPMG spun off its advisory practice, Bearing Point, through an initial public offering (IPO) that was disclosed in May 2000, two months after the Nasdaq peaked (Larry Greenemeier, “IPO Still on for KPMG Consulting,” InformationWeek, Jan. 8, 2001). PwC’s road to divesture was not as easy as KPMG’s and EY’s. After an unsuccessful attempt to sell its advisory services practice to Hewlett Packard for $18 billion, then an unsuccessful IPO in the summer of 2002 when the market for new issues had collapsed, PwC sold its advisory services practice to IBM for $3.5 billion in 2002. Further details on the prior round of divestitures may be found in a prior CPA Journal article (R. Mithu Dey, Ashok Robin, and Daniel Tessoni, “Advisory Services Rise Again at Large Audit Firms: Like a Phoenix, Revenues Reborn amid Renewed Concerns,” August 2012, https://www.nysscpa.org/1208-rdardt).

A Closer Look at Each of the Big Four

Deloitte.

Deloitte, the only Big Four accounting firm that did not sell its advisory services practice after the passage of SOX, successfully navigated the law’s requirements while increasing the advisory services provided to non-audit clients. As a result, Deloitte’s predominance of advisory services as a percentage of total revenue is glaring. As depicted in Exhibit 3, advisory services was the leading source of revenue for Deloitte from 2000 to 2022, notwithstanding a brief dip after the passage of SOX as it navigated the new environment.

Exhibit 3

Deloitte Revenue Sources

In addition, the graph depicts the significantly higher growth rate of advisory services as compared to assurance and tax services. This growth started in 2009, when Deloitte’s revenue sources comprised advisory services (39%), assurance services (37%), and tax services (24%). The growth continued until 2022, when the revenue sources diverged significantly, to advisory services (57%), assurance services (28%), and tax services (15%). Deloitte is the largest of the Big Four, with total revenue being more than double that of the fourth firm, KPMG. Another perspective on understanding the size of Deloitte is that its revenue in 2022 was approximately 85% of the total revenue of the non-Big Four accounting firms in the Top 100: Deloitte’s revenue was $28 billion, and the remaining 96 non-Big Four was $32 billion. The authors assume that, as Deloitte’s revenue sources continue to shift, the power structure and resource allocation will also shift to support the lead revenue source.

PricewaterhouseCoopers.

PwC sold its advisory service practice to IBM in 2002; as a result, its advisory revenues were flat until about 2005, when the non-compete agreement expired. Since 2005, both advisory and assurance revenues have continued to increase. As depicted in Exhibit 4, PwC has had relatively consistent growth in all three revenue sectors. In 2022, PwC’s total revenue of $21 billion was derived from advisory services (50%), assurance services (26%), and tax services (24%). Advisory services went from 14% in 2002 to 50% in 2022, when it became the company’s primary revenue line at $10,365 million—a 55% increase from the previous year’s advisory income of $6 million. The dramatic increase in advisory service revenue in the United States makes the firm’s decision to stop offering some advisory services surprising. The firm anticipates a loss of $50 to $100 million in revenue from these services. To offset the loss, the firm plans to add new revenue sources, such as fraud detection and improved audit services around the evaluation of going concern risk (Mark Maurer, “PwC to Limit Consulting Services It Offers to U.S. Audit Clients,” Wall Street Journal, Sep. 11, 2023, https://tinyurl.com/2s4zbdjr). In 2022, PwC’s assurance service income decreased by about 16% from the previous year, which may have resulted from the firm not providing assurance services to advisory clients.

Exhibit 4

PwC Revenue Sources

Ernst & Young.

Exhibit 5 shows that advisory service revenues were almost nonexistent for EY from 2000 to 2008 because EY had sold its advisory service division in 2000 to Capgemini and was bound to a non-compete agreement till 2008. EY re-entered the advisory market after the expiration of this agreement, and its advisory revenues exceeded its tax revenues by 2013 and assurance revenues by 2015. Unlike the other Big Four, in 2020, EY’s tax revenues were greater than its assurance revenues. Historically, as demonstrated in the data for other firms, tax revenues are usually lower than assurance revenues. EY’s assurance service revenues contribute the smallest percentage of total revenue. As with PwC and Deloitte, EY’s advisory services revenue is on a growth trajectory, growing by about 360% since 2009. In 2022, EY’s total revenue of $19 billion was derived from advisory services (48%), assurance services (25%), and tax services (27%).

Exhibit 5

EY Revenue Sources

In 2022, EY Global sought to separate its assurance and advisory services division due to “rising concerns by governments and regulators regarding growing conflicts of interest between the audit and consulting service divisions of the Big Four” (Michael Sainsbury, “Big Four Global Shake-up in Wings as EY Moves to Spin Off its Audit Business,” Michael West Media, May 26, 2022, https://tinyurl.com/mrx2hee5). Additionally, EY’s global managing partner, Andy Baldwin, stated that the factors in the regulatory environment, such as mandatory firm rotation, tightening of conflict-of-interest rules, and the need to access capital, are the reasons for the suggested split (Interview on Reuters Podcast, The Exchange, “The Complexities of EY’s Big Breakup Bet,” https://tinyurl.com/57kakwby). Despite the lofty goals of the split, EY was unable to operationalize the split in a manner that benefits all partners (Jean Eaglesham, “EY Halts Breakup Plan After Revolt by U.S. Leaders,” Wall Street Journal, April 11, 2023, https://tinyurl.com/5n7dm8e3).

KPMG.

Like EY and PwC, KPMG spun off its advisory service through an IPO to BearingPoint in 2000. The non-compete agreement with BearingPoint expired in 2006; since then, advisory service revenues have grown by 279%. As shown in Exhibit 6, from 2006, advisory revenues have soared; by 2014, they exceeded assurance revenues. Tax revenues have also grown, contributing the same percentage as assurance revenue. In 2022, KPMG’s total revenue of $11 billion was derived from advisory services (43%), assurance services (29%), and tax services (28%).

Exhibit 6

KPMG Revenue Sources

Impact of Advisory Service Growth Internally

Tension between Advisory Services and Assurance Services.

Within the Big Four, the rate of advisory service growth has outpaced that of assurance services. The consequence of dissimilar growth and competition for human and capital resources within the firm has led to disgruntled partners, as witnessed in the case of AA. The major difference today from the AA case around the turn of the century is that most advisory service revenue is now generated from non-audit clients. Thus, firms and clients now must decide whether to engage in an assurance or advisory relationship, placing the firm in a position to fight over the same potential client. A firm’s commitment to rebuilding and expanding its advisory practice impacts its culture and strategy, which includes the following steps: changing the culture and tone at the top, adjusting profit sharing, incentivizing new business promotion, and decreasing investment in assurance services. The tension created in this environment should not be downplayed. AA provides an example of how the interplay between auditing in the public interest and providing advisory service could impact the Big Four in the coming years. During AA’s expansion of its advisory service practice, 1 in 10 assurance partners was forced out, and its in-house ethics watchdogs were weakened; in contrast, those who brought in new advisory business were promoted (Flynn Mc. Roberts, “The Fall of Andersen,” Chicago Tribune, Sep. 1, 2002, https://tinyurl.com/3kpm58dy). Consequently, the firm’s ability to protect the public interest was weakened, ultimately contributing to the firm’s downfall.

Profit sharing.

Another source of tension for CPA firm partners is profit sharing. The AA case demonstrates a possible consequence of the tension. AA and AC were organized into two separate business units, so the firm’s less profitable area (assurance services) would receive a smaller percentage of the profits from the more profitable area (advisory services). But the infighting continued, as AC grew much faster and was much more profitable than AA, leading to the entities entering an arbitration process in December 1997 that lasted for three years (Ken Brown, “Andersen Consulting Wins Independence,” Wall Street Journal, Aug. 8, 2000). In 2000, the arbitrator ruled in favor of AC, which was granted its immediate independence from AA and use of the Andersen name until the end of the year. Per a former assurance partner interviewed in a research paper, “assurance partners lost a source of revenue which accounted for 50%, 60% of their total compensation” because of the ruling (Yves Gendron and Laura Spira, “What Went Wrong? The Downfall of Arthur Andersen,” Contemporary Accounting Research, vol. 26, no. 4, 2009, pp. 1007). This led to both firms competing in the same space for the same clients.

Although the profession can learn from Andersen’s prior experience, a major difference in today’s regulatory environment is that firms and clients must decide whether to engage in an assurance or advisory capacity, which places the firm partners in a position to fight over the same potential client. In this context, it is worth noting that EY’s attempt to separate its tax, advisory, and assurance practices failed because of concerns over profit sharing. According to Bloomberg News, the initiative failed because the partners were unable to reach a consensus on compensation and the allocation of resources to the audit practice in the aftermath of the tax and advisory spin-off (Sam Skolnik, “EY Failed Split Gives Break to US Law Firms Fearing Competition,” Bloomberg Law, May 1, 2023, https://tinyurl.com/ymb7b3pn).

Unchartered revenue sources leading to regulatory fines.

The number of U.S. public companies that make up the Big Four’s primary client base is less than half of what it was in the late 1990s (Opinion, “Where Have All the Public Companies Gone?,” Bloomberg, April 9, 2018). In addition, when a firm accepts a client as an advisory client rather than as an assurance client, that decision also reduces compensation for assurance partners. With so many variables causing assurance partners’ compensation to be reduced, it seems only reasonable that they will pursue other avenues to increase their income stream. One of those avenues is providing advisory services to assurance clients while remaining within SOX’s regulatory framework (Ken Tysiac, “How Auditors Can Stay Independent while Advising on Revenue Recognition,” Journal of Accountancy, December 2019).

Not all services fall within SOX’s regulatory framework. Examples of independence violations include accepting an assurance client while providing advisory services to its clients’ affiliates; providing advisory services to assurance clients without approval from the clients’ assurance committee; representing independence in assurance reports while providing prohibited advisory services to its clients’ affiliates; and failing to identify and avoid prohibited advisory services. Although this article provides references to four violations (see “What about the United States?” below), references to several violations may be found in Steven Mintz’s “Now is the Time to Operationally Split Audit and Nonaudit Services,” (The CPA Journal, Oct/Nov 2020, https://www.nysscpa.org/2010-sm). Thus, reduced revenue sources may cause assurance partners to pursue new avenues to increase revenue and compensation.

Competition for talent.

Public accounting firms rely heavily on their professional staff. Tension arises within the firm when assurance or advisory service divisions are competing against each other for talented staff. Top accounting graduates may choose the advisory division over the assurance division for various reasons, including higher compensation; better opportunities for advancement; a wider pool of potential clients; a broader range of work experience to place on a resume; a less risky environment; lower individual liability exposure; and not needing to become a CPA or taking the 30 additional credits hours to become certified (Dey, Robin, Tessoni, 2012). In addition, with the current shortage of accountants and accounting majors, the competition for talent is intensifying.

Impact of Advisory Service Growth Globally

In addition to internal tension, there is also external global tension caused by the rate at which advisory service revenues are outpacing assurance service revenues. Global revenue from advisory services reported by the Big Four was approximately $100 billion in FY2022, contributing 51% to total revenue, whereas assurance and tax contributed only 29% and 21%, respectively. In general, CPA firms abide by regulatory guidelines; however, regulators across the globe are expressing concerns and contemplating possible action. The discussion below explores how regulators are attempting to address concerns about the impact of advisory services on assurance independence and assurance quality in the European Union (E.U.), Australia, the United States (U.S.), and the United Kingdom (U.K.).

The pattern of advisory services dominating public accounting firm revenue sources is also consistent for the global revenues of the Big Four. The composition of revenue at the global level was analyzed to better understand the importance of advisory service revenues for each firm and the importance of the U.S. firm’s contribution to the respective global firm. Looking at FY22 global revenue data from each of the Big Four websites as shown in Exhibit 7 reveals that of the three revenue sources, revenue from advisory services is approximately $45 billion for Deloitte, $21 billion for PwC, $20 billion for EY, and $15 billion for KPMG. To provide a sense of the contribution of U.S. revenues to global revenues, U.S. revenues were taken from Exhibit 2 and compared to global revenue from Exhibit 7 to calculate how total U.S. revenue contributes to each firm’s total global revenue: 43% for Deloitte, 41% for PwC, 42% for EY and 33% for KPMG. Thus, advisory revenue dominates globally, and U.S. firm contributions to the global firm are greater than one-third. This analysis illuminates the delicate balance between the Big Four firms, advisory services, regulators, and auditor independence.

Exhibit 7

Global Revenue Sources for the Big Four in FY22

Auditor rotation: E.U.

