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Assessing the Lords recommendations

Robust regulatory changes are necessary to create a fairer and more transparent audit market, according to recommendations by the UK House of Lords. The Accountant examines some of the key areas in the report.

Regular mandatory tendering of audit contracts

House of Lords (HoL): Recommends that FTSE 350 companies carry out a mandatory tender of audit contract every five years. The audit committee should be required to include detailed reasons for their choice of an auditor in their report to shareholders.

Non-audit services

HoL: A complete ban on audit firms carrying out non-audit work for clients whose accounts they audit is not justified. The committee recommended that a firm’s external auditors should be banned from providing internal audit, tax advisory services and advice to the risk committee.

Living wills

HoL: The government’s introduction of living wills for the Big Four auditors would lay out all the information the authorities would need to separate the good from the failing parts of an audit firm so disruption to the financial system from a collapse is minimised.

Regulators are too fragmented

HoL: The regulation of accounting and auditing in the UK is fragmented with manifold overlapping organisations and functions. Wider powers sought by the Financial Reporting Council would go some way to simplifying and streamlining matters for audit but further impetus needs to be given to rationalisation and reform.

IFRS a rules-based standard

HoL: IFRS is more rules-based than UK GAAP. IFRS might be limiting auditors’ scope to exercise prudent judgment. The government and regulators should not extend application of IFRS beyond the larger, listed companies where it is already mandatory. Continued use of UK GAAP should be permitted elsewhere.

Risk committee advisers

HoL: Recommends every bank should have a properly constituted and effective risk committee. It should be up to the external auditor to ensure that this is done, by making clear that if it is not, the auditor will say so in a qualification to the accounts.

Public sector work and the Audit Commission

HoL: The report recommends that the government should make greater efforts, within EU procurement rules, to enable non-Big Four firms to win public sector work. The report also states the abolition of the Audit Commission could provide an opportunity to increase competition and choice in the audit market.

Recommendations to the OFT

HoL: The committee makes several references to the Office of Fair Trading (OFT), recommending it looks at several issues, including restrictive bank covenants, the role and scope of an auditor, unlimited liability and the provision of non-audit services.

INDUSTRY REACTION

IFRS

BDO audit partner James Roberts agrees with the findings of the House of Lords report that IFRS might be limiting auditors’ scope to exercise prudent judgment.

"In terms of reliability and prudence, IFRS has gone to the slightly wrong side in a bid to get greater relevance. Our view is accounting has become overly complex in financial reporting sense," Roberts said.

But ACCA chief executive Helen Brand warned the Lords’ criticisms and its effect on audit quality are "misguided and could have potentially serious implications internationally".

According to Brand, the recommendations from the report need further clarification.

"It is important to note that the specific IFRS weakness identified s – around expected rather than incurred loan losses – is already being remedied," she said. "The recommendation UK GAAP should be continued ignores the fact the key accounting standards in UK GAAP – on financial instruments – are virtually identical to existing IFRS.

CPA Australia CEO Alex Malley also disagreed with the criticism of IFRS.

"The Lords have failed to acknowledge the market has moved on since 2008. Since IFRS was introduced in 2005, stakeholders have become more familiar with it," Malley said.

ICAEW head of financial reporting Nigel Sleigh-Johnson added: "The report focuses of course on audit not financial reporting, and I don’t think it provides sufficient evidence for the assertions IFRS is ‘an inferior system’ and there should be no extension of mandatory IFRS reporting here."

OFT investigation

The report has recommended an investigation by the UK Office of Fair Trading (OFT) to examine restrictions of competition, conduct a market study of restrictive bank covenants and several other issues such as additional auditor assurance to investors.

PwC head of UK public policy Pauline Wallace said she is "disappointed" the report has decided to recommend an investigation by the OFT because she said the market is already very competitive.

Grant Thornton UK partnership oversight board chairman Steve Maslin is also sceptical about what the investigation will entail.

Maslin says he welcomes recommendations for a detailed investigation by the OFT, but is concerned about the OFT’s current perception.

"The OFT enquiry must, at the very least, lead to the banning of ‘Big 4-only’ clauses in bank agreements, which nearly all commentators, including the four larger firms, say are wrong. If not, it will show the UK regulatory framework in a poor light, with lots of regulators conducting lots of toothless reviews."

 

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