The UK’s Financial Reporting Council (FRC) has set out its principles for an operational separation of the audit practices of the Big Four firms.

The aim of the operational separation is to ensure that audit practices are focused on the delivery of high-quality audits in the public interest and ‘do not rely on persistent cross subsidy from the rest of the firm’.

The FRC has set out its desired outcomes:

  • Audit practice governance prioritises audit quality and protects auditors from influences from the rest of the firm that could divert their focus away from audit quality;
  • The total amount of profits distributed to the partners in the audit practice does not persistently exceed the contribution to profits of the audit practice;
  • The culture of the audit practice prioritises high-quality audit by encouraging ethical behaviour, openness, teamwork, challenge and professional scepticism/judgement; and
  • Auditors act in the public interest and work for the benefit of shareholders of audited entities and wider society.

The FRC has asked the Big Four firms to agree to an operational split of their audit practices on this basis and to provide a transition timetable to complete implementation by 30 June 2024. An implementation plan should be submitted to the FRC by 23 October 2020.

FRC CEO Jon Thompson said: “Operational separation of audit practices is one element of the FRC’s strategy to improve the quality and effectiveness of corporate reporting and audit in the United Kingdom following the Kingman, CMA and Brydon reviews.

“Today [6 July 2020] the FRC has delivered a major step in the reform of the audit sector by setting principles for operational separation of audit practices from the rest of the firm. The FRC remains fully committed to the broad suite of reform measures on corporate reporting and audit reform and will introduce further aspects of the reform package over time.”

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Industry Reactions

KPMG UK head of audit Jon Holt said: “KPMG supports operational separation in the UK. We are committed to working with the FRC to help shape the future for a profession which delivers high quality audits, acts in the public interest and supports successful and attractive capital markets around the world.

 "As a firm we have made changes which demonstrate how serious we are about rebuilding trust in our profession. For example, we were the first firm to announce the discontinuance of non-audit services to FTSE 350 companies we audit, to introduce graduated findings in our audit reports and to change our governance to create a separate Audit Board, which is solely focused on the performance management of our audit business.

 “It is clear however that operational separation of the UK’s audit firms is just the first step on the journey to restoring trust in UK plc. Along with the creation of a new, stronger regulator in ARGA, there must be an ambitious package of wider reforms across the corporate landscape. Including clarifying and enhancing the responsibilities of Boards, Directors and management in respect of corporate entity governance and the success or failure of the enterprise. Serious consideration should be given to the introduction of a UK version of the Sarbanes Oxley Act, which was effective in introducing expanded requirements for all U.S. public company boards, management and public accounting firms in 2002.”

EY UK chair Hywel Ball said: “The package of reforms being considered by the Government presents a significant opportunity for the UK to enhance the audit, corporate governance and corporate reporting ecosystem as a whole. The right reforms, properly implemented, have the potential to restore trust and reinforce the UK’s status as one of the most attractive markets worldwide for companies, investors, employees, and others.

 “We will continue to work with the FRC on its proposals for operational separation, but these proposals alone will not deliver all the changes needed. As part of the audit profession’s evolution, a holistic package of reforms, including improved director accountability and changes to the scope of audit, is required to deliver effective and sustainable change.”

A PwC UK spokesperson said: “We share the FRC’s objectives of improved quality and confidence in audit, market resilience and the continued attractiveness of the profession as a career, and are committed to playing our part.  We will continue to engage constructively with the FRC on the complexity and detail of these principles. The proactive steps we took a year ago to create a distinct Audit practice as part of our Programme to Enhance Audit Quality mean we are already aligned with many of the principles.”  

Deloitte UK deputy CEO and managing partner, audit& assurance, Stephen Griggs said: “We welcome this clarity from the FRC on the principles of operational separation and will continue working with them to develop our plans over the coming months.

 “Deloitte has been consistent in our support for reform. We remain committed to playing our role in delivering change that embraces audit quality, improves choice and restores trust.

 “Today’s announcement is an important step towards addressing this, but must also be considered alongside a wider package of reform, including in vital areas such as corporate reporting, the role of directors and the regulatory environment in which we operate. While delays are perhaps understandable due to COVID-19, it is crucial that we do not lose momentum.”

Mazars UK head of audit Bob Neate said: “Today’s principles for operational separation of audit announced by the FRC are a welcome first step towards audit reform.  Whilst we welcome this FRC initiative, operational separation of audit will not alone achieve the objectives of enhancing audit quality and building a truly competitive and resilient audit market.

“As identified through the various Government commissioned reports published in 2018 and 2019, including by the Competition and Markets Authority (CMA), true audit market reform to meet the public interest requires a package of interlocking measures.  We continue to believe the proposals of the CMA, which recommended a package of joint audit, strengthening audit committee oversight and robust operational separation, is the best route to fully achieve these objectives. We would encourage the Government to indicate its support for the CMA’s proposals to restore confidence in the audit market without any further delay.”