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26 Feb 2013 06:27pm

Competition Commission publishes full audit report

The Competition Commission has published its full provisional report into the audit market today, after a summary last week concluded the audit market was not serving shareholders well enough

The 297-page report concludes that a lack of visibility on audit quality is having a negative impact on competition, and putting companies off changing auditors more frequently.

"It is therefore our provisional view that the reluctance of company management to provide information about the audit judgements and audit process is a feature that prevents, restricts, or distorts competition," the report reads.

The report says it had been able to find no evidence that the Big Four had undertaken “low-balling”, by undercutting the price of mid-tier companies, no evidence of bundling audit services together with audit-related work, and no evidence of tacit collusion.

Equally, it found no evidence that regulations were “skewed in the larger firms’ favour”, or that there are “regulatory distortions in the relevant market.”

Nonetheless it highlights the risk of long-term relationships to the independence of audits. The report points out that the “risk-reward balance offered to audit partners was attractive; and on balance it appeared to us that audit was a relatively attractive service line.” 

“We identified a number of companies from which audit firms appeared consistently to earn above average profit.”

In investigating why the Group A firms were unsuccessful in winning FTSE 350 audit engagements, the Commission says it failed to identify any single large investment they would need to make to compete on a level with the Big Four.

However, it discovered from potential audit customers that they looked for a “substantial track record” of auditing FTSE 350 companies when selecting auditors.

Since only the Big Four were able to demonstrate that experience, the customers did not feel the need to look further.

The Commission warned that it was difficult to identify an “objective” metric to monitor the effectiveness of the audit market, but that the Audit Quality Review Team, which is part of the Financial Reporting Council, had identified a “range of issues regarding quality and a lack of auditor scepticism.” The Commission said it had concerns that innovation was “largely directed towards service delivery mechanisms, rather than delivering a service which best responded to shareholders’ demand for assurance.”

It also raised concerns that shareholders would like more information about the audit and the process of appointing auditors.

As last week, the report reiterated that companies were reluctant to switch auditor due to costs, a lack of knowledge about the quality of an incumbent firm, and “deep-rooted relationships of trust and confidence”.

It concluded that “in general, companies do not lightly walk away from such relationships, which means that audit firms are likely to have to substantially underperform or overcharge before their tenure is put at risk.”

“However, where there is a gap between market expectations and company performance or a company is otherwise under financial pressure, this conflict may generate significant contradictory incentives.”

The report also investigated the time and risk involved in changing a company auditor.

“Audit firms told us that, when newly appointed, they made considerable investments in companies during the early years of an engagement (in terms of additional hours)," reads the report. "We were told that it took perhaps two to three years before an audit firm fully understood the complexities of a company, but that this investment led to increased quality and efficiencies from which companies benefited. We were told that audit firms had much to lose should a company switch, in terms of income, reputation, and the ability to win further engagements.

"This meant, they said, that companies were able to ensure that their audit services were offered competitively, even outside a tender process.”

Today's report omits some parts of the research deemed to be commercially sensitive, including the breakdown of statutory audit revenue by firm.

In the report, PwC gave evidence rejecting claims that it allows the relationship with its clients to influence its professional view, saying the relationship was not “without tension”.

PwC continued, “For us the preservation of independence and maintenance of professional scepticism are overriding requirements and this sometimes means asking difficult questions and giving the company messages it would prefer not to receive.”

The report says the Commission got input from all the Big Four but only received detailed submissions from Deloitte and PwC.

The Competition Commission began the investigation into competition in the audit market after the Office of Fair Trading referred the issue to it in October 2011. Since then the Big Four and mid-tier firms have all been vigorously campaigning to put their case for either more competition to be introduced in the market, or for the status quo to remain. Last week the Commission published the headline findings and summary.

Concluding the report, the Commission said auditors are "less independent and less responsive to shareholder demand" than they would be in a more competitive and "well-functioning market."

"In our provisional view, most companies and most auditors perform their functions diligently and effectively most of the time. However, the point of audit is not to act as a redundant safeguard, but to be effective at times of conflict and financial pressure. We are not currently satisfied that it is."

Julia Irvine

Helen Roxburgh

 

 

 

 

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