Plus ça change at the FRC? - the new accounting regulator starts to take shape - DAC Beachcroft

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Plus ça change at the FRC? - the new accounting regulator starts to take shape

Published 25 July 2019

Last year’s Kingman Report into the future of audit in the UK, and of the Financial Reporting Council (FRC) in particular recommended the replacement of the FRC with a new regulator – the Audit, Reporting and Governance Authority (ARGA). To the extent that this metamorphosis does not require a Parliamentary mandate, the Secretary of State has decreed that it should begin. In response, the FRC has recently published its plan and budget for 2019/20. This sets out strong indications of what audit firms should expect in the new environment:

  • Increased regulation, monitoring of audit work and enforcement activities is planned and budgeted for.

  • The first thing to strike a reader is quite how much the proposed ARGA looks like the FRC, albeit with tweaks around the edges. In many respects it will be a similar organisation, but expanded and with some augmented objectives.
  • One development which clearly augurs a step change in regulation is the increase in FRC staffing levels, with a proposal to take on 80 new recruits and a planned increase in core operating costs of 14% from £28.4m to £32.4m. Enforcement case costs in particular are predicted to rise substantially, up to £5m before taking into account costs awards in the FRC's favour. The Audit Enforcement Procedure (AEP) means that the FRC has the scope, and powers, to open many more investigations, and this requires more resourcing. The fact that the FRC is bringing in this resource is the best evidence that the FRC plans to use these powers and pursue many more investigations.
  • Inspection and enforcement are to be key priorities for the new regulator, just as they always have been. Audit fines nearly doubled year-on-year in 2018/19. We expect to see this matched or increased. Even with no change in the size of fines, the greater number of investigations being opened means that more investigations will result in financial sanctions. The FRC notes that the AEP allows a wider range of penalties – i.e. they can go much higher, but also lower. However, recent sanctions published suggest we are likely to see the higher end of the range being used more frequently than the lower.
  • The FRC has launched a consultation on whether the work of auditors on going concern requires change, with an emphasis on transparency in regard to the work undertaken and the reasons underpinning the auditors' conclusions. The FRC suggests auditors should be required to demonstrate they have challenged management's own going concern assessment. We have a personal concern that superficial "box ticking" and "being seen to do the right thing" could take precedence over audit quality, more generally – a perverse risk of heavier regulation. But that is a wider topic beyond the scope of this article. What we do predict is that the cost of audit will rise, and ever more resources will be committed to dealing with regulation.

  • The Secretary of State has perhaps predictably (given the headlines it generates) focused on fraud: “Following recent evidence given to the BEIS Select Committee by audit firms, I would encourage the FRC to take steps to ensure that audit firms are correctly applying audit standards in relation to fraud.” Challenging audit members to demonstrate that they have properly applied professional scepticism will be a strong focus for ARGA, and an area where we have concerns.

  • We are worried for the profession. There seems to remain a fundamental misunderstanding – both among the public at large and among politicians – of an auditor’s role. We are concerned that failure to spot a fraud will attract draconian sanctions, regardless of whether identifying that fraud was beyond the scope of a reasonable audit. With a breach of relevant standards replacing "misconduct" as the new benchmark for regulatory enforcement under the AEP, the danger of this is obvious. Post hoc ergo propter hoc enforcement plays well to the gallery of public opinion. 

  • An interesting development for practitioners negotiating with the FRC is that the FRC is already preparing voluntarily to apply Freedom of Information provisions to all of its work, prior to its designation as a public authority. We welcome this move towards transparency. However, it will be interesting to see how the freedom of information jurisdiction interacts with legal privilege concerns of those who disclose privileged information and documentation to the FRC. (See our article on related issues.)

  • Finally, the FRC is pressing forward with its monitoring and supervision of the Big Six audit firms (the Audit Firm Monitoring and Supervisory Approach – ‘AFMAS’). This recognises the systemically vital role that audit firms play within the financial system. Audit is a utility which UK Plc cannot do without.

This final point illustrates, we believe, the need for an effective advocacy body speaking up for the audit sector as a whole. The FRC says there needs to be a ‘step change’ in audit quality. That may be so, and we are sure the profession favours changes which drive an improvement in standards. But the whole tenor of public debