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The UK takes the lead on a global audit issue

Proposals expected addressing three reviews of the UK audit market.

The UK government is soon expected to publish proposals which respond to the recommendations from three reviews of the UK audit market. Some of those issues are specific to the UK but some such as audit quality, use of technology in audit, and the auditor selection decision for large company audits are longstanding global issues.

Audit regulators have long shared views and co-operated on audit quality. They have been slow to react to the use of technology in audit but there are signs they are beginning to cooperate on that too, not least because companies and their audit firms are already making extensive use of technology which does not easily fit with traditional audit standards. It is not hard to imagine that audit regulators will begin to move in broadly the same direction at broadly the same pace. But I would argue the incentives to act together are weak on the auditor selection decision.

In part, this is because the issue is often confused by mis-using the term ‘competition and choice’. Audit regulators do not have the skills to identify and address competition issues, and they are generally disinclined to intervene. Competition is stiff between the firms that dominate the large company audit market. Audit committees do have a broad choice of quality firms to select from. But audit committee are generally sticking with what they know. Given all the scrutiny that audit committees face, why wouldn’t they choose what they perceive to be the ‘safer’ option?

Audit selection rests in the hands of audit committees

There is broad agreement that too few firms have significant market share, especially if one of the largest firms were to fail or if one of the largest firms were to otherwise withdraw from the large company audit market. For many years a number of firms have been trying to increase their market share. The common problem they face is they often finish a gallant second in the auditor selection process. Tendering is expensive and at least one firm has opted out of new FTSE350 tenders until market conditions change.

The auditor selection decision rests in the hands of audit committees. It would now seem that the UK government is preparing to act to influence that selection decision in a way that will result in large companies using a wider range of auditors.

It sounds like that will be by way of a regulatory nudge. Companies are unlikely to be told to change their lead auditor, but the lead auditor could be required to work with a second auditor. Sustainable change in market structure could be achieved if that is enabled in a manner where the second auditor can demonstrate to the company’s audit committee that it knows the sector, it delivers high audit quality, and it has the scale to address the company’s assurance needs.

And so when the audit committee makes its next lead auditor appointment decision, in sticking with what it knows it will know a wider range of firms.

Many other countries share the UK’s concern about large company audits being concentrated in too few firms, and many of those countries share similar market structures which make change difficult. They too will be watching to see what the UK government proposes, and whether sustainable change for the good follows.

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