The financial crisis of 2007–2009 revealed huge losses for banks, which had previously received a clean bill of health from auditors. In response, the European Commission was mobilized to understand the role and scope of assurance services and how the assurance function could be enhanced in order to contribute to increased financial stability, resulting in the green paper, “Audit Policy: Lessons from the Crisis” (https://tinyurl.com/5cwhx8sc). One purpose of the green paper was to open a debate on the role of the auditor and auditor independence. The debate and discussion led to several changes that impacted advisory service. In its 2014 E.U. Statutory Assurance Reform, the European Union took several steps, effective June 2016, to strengthen the capital markets by enhancing auditor independence and increasing audit quality. The rules require entities listed on the regulated European market to rotate accounting firms every 10 years. The audit reform also includes the following three guidelines related to advisory services: it expands prohibited advisory services to not only include some areas already included for U.S. companies, such as bookkeeping and financial services preparation, but also other areas such as tax and tax compliance; makes the audit committee responsible for establishing an approval process for all advisory service commissioned to its firm audit; and establishes a cap for advisory service of approximately 70% of audit fees paid in the last three years of a statutory audit (Allan B. Afterman, “European Audit Reform,” The CPA Journal, February 2016, https://www.nysscpa.org/1602-aa)

Since then, a scandal in 2020 involving Wirecard, a German payment processor and financial services company, whereby $2.97 billion was found to be missing from the balance sheet, led many German politicians to call for European regulators to break up the Big Four or implement the U.K. operational split model, to be discussed below (“Big Four Hobbled by Conflict-of-Interest Issues,” Business Times, July 2, 2020, https://tinyurl.com/yc58tdw6). As a result of the audit failure at Wirecard, in April 2023, the German audit watchdog APAS fined EY 500,000 euros and banned the firm from offering audit services in Germany to listed companies and financial sector companies for two years (“EY Fined, Banned from Some Audits in Germany over Wirecard scandal,” Reuters, April 3, 2023, https://tinyurl.com/k7ryyx5z).

Increased monitoring—Australia.

The Big Four provide 95% of the assurance service for corporations listed on the Australia Securities Exchange 200 (ASX 200). In 2018, the Australian Securities & Investments Commission (ASIC) reviewed the financial statement audits conducted by these firms and found that 1 of 5 audits did not provide sufficient assurance that the financial statements were free of material error (Edmund Tadros, “Aussie Arms of Deloitte, EY, KPMG, and PwC Refuse to Carve Out Audit Work,” Financial Review, Jan. 31, 2019, https://tinyurl.com/bdrjay3z). In the report, ASIC voiced concerns about auditors increasing their focus on the firm’s advisory service revenues and providing advisory services for assurance clients (Michael Roddan, “Big Four in ASIC Sights Over Assurances,” The Australian, September 10, 2019). These concerns were central to Australia’s parliamentary committee inquiry into the Big Four firms’ advisory operation in late 2019. During the inquiry, the former chairman of the Australian Competition and Consumer Commission (ACCC), Allan Fels, stated that conflicts of interest are not handled well by firms driven by profit and income-earning motives and recommended a separation of audit and non-audit work (Hannah Wootton and Edmund Tadros, “Big Four Break-up Easier than More Regulation,” Australian Financial Review, Nov. 29, 2019).

Another submission to the parliamentary inquiry by a former EY audit partner called for an operational split of the Big Four because he was concerned about the impact of partners sharing in audit and non-audit profits, the effect of firm leadership’s primary focus on growing advisory services, and the influence of advisory services on a firm’s culture. He cautioned, however, that the operational split could lead to difficulty recruiting talented staff, and that a split would not be feasible if it were done only in Australia (Hannah Wootton, “Ex-Partner Calls for Firms to be Split,” Australian Financial Review, Nov. 27, 2019).

Ultimately, the Australian Parliamentary Committee did not call for an operational split of the Big Four. They instead made several recommendations that included empowering the relevant regulatory agency to do the following: create a system for more transparency in the reporting of audit deficiencies; enact rules requiring the publication of all audit firm inspection reports; develop and introduce categories of non-audit and audit fee disclosures; develop a list of non-audit services prohibited to an audited entity; enact legislation requiring auditors to declare that they have not provided prohibited non-audit service to the audited entity; and amend the ethical rules to state that “no audit partner can be incentivized, through remuneration advancement or any other means or practice, for selling non-audit service to an audit entity” (Parliamentary Joint Committee on Corporations and Financial Service, Regulation of Auditing in Australia: Interim Report, February 2020, https://tinyurl.com/bdczckuv). The final report, issued in November 2020, reiterated the recommendations and also included the opinion of the parliamentary opposition party, the Greens. The Greens called for an operational split of assurance service and advisory service as suggested by former chairman of the ACCC, Allan Fels (Parliamentary Joint Committee on Corporations and Financial Service, Regulation of Auditing in Australia: Final Report, November 2020, https://tinyurl.com/324mvzmt).

