UK audit shake-up after spate of corporate failures; The two sides of the EY break-up

 

UK audit shake-up targets big firms after spate of corporate ...

 

The Big Four

Britain to shake up audit market after Carillion crash

Britain to shake up audit market after Carillion crash - Reuters

 

FILE PHOTO: A view of the London skyline shows the City of London financial district, seen from St Paul's Cathedral in London, Britain February 25, 2017. REUTERS/Neil Hall/File Photo/File PhotoReuters

UK Audit Shake-Up Targets Big Firms After Spate of Corporate Failures

LONDON (Reuters) - Britain set out sweeping reforms of big company audits on Tuesday after high-profile collapses at builder Carillion and retailer BHS in recent years hit thousands of jobs and raised questions about accounting quality.

The business ministry detailed changes to auditing and corporate governance that will be put into law, though the measures are unlikely to come into force until 2024 or later and smaller firms will be shielded from the new rules.

The reforms are in response to 150 recommendations from three government-sponsored reviews on improving auditing in a market dominated by KPMG, EY, PwC and Deloitte, known as the Big Four.

The new law would create a more powerful regulator, the Audit, Reporting and Governance Authority (ARGA), to push through changes set out by government.

In the meantime, the current watchdog, the Financial Reporting Council (FRC), will have powers to vet audit companies and ban failing auditors, the ministry said.

Britain will also review a European Union definition of "micro entities", which benefit from simplified accounts. They typically have a balance sheet of no more than 350,000 euros ($377,230) and employ no more than 10 people.

Loosening the definition would mean more firms saving money by filing simplified accounts, though it could raise investor protection concerns. Other reporting requirements will also be reviewed to help attract growth companies to Britain.

The FRC currently focuses on big listed companies, but ARGA's remit would expand to include about 600 private firms with more than 750 staff and an annual turnover of over 750 million pounds ($949 million), a higher threshold than initially flagged. BHS was unlisted.

NO UK SARBANES-OXLEY

To curtail the dominance of the Big Four, the top 350 listed companies would have to appoint a non-Big Four accountant, or allocate a certain portion of their audit to a smaller accountant such as Mazars, BDO or Grant Thornton.

The business ministry could introduce market share caps on the Big Four if there is no improvement in competition.

Directors of premium listed companies would also have to state why they think their internal controls are effective.

This would be done under Britain's "comply or explain" corporate governance code, which the FRC can change without legislation.

UK companies pushed back against enshrining in law a version of mandatory U.S. Sarbanes-Oxley rules, which force U.S. directors to personally attest to the adequacy of internal controls, and face prison for breaches.

"Lessons from Carillion and other recent company failures have been ignored, with little emphasis now on tightening internal controls and modernising corporate governance," said Michael Izza, chief executive of ICAEW, a professional accounting body.

FRC chief Jon Thompson said: "The Government’s decision not to pursue the introduction of a version of the Sarbanes-Oxley reporting regime is, the FRC believes, a missed opportunity to improve internal controls in a proportionate, UK-specific manner."

Big firms would also have to state what external checks, if any, were made on the reliability of their non-financial information in annual reports, such as risks from climate change.

Larger companies would have to confirm the legality of their dividends, a lesson from Carillion. 

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Insight - The two sides of the EY break-up

 

For its part, EY is under particular pressure due to its auditing of collapsed German payments firm Wirecard AG – although it’s not clear that a break-up would rid it of any liabilities arising from that failure. Perhaps EY is preempting tougher regulation.Or perhaps it just sees an opportunity to monetise some of it assets.

  A possible split of EY into separate audit and consulting firms must confront the problem faced by all break-ups: How do you create attractive businesses out of both when one is likely to be seen as inferior?

Here, that would be the newly established standalone auditor. EY – or any Big Four accounting firm that attempts such a separation – has its work cut out to make pure-play audit a success.

The revelation by Michael West Media that EY is considering the move heralds a potentially seismic shift for the industry.

A succession of accounting scandals has long prompted attacks on the Big Four for earning fees from audit clients by selling consulting services such as strategy or restructuring advice.

There’s an inherent conflict of interest in offering these to the same executives whose homework you’re meant to be marking.

While regulatory scrutiny is forcing firms to tread carefully, creating distinct companies is the most reliable remedy.

The United Kingdom’s competition watchdog called for an “operational separation” of audit and consulting within the existing firms in 2019, stopping short of demanding full break-ups because of cost and complexity.

For its part, EY is under particular pressure due to its auditing of collapsed German payments firm Wirecard AG – although it’s not clear that a break-up would rid it of any liabilities arising from that failure.

Perhaps EY is preempting tougher regulation.

Or perhaps it just sees an opportunity to monetise some of it assets.

One option under consideration is the sale of a stake in the consulting business to a private buyer or to the stock market, creating a windfall for EY’s current partners, according to the Financial Times. Demand would likely be strong.

Just look at the private-equity money piling in lately. PwC sold a tax advisory practice to Clayton, Dubilier & Rice for a reported US$2.2bil (RM9.6bil) last year, while KPMG offloaded its UK restructuring arm to HIG Capital LLC.

But what about the rump that remains?

While the underlying economics of the Big Four are opaque, there’s a widespread suspicion that consulting subsidises audit.

At the very least, the ability to share costs means audit fees are lower than they would be for a distinct firm, regulators have found.

Retaining talent

The biggest challenge is how a standalone auditor would attract and retain talent without offering an in-house career in consulting as an option.

Short-sellers and forensic investigators aside, checking company accounts is for many a laborious gateway to other roles.

Audit partners accused of getting it wrong have regulatory probes hanging over them for years (an investigation into Rolls-Royce Holdings Plc’s 2010 accounts only just closed).

No wonder juniors tend to jump ship to better paid and less risky careers in consulting or investment banking not long after they’re qualified.

So auditing will have to be made more attractive, both financially and culturally.

One place to start is expanding the function beyond checking financial statements to offering sophisticated checks on companies’ claims on non-financial performance such as climate and social impact.

When the United States Securities and Exchange Commission is clamping down on greenwashing by investment funds, it’s clear the future of environmental, social and governance investing rests on companies proving they’re not cooking the books on these issues too.

These public-interest assessments are going to be increasingly scrutinised by investors in future.

They are already offered under the umbrella of so-called assurance services, but ought to become a more developed part of corporate reporting.

That would involve transferring some skills over from the consultancy side. The trick will be to add in parts of the current consulting business that are relevant to a more modern vision of audit, without just recreating a new auditor-cum-consultancy.

Of course, separation won’t eliminate all the conflicts in audit.

The chief culprit is the way managers often effectively appoint the audit partners who are meant to be their policemen.

But the prize for stock-market investors is improved audit quality, and a break-up could support that.

The goal should be to create a virtuous circle.

Make audit more enticing as a long-term career, attract people who do the work better – and hopefully cut the number of blow-ups. — Bloomberg

Chris Hughes is a Bloomberg Opinion columnist covering deals. The views expressed here are the writer’s own.

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Probe on ‘Big 2’ accouting firms: KPMG and Deloitte still on over 1MDB accounts

 

Financial scandals are pandemic too

Probe on ‘Big 2’ accouting firms: KPMG and Deloitte still on over 1MDB accounts

KPMG and Deloitte being investigated over 1MDB accounts

KUALA LUMPUR: The Malaysian Institute of Accountants (MIA) is investigating KPMG and Deloitte, the two accounting firms involved in signing off the accounts of the controversial 1Malaysia Development Bhd (1MDB).

The investigations are on whether the auditors in question who handled the accounts had breached the Accountants Act when signing off 1MDB’s accounts between 2009 and 2014.

The MIA has the power to regulate the accounting profession in Malaysia.

“There are complaints lodged against KPMG and Deloitte and we are investigating the auditors in question. The complaints are on the auditors and it is ongoing,” MIA’s chief executive officer Nurmazilah Mahzan told StarBiz in an interview.

Nurmazilah said it could not be determined at this stage when the investigations would be completed.

“The results of the investigations will be studied by a committee. The process is continuing but we have not got the final verdict yet. We cannot predict how long it will take at this point in time. If the auditors are found guilty or if there is a basis to these complaints then we have to wait for the judgement of the disciplinary committee,” she added.

MIA’s executive director for surveillance and enforcement Datuk Muhammad Redzuan Abdullah said the investigations were at the disciplinary committee level now and investigations had started since mid-2016.

The scandal-riddled 1MDB that had accumulated debts of RM42bil over the five years between 2009 and 2014, has had four auditors since its inception. They are Parker Randall, Ernst & Young, KPMG and Deloitte.

1MDB appointed Ernst & Young as its auditor when it was set up in mid-2009. However Ernst & Young resigned in 2010 without signing off the accounts of the fund that was set up by the previous government headed by Datuk Seri Najib Tun Razak.

KPMG stepped in to take over from Ernst & Young and signed off the accounts for the financial years ended March 31 in 2010, 2011 and 2012. The accounts were signed off without any qualification from the auditors.

Deloitte took over the auditing in December 2013 after 1MDB contended that KPMG could not “conclude” its 2013 accounts.

1MDB had also said in May 2015 that Deloitte had signed off 1MDB’s accounts for 2013 and 2014. When questions arose as to why KPMG could not conclude the accounts for 2013, 1MDB stated in 2015 that Deloitte had signed off the accounts without any qualification.

Nevertheless, resignations by Ernst & Young and KPMG as auditors then had raised questions over the fund. In the accounting world, a firm rarely leaves a job half-done, especially more so when it involves big and prominent clients such as 1MDB.

After KPMG left, 1MDB obtained an extension of six months to submit its accounts for end-March 2013.

It was reported then that KPMG had relinquished its role as auditor. Deloitte then came in and managed to close the books within the extended period of six months.

