From Polly Peck to Satyam, recurring audit failures have undermined investor confidence in corporate governance. The Institute of Chartered Accountants in England and Wales and the Financial Reporting Council hope to address those concerns through its newly published “Audit Firm Governance Code”.
This comply or explain Code will apply to the eight largest U.K. accounting firms which collectively are responsible for the audits of 95 percent of the companies listed on London Stock Exchange. At the time of wriiting the Code covers Baker Tilly; BDO; Deloitte; Ernst & Young; Grant Thornton; KPMG; PKF; and PwC.
The structure of the Audit Governance Code reflects the UK Corporate Governance Code for listed companies with 20 principles and 31 provisions, with adaptations for the audit firms which are generally owner-managed partnerships. One of the key provisions is the publication of an annual “transparency report” explaining how it has complied with the main independence requirements of the Code.
For the first time, auditors involved with public companies will have to appoint independent non-executive directors. Although the Code says the NEDs have a duty of care to the audit firm appointing them, “They should command the respect of the firm’s owners and collectively enhance shareholder confidence by virtue of their independence, number, stature, experience, and expertise.”
NED independence reflects the core aims of the Code to boost investor confidence in the quality of listed-company audit work, hopefully reducing the risk of a big accounting firm failing or pulling out of the audit market. According to recent research by Grant Thornton, the firm claims that in the event of a Big Four collapse, 20% of the 7200 largest businesses in the G20 would be left stranded without an auditor.
In the responses to the FRC/ICAEW consultations there was a great deal of speculation in the press that audit firms will be able to find candidates of sufficient independence and stature to meet the Code’s objectives. From an investor’s perspective, whether the newly-empowered NEDs will be able to challenge firms on their audit/non-audit strategies will be their true test.