When the Competition and Markets Authority (CMA) reported back to the government late last year on how best to introduce competition into the audit sector, its headline suggestion revolved around joint audits. The CMA proposed that audits of FTSE 350 companies be carried out by at least two firms, one of which should be non-Big Four, as a way of increasing the choice of auditors available to the largest listed businesses.
While joint audits are relatively unknown now, they were reasonably common in the UK during the 1980s, often happening after a merger when the original companies brought their own auditors to the table to assess the combined business. By the 1990s the largest audit firms had undergone their own consolidations and become global networks. These large firms became more confident in their own methodologies, says Katharine Bagshaw, ICAEW manager, auditing standards.
“Their risk management teams looked at joint audits and said, ‘we simply can’t afford to take responsibility for the work of another firm, however closely we work with them, because we can’t control them. Management has to understand that there was, and always will be, a risk that things fall between the cracks with joint audits’. And while the evidence is mixed, there are inevitably cost implications,” she says.
Experience from these earlier days showed that the two audit firms involved often did not get on or even agree. This does not surprise Mazars’ global head of audit, David Herbinet. “Those joint audits were always voluntary. When you have voluntary joint audits in a free market, one firm will always try to outbid and get rid of the other. That’s the worst possible experience of joint audit you can have.”
Herbinet is a long-time advocate of joint audits, having seen how they work for listed companies in France, where they are compulsory. Mandating the process means the different auditors have to work together and make the process function, he says.
“This completely changes the relationship from conflict to one of collaboration. The value of the joint audit very much depends on the relationship between the auditors. “If there is a problem, the audit committee will call the two firms together and say, either you make this work or we will change you both. When companies say that, I can promise you, the relationship becomes better pretty quickly.”
High on the list of firms’ concerns about joint audits is the allocation of responsibility. Joint auditors are joint and severally liable for the audit, with both parties signing off on the group audit report and needing to be comfortable with the work that their side, and the other side, has done.
The lack of proportionate liability in the UK is a big issue, says Bagshaw. “If the smaller of two firms in a joint audit has done, say, 20% of the audit work and makes a mistake, the larger firm could in theory be held wholly responsible, particularly if the larger firm has the money and the smaller firm doesn’t,” she says.
“Firms are worried that they will be held responsible for something they can’t control.” The law doesn’t distinguish in terms of liability – or insurance – says Tony Bromell, head of integrity and markets in ICAEW’s Technical Strategy Department. “A firm would need to take a good look at their insurance policy as even if they are only doing 20% of the work they could be liable for more. It may be that the judge would take the work allocation into account when splitting up who pays for what, but these are untested waters.” France has the concept of contributory negligence, which Herbinet says is akin to proportionate liability and which Mazars would like to see operate here.
“There’s no reason why an auditor should pay for the mistakes of others, but they should be fully responsible for their own mistakes. If there is a loss to the shareholders of, say, £10m, the two firms would be jointly liable for that amount. Then you would have a behind-the-scenes process to determine how much of the penalty each firm should pay.”
Appointment and allocation
The practice in France is for each firm to tender as if it were proposing to take on the entire audit. The company chooses the two best proposals, then goes back to the firms to ask whether one can match aspects of the other firm’s tender.
“They pick the best elements from each of the proposals and ask the two firms to work together to deliver that. This raises the bar and helps with audit quality, service qual - ity, and cost,” says Herbinet. Typically the group’s audit committee, with input from the CFO and finance department, decides on how the work will be allocated between the two firms, both of which need to be available for whatever is required of them.
Herbinet says the actual allocation is often very different from that proposed by the firms and is usually more about the focus than a strict percentage of the time. “For example, one firm might cover operations in the US and the other China. Clients make their allocation based on their experience so if after a couple of years they think that the current arrangement is not working as well as it should, then they may decide to swap things around. Changing the allocation and rotating the work is a normal feature of a joint audit – it happens all the time.
It’s something that the audit committee and auditors can work on together to constantly improve the quality of the service and the quality of the work.” This approach works whether clients are appointing their joint auditors simultaneously or are staggering the appointments over a shorter period, changing each of the firms after 10 or 20 years. There is no particular reason why both firms should start and finish in the same year, says Bromell.
“Overlapping changes could complicate things. But one of the principal worries about changing auditors has always been the loss of built-up knowledge about the client. Staggering any change might help with this, although it would increase the frequency of transition years for the client.”
Planning and reviewing
Once the two audit firms have been appointed, work starts with them both sitting down to agree on the overall audit approach and prepare a joint risk-based audit plan. This covers the usual issues from addressing fraud and material misstatement risks to assessing the client’s control environment, identifying risk areas and determining materiality, and setting out the audit procedures needed to complete the engagement properly. A single set of joint audit instructions is issued which all teams from both firms follow.
The two firms will have to plan the work as if, in effect, they were one, says Bromell. “Between them, they will need to cover everything and review everything so they are both comfortable about signing off in a way that maximises efficiency. They don’t want to duplicate work or use up too much management time: they certainly don’t want to increase the burden on their clients.”
France has a separate professional audit standard which governs how the audit should be conducted. “This sets out how the two firms plan together, cross-review much of each other’s work, and report jointly to the audit committee and then to the shareholders in a single opinion at the AGM,” says Bagshaw. She thinks that the standard setters and professional bodies would need to think carefully about what, if any, additional guidance were needed should joint audits become mandatory in the UK. “Bearing in mind that joint audits are encouraged under EU law, it seems highly unlikely that there would be absolutely no guidance or standards developed to help firms.”
New standards are usually a long time in the making, suggesting guidance from the regulators and professional bodies might be a more likely route – at least initially. But whatever is issued could be of interest not only to the UK, but to the international audit world. “Many regulators around the world are looking carefully at us to see if we go down the joint audit route,” says Bagshaw. “If we do, and if it looks like others will follow our lead, pressure would build on standard-setters to issue something more formal.”