Earlier reports quoting sources said the primary reason why KPMG could not give an opinion on 1MDB’s accounts was because it was not able to make a fair assessment of the value of the assets backing the fund’s US$2.3bil investment placed with a Hong Kong-based asset management company.

Subsequently Deloitte managed to complete the books wherein the fair value of the investments was put at RM7.18bil based on the assessment done by a third party engaged by the fund administrator.

Recent reports said KPMG which had then signed off on three unqualified audit reports for 1MDB, had informed its board of directors that the audited financial statements did not reflect a true and fair view of the company.

It was also reported that Deloitte in 2016 also said its audit reports on 1MDB’s financial statements issued on March 28, 2014, and Nov 5, 2014, for the financial years ending 2013 and 2014 should no longer be relied upon.

Credit: Daniel Khoo The Staronline


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School grades don't matter much?

Accounting firms PwC and EY start a trend in recruitment to help business and society

 

Big Four

WE all know that good grades in school won’t necessarily land you that first job. They do however go a long way towards convincing a potential employer that you’re likely to perform well if hired. That’s why you’re routinely asked to produce certificates and transcripts during the application process. How else can the employer get a quick reading on the discipline, intelligence, diligence and knowledge of a school-leaver or a fresh graduate?

But what if an employer decides that your grades shouldn’t matter as much? How will that change things?

For the answer to that, we ought to be watching the Big Four accounting firms in Britain.

Starting in June last year, PricewaterhouseCoopers (PwC) stopped using the UCAS tariff as an entry criterion for most of its undergraduate and graduate recruitment schemes. Developed by the Universities and Colleges Admissions Service, the tariff is the British system for allocating points to those seeking undergraduate placements.

The system applies to a long list of entry qualifications — for example, A levels, City & Guilds diplomas, and music examinations — and the points for each qualification are worked out based on the levels of achievement.

Before this, a person usually must have a minimum number of UCAS points before PwC would consider his job application, even if he’s a graduate. This is apparently a common practice in Britain. With the policy change, the accounting firm can now overlook mediocre A-level results if the candidate has gone on to soar in his degree programme.

PwC says the reduced emphasis on UCAS points is because it’s important to be a progressive and socially inclusive employer, and because it wants to reach the broadest range of talented students.

“There’s strong correlation that exists in Britain between social class and school academic performance. This data suggests that by placing too much emphasis on UCAS scores, employers could miss out on key talent from disadvantaged backgrounds, because they may perform less well at school. That’s why, from an academic perspective, we’re focusing on your degree,” it explains on its website.

And then in August, Ernst & Young (EY) announced that it would remove academic qualifications from the entry criteria for its 2016 graduate, undergraduate and school-leaver programmes. Instead of insisting on certain standards for UCAS points and degree classification, the firm relies on “a new and enhanced suite of online “strengths” assessments and numerical tests to assess the potential of applicants”.

In other words, EY recruits by evaluating the candidates’ strengths and promise, not just their past performance.

This decision came after talent management firm Capp had studied EY’s student selection process over 18 months. The analysis found that EY’s strengths-based approach in recruitment, introduced in 2008, is a robust and reliable indicator of a candidate’s potential to succeed in his role in EY.

“At EY, we are modernising the workplace, challenging traditional thinking and ways of doing things. Transforming our recruitment process will open up opportunities for talented individuals regardless of their background and provide greater access to the profession,” says Maggie Stilwell, the managing partner for talent.

“Academic qualifications will still be taken into account and indeed remain an important consideration when assessing candidates as a whole, but will no longer act as a barrier to getting a foot in the door.”

“Our own internal research of over 400 graduates found that screening students based on academic performance alone was too blunt an approach to recruitment. It found no evidence to conclude that previous success in higher education correlated with future success in subsequent professional qualifications undertaken.”

It’s interesting that Stillwell describes an overriding dependence on academic qualifications as a blunt approach. Stephen Isherwood, the chief executive of Britain’s Association of Graduate Recruiters, has a similar view. The PwC press release on the firm’s move to drop the UCAS points entry criteria, quotes Isherwood: “Using a candidate’s UCAS points to assess his potential is a blunt tool and a barrier to social mobility. This is an innovative step by one of the most significant graduate recruiters in Britain. Other graduate employers should follow its lead.”

PwC definitely sees itself as a trendsetter, saying its new recruitment assessment process could drive radical change across its industry. However, these radical changes haven’t happened yet. So far, Deloitte and KPMG, the other two firms in the Big Four, are still sticking to their minimum academic requirements in Britain.

It’s too soon to conclude that the recruitment changes by PwC and EY are a failed experiment.

The war for talent is intense among accounting firms. Businesses can’t stay at the top without thinking out of the box, taking bold steps, and being caring. It should be no different when it comes to how they hire people.

By Errol Oh Optimistically cautious viewpoint

Executive editor Errol Oh joined an accounting firm right out of school. That doesn’t happen in Malaysia anymore.

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Big Four Corporation

The Big Four are the four largest international professional services networks, offering audit, assurance, tax, consulting, advisory, actuarial, corporate finance, and legal services. Wikipedia