Since the inquiry, the regulatory environment in Australia remains acute, primarily due to the 2023 disclosure that PwC executive knowingly utilized confidential governmental information obtained from a former partner working for the Australian government to the benefit of its U.S. clients (Lewis Jackson, “PwC Australia Flags Revenue Hole, Partner Profit Cue due to Tax Scandal Legacy,” Reuters, Aug. 31, 2023, https://tinyurl.com/yc8ec4bw), and the revelation that the current prime minister, Anthony Albanese, may have secured an internship with PwC for his son (Mirah Davis, “Prime Minister Anthony Albanese defends son Nathan’s Internship at Consulting Giant PwC,” Sky News, Aug. 21, 2023,. As a result of these scandals, governmental officials have announced an “inquiry into the management and assurance integrity by consulting services” (Ross Stitt, “Reforms coming in Australia in a Big Crackdown on Tax Adviser Misconduct,” Aug. 23, 2023, https://tinyurl.com/4jmpe636). In the aftermath of the scandal, PwC lost a number of clients resulting in the firm laying off over 338 employees, and hiring three independent board members, including one as chair (Lewis Jackson, “PwC Australia Cuts 338 Jobs as Major Bank Ends 55-Year Audit Relationship,” Reuters, Nov. 8, 2023, https://tinyurl.com/2umywdkz; Edmund Tadros, “PwC Seeks Absolution But Can It Really Change?,” Financial Review, Sep. 29, 2023, https://tinyurl.com/t59bx4us).

Operational split of assurance service—U.K.

As in the United States and Australia, the Big Four dominate the market for audit services in the United Kingdom, providing services to 97% of Financial Times Stock Exchange (FTSE) 350 companies. One of the most significant shifts on the issue of Big Four audit and non-audit services occurred in the United Kingdom in 2020, when the Financial Reporting Council (FRC), the U.K. accounting and audit monitoring agency, issued rules calling for the operational split of the Big Four’s assurance and advisory service by 2024 to ensure maximum focus on audit quality. The triggering events for the U.K. regulator included the Big Four missing several financial problems, such as fraud involving firms like Thomas Cook, Carillon, and BHS. Thomas Cook collapsed after 178 years, even though two of the Big Four for over 12 years were “repeatedly signing off the company’s accounts with a clean bill of health despite admitting they had raised significant risks to its financial stability with its board” (Tabby Kinder, “PwC and EY Accused of Complicity in Thomas Cook collapse,” Financial Times, Oct. 22, 2019, https://tinyurl.com/3zzv4uvm). Similarly, Carillion collapsed after receiving an unqualified audit report from KPMG, which was its auditor for the prior 19 years (Jasper Jolly, “KPMG Being Sued for £1.3bn Over Carillion Audit,” Guardian, Feb. 3, 2022, https://tinyurl.com/yc7waycx). Finally, BHS collapsed after being audited by PwC, which recognized and accepted the serious shortcomings with their audit work of BHS (Madison Marriage and Adam Samson, “PwC Hit with Record U.K. Fine of £6.5m over BHS Audit,” Financial Times, June 13, 2018, https://tinyurl.com/yfj9mrkn).

To effectuate the operational split, the Big Four must create a structure separating audit management, remuneration, and their chief executives from other advisory and tax services. This includes creating an audit board, publishing the profit and loss statement for audit only, and compensating audit partners from only assurance service revenues (Nina Trentmann, “U.K. Regulator Orders Big Four to Separate Audit Practices by 2024,” Wall Street Journal, July 6, 2020, https://tinyurl.com/55wec6cz).

In its market study, commissioned by the U.K. parliament after the Big Four failures, the Competition and Markets Authority, a U.K governmental agency responsible for strengthening competition and reducing anti-competitive conduct, cited the negative impact of non-audit services on the audit quality provided by the Big Four as one of the factors contributing to their recommendation of the operational split to U.K. regulators (Competition and Markets Authority, Statutory Audit Service Market Study, April 18, 2019, https://tinyurl.com/ensaxwt8).

