The big four accountancy firms have been challenged by the UK reporting regulator to show they can effectively manage risk, or face the possibility of outside regulation.
In a discussion paper, the Financial Reporting Council, which regulates accountants, stressed the need to reduce the risk of one of the big four firms failing, which it says could leave “a few large companies unable to find an auditor”.
The danger was underlined in Japan recently when the local business of PricewaterhouseCoopers was banned from auditing for two months following an accounting scandal at a client.
The loss of a big four firm in the UK would cause “uncertainty for companies and investors and a risk of disruption to the markets, at least in the short term”, the FRC said.
Its discussion paper follows a recent report on the audit market commissioned by the government and the FRC. It asks whether market-led solutions or more effective regulation could reduce risk.
The big four firms invest millions of pounds a year in audit quality and risk management, but cases of serious accounting errors and corporate fraud continue to emerge. The top firms have long said the most effective means of mitigating risk is by statutory limits on auditors’ liability in cases of client bankruptcy. Under the company law reform bill passing through parliament, such limits are due to be introduced.
Last year the FRC reported on the results of its first annual inspections of big four audits, a process initiated after the global wave of corporate scandals. But accountancy regulators have yet to explore the use of techniques common to prudential regulators in the banking and insurance sectors, such as sophisticated risk analysis and real-time reporting.
PwC’s travails in Japan have revived questions about the global structure of accountancy firms. They are organised as networks of separate legal entities in each country, but reputational damage can often spill across borders.
The temporary suspension of Chuo Aoyama PwC revived memories of the demise of Andersen, once the world's biggest accountancy firm. It disintegrated in 2002 as clients and staff fled, following its indictment in the US in the Enron scandal.
Another means of mitigating the risk of a big four failure would be to bring more firms into the market for large company audits, the FRC says.
Radical solutions suggested by some commentators include the mandatory transfer of clients to non-big four firms, the forced break-up of the big four, or the establishment of a state-backed auditor.
The recent FRC-backed study concluded it was unattractive for medium-sized firms to make the investments they would need to enter the market for large company audits.
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