Review of the audit regime to help restore confidence in large companies

  • The government will tackle the dominance of the ‘big four’ audit firms and create a new regulator to reduce the risk of sudden collapse of large companies, protect jobs and boost the UK’s reputation as a destination for foreground for investments
  • the reform is already underway, with the business secretary taking action today to allow the regulator to ban failing auditors from reviewing the accounts of large companies
  • government pledges to review corporate reporting burdens on businesses to maximize Brexit benefits and reduce burdens

The government will revamp Britain’s corporate reporting and auditing regime through a new regulator, greater accountability for big business and by tackling the dominance of the big four audit firms, confirmed today (Tuesday May 31) the Business Secretary.

Effective corporate reporting and auditing allow investors and the public to assess the health of large companies. It is essential to sustain confidence in businesses, to encourage investment and growth which, in turn, help to create jobs.

Reforms to improve the audit regime and corporate transparency will help prevent sudden large-scale collapses like Carillion and BHS, which have hurt countless small businesses and led to job losses.

In addition, the government today announced that it will review the wider reporting burdens on large and small businesses, including those imposed by retained EU legislation. This will help UK businesses grow while boosting investment, as we take advantage of Brexit freedoms to regulate in a more proportionate and agile way that works for UK businesses.

In particular, the government will update the definition of micro-enterprises. This threshold, a remnant of an EU directive, could force too many small UK businesses to spend time and money preparing accounts at a level of detail needed only by large companies, distracting them from concentrating on growth and job creation. The government will also review reporting requirements for smaller public-interest entities to help attract high-growth companies and consider whether there are unnecessary restrictions on equity-based director compensation.

Corporate Responsibility Minister Lord Callanan said:

Collapses like Carillion have made it clear that auditing needs improvement, and these reforms will ensure the UK sets a global standard.

By restoring confidence in auditing and corporate reporting, we will strengthen the foundations of UK plc, so that it can drive growth and job creation across the country.

The Financial Reporting Council (FRC) will be replaced by a new, stronger regulator – the Audit, Reporting and Governance Authority (ARGA) – with stronger enforcement powers and funded by a levy on industry. Work on this has already begun, with the business secretary acting today to allow the regulator to ban failing auditors from scrutinizing the accounts of large firms.

For the first time, the largest private companies – not just publicly listed ones – will fall within the scope of the regulator, reflecting the impact they have on the wider economy.

No additional regulation will be added to small businesses through the reforms: the focus is on the UK’s biggest businesses, as many jobs, providers and pensions depend on them. Unlisted companies with more than 750 employees and an annual turnover of more than £750m will fall within the regulator’s scope, a threshold set after consultation to ensure reforms are as targeted as possible and minimize unnecessary charges.

Directors of the largest companies who violate their legal obligations to be transparent with auditors or who lie about the state of their company’s finances will face penalties such as fines, and the government will act to remedy “rewards in case of failure” – where the bosses pocket bonuses despite the collapse of their company.

Big companies will need to be more transparent about their profits and losses — not handing out dividends while they’re on the brink of collapse — while providing more information to investors and the public about what they’re doing. have done to prevent fraud, what company measures have been independently verified and what risks their business faces.

To stem the unhealthy domination of the audit firms of the “big four”, FTSE350 companies will be required to carry out part of their audit with a challenger firm. The new regulator ARGAwill also have the power to compel large audit firms to keep their audit and non-audit functions operationally separate and impose market capitalization if market conditions do not improve.

The government has previously confirmed its commitment to publishing a bill to revamp the UK’s corporate auditing and reporting regime during this session of parliament.

The Department of Housing and Communities Upgrading has also today published a response to the consultation on plans to strengthen the local audit framework in response to the Redmond Review. Plans include establishing ARGA as the leader of the local audit system, which will ensure local councils and bodies provide value for money to ratepayers.

Notes to Editors

The plans, which build on recommendations from independent reviews by Sir John Kingman, Sir Donald Brydon and the Competition and Markets Authority, were published today (Tuesday) in the government’s response to a public consultation on auditing and corporate governance reform.

The reform is already underway. The government has announced its intention to publish a bill, and the FRC made good progress on many of the recommendations from the reviews. Changes in the mindset and judgment of auditors will be driven by the continuous improvement of auditing standards and guidelines, while professional bodies will need to improve qualifications, skills and training.

Today’s post also sets out the full range of government action (a table of key measures can be seen below), starting with a new Ministerial Instruction issued today – an immediate step taken to strengthen oversight of the audit profession by the regulator.

Previous business failures have had a significant impact on individuals and the economy:

  • 9,000 layoffs were made, 555 retail stores closed and 1,286 businesses and government entities owed money following the collapse of Thomas Cook
  • 11,000 jobs at risk as BHS collapses
  • 7,000 suppliers and subcontractors affected by Carillion’s bankruptcy
Current plan Planned reform
Public Interest Entities (PIE) The British definition of PIE is inherited from the EU: listed companies, banks & building societies, insurance companies. Very large unlisted companies (>750 employees and >£750m annual turnover) will also become PIEso the new regulator will review their reports and audits and they will have to meet new transparency requirements.
The regulator The Financial Reporting Council (FRC) has a complicated mix of statutory, voluntary and contractual functions, funded by partly voluntary levies. A new statutory regulator – the Audit, Reporting and Governance Authority (ARGA) – will replace the FRC, financed by a compulsory levy on industry. He will have new powers, in particular to order companies to adjust their accounts without going through the courts.
Director’s responsibility The FRC does not have the power to act against company directors (unless they are accountants). The regulator will be able to investigate and sanction directors of large companies for breaches of corporate reporting and auditing obligations.
Director’s responsibility It is often unclear under what circumstances a CEO’s bonus would be withheld or clawed back. The FRC will consult on amending the Corporate Governance Code to increase transparency around bonus clawbacks.
Accountants and the Accounting Profession The FRC has the power to investigate and sanction auditors, but in the case of other accountants it relies on voluntary agreements with approved professional accountancy bodies. The regulator will have statutory powers to oversee the regulation of professional bodies in the accountancy profession and to investigate and sanction accountants in matters of public interest relating to corporate reporting.
Transparency Companies are not doing enough to demonstrate how they identify and manage future risks. Big PIE should explain how they identify and manage risks, and describe the measures taken to prevent and detect fraud. Directors of Premium listed companies will also have to declare whether their internal controls are effective, in accordance with the Corporate Governance Code.
Transparency Companies are not required to disclose their distributable reserves and accounting bodies provide guidance on what counts as ‘realized’ profit and loss (which is the legal basis for issuing dividends). Big PIE must publish their distributable reserves and confirm the regularity of dividend payments. ARGA issue guidance on what should be treated as “realized” profits and losses.
The audit market The FTSE350 The audit market is strongly dominated by 4 major audit firms. FTSE350 companies will be required to either appoint an auditor from outside the Big Four or allocate a certain portion of their audit to a smaller firm, which will increase competition while avoiding duplication of effort. If necessary, the Commercial Secretary may introduce a market share cap.
Verification scope Companies are not required to indicate how they guarantee non-financial information in their annual reports (this information largely escapes statutory audit). Big PIE will have to specify how they ensure the quality and reliability of the information contained in their annual reports outside the financial statements, including on climate, risks and internal control.

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