In May 2022, the government implemented significant changes to audit regulations and replaced the FRC with the Audit Reporting and Governance Authority (ARGA). These reforms were designed with several objectives: to rebuild trust in the accounting profession, to reduce the dominance of the Big Four in providing assurance services to companies listed on the Financial Times Stock Exchange (FTSE), and to fortify accountancy enforcement and monitoring mechanisms (https://tinyurl.com/4pjxze55). The revamped regulations stipulate that FTSE 350 companies must either engage the audit services of a Big Four competitor or allocate a portion of their audit services to such firms. Notably, ARGA has been granted the authority to impose market caps on the Big Four’s audit activities should their audits fail to be rigorous or if there is no substantial reduction in their market dominances (https://tinyurl.com/4pjxze55). Although there has been a change in government since the Carillion collapse, under current Prime Minister Rishi Sunak, the United Kingdom has not focused on additional audit regulations.

What about the United States?

The danger of expanding advisory services is not new to the U.S. market, having been part of the rationale for Congress to reduce some advisory services while eliminating others with the passage of SOX. In a 2014 speech, former PCAOB Board Member Steven B. Harris argued that the provision of advisory services is a threat to audit firms because it impacts the following items: the firm’s allocation of resources; the partner’s evaluation shifts from assurance quality to revenue generation; and the firm’s ability to sufficiently monitor conflicts of interest related to advisory service (Steven Harris, “The Rise of Advisory Service in Audit Firms,” PCAOB, November 24, 2014). In addition, the PCAOB’s 2017-2021 Strategic Plan lists as a weakness in its SWOT analysis the “potential for catastrophic risk within the audit industry, including risks relating to the provision of audit and non-audit service” (PCAOB, Strategic Plan: Improving the Quality of the Audit for the Protection and Benefit of Investors 2017-2021, p. 10, https://pcaobus.org/about/strategic-plan-budget).

U.S. regulators continue to raise red flags and issue warnings. Unlike other countries, the United States has, until very recently, taken no action to stem the rising tide of advisory service revenues. The SEC is investigating auditors for conflicts of interest to determine whether sales of advisory services compromise auditors’ independence (Dave Michaels, “Big Four Accounting Firms Come Under Regulator’s Scrutiny,” Wall Street Journal, March 15, 2022). In addition, SEC Enforcement Director Gurbir Grewal noted in a December 2021 speech that “you will see that we will have a firm commitment moving forward to continue to target deficient auditing by auditors, auditor independence cases, and cases around earnings management.”

The SEC has issued several fines against the Big Four since 2014 to settle auditor independence violations. For example: in 2021, EY agreed to pay $9.3 million to the SEC to settle charges for violating the auditor independence rules by rigging bids for audit work (Dave Michaels, “Ernst &Young to Pay $10 Million to Settle SEC Prone of Bid Violations,” Wall Street Journal, Aug. 2, 2021); in 2019, PwC agreed to pay $8 million to settle charges that its independence was impaired when prohibited non-audit work was mischaracterized as audit work (Mark Maurer, “PwC to Pay $8 Million to Settle SEC charges over Auditor Independence and Improper Conduct,” Wall Street Journal, September 2019); in 2015, Deloitte agreed to pay $1.1 million to the SEC to settle charges for violating auditor independence rules (Tammy Whitehouse, “SEC Slaps Deloitte for Auditor Independence Violations,” Compliance Week, July 1, 2015); and in 2014, KPMG agreed to pay the SEC $8.2 million to settle charges that its audit was impaired when it provided accounting services to affiliates of its audit client (Michael Rapoport, “KPMG to Pay $8.2 Million to Settle SEC Charges,” Wall Street Journal, January 24, 2014). In the United States, investigations have been conducted and fines have been issued, but no new significant requirements to stem the rising tide of advisory services have been proposed or implemented.

In a December 2023 report, the PCAOB indicated that it intends to examine audit firms’ “tone at the top” in an attempt to understand the culture behind the continuing increase in audit deficiencies (PCAOB, Spotlight, “Staff Priorities for 2024 Inspections and Interactions With Audit Committees,” December 2023). The extent to which this will have an impact on audit firms or regulators is unclear.

Academic Research

Academic studies have examined the consequences of the rise of advisory services at large audit firms (Dana Hermanson, “How Consulting Services Could Kill Private-Sector Auditing,” The CPA Journal, January 2009). Research finds that audit quality did not suffer after SOX; however, audit quality did suffer before SOX when no constraints were placed on the type or amount of advisory services audit firms could offer clients (Ling Lei Lisic, Linder Myers, Robert Pawlewicz, and Timothy Seidel, “Do Accounting Firm Consulting Revenues Affect Audit Quality? Evidence from the Pre-and Post-SOX Eras,” Contemporary Accounting Research, v. 36. no. 2, 2019, pp. 1028–1054, https://doi.org/10.1111/1911-3846.12424). Pre-SOX audit quality was lower when the majority of an audit client’s revenue stemmed from consulting services rather than audit services (which SOX now prohibits) and when audit firm revenues generated from advisory services exceeded those of assurance services. (These circumstances are now recurring, as the data in Exhibits 3 to 6 show.) Another study finds that a greater emphasis on advisory service does distract from the audit function, thus reducing audit quality (Erik Beardsley, Andrew J. Imdieke, Thomas C. Omer, “The Distraction Effect of Non-assurance Service on Assurance Quality,” Journal of Accounting and Economics, v. 71, no. 2, 2021). In addition, a new study finds that advisory opportunities play a significant role in auditor-client choice decisions; in other words, a client may choose a non-Big Four firm for its audit and one of the Big Four for advisory services (Elizabeth Cowle, Tyler Kleppe, James R. Moon, and Jonathan E, Shippman, “Client Consulting Opportunities and the Reemergence of Big Four Consulting Practices: Implications for the Audit Market,” Accounting Review, 2022; https://doi.org/10.2308/TAR-2019-0557). Academic research finds that increasing advisory service may impact audit quality.

It is important to highlight that when PwC announced its decision to scale back on offering certain consulting services to publicly traded companies, it cited 15 years of academic research as part of its rationale (Maurer, 2023). However, the company did not cite the specific sources or details of the research upon which they based their decision.

SPACs and Private Equity

Another factor that may affect the balance between assurance services and advisory services is the increasing presence of special purpose acquisitions companies (SPAC) and private equity firms in CPA firm ownership and capital sources. Public accounting firms are changing as their source of capital and ownership is changing by SPACs and private equity. A SPAC raises capital through an initial public offering (IPO) for the purpose of acquiring an existing operating company. A SPAC is essentially a structure for raising capital, one that is much quicker than a traditional IPO. A private equity firm generally buys companies, initiates changes, and extracts profits. Whether a SPAC or private equity firm is used, both forms are beginning to change the sources of cash for public accounting firms. Both provide a cash infusion into public accounting firms but change their structure. Public accounting firms are in need of cash for several reasons, including the pursuit of talent, technology, and growth (Andrew Kenney, “Private Equity Eyes Accounting Firms Large and Small,” Journal of Accountancy, Feb. 1, 2023; https://tinyurl.com/4d2f3y94). Current regulations require public accounting firms to be majority-owned by CPAs, which may lead the new owners to separate the business into an audit division that is majority CPA owned, and an advisory division that is majority SPACs and private equity owned.

Rising Tensions

The faster growth of advisory services as compared to assurance services and their resulting greater contribution to total firm revenue has caused tension within large audit firms and regulators worldwide. This tension will eventually lead to some resolution. What form that resolution takes is a question that firms and regulators are struggling to answer.

As identified above, regulators worldwide continue to grapple with the growth in advisory services by implementing various measures to protect the public. The Big Four are also grappling with this issue. The experience of AA around the turn of the century is a noteworthy example of how such tension can be handled. The AA example is even more relevant in light of EY’s failure to manage the tension caused by splitting services due to partners’ disagreement on whether tax services would be allocated to advisory or assurance, a significant sticking point. This becomes especially acute as environmental, social, and corporate governance (ESG) assurance and advisory services continue to grow, raising more complicated questions as to whether a client should be an assurance or an advisory client. The tension will persist until firms, regulators, or market conditions force a change.

R. Mithu Dey, PhD, CPA, is an associate professor of accounting at the school of business at Howard University, Washington, D.C. She previously worked at PwC and ExxonMobil.
Lesia Quamina, JD, LLM, CPA, is an assistant professor in the business management program at Goucher College, Baltimore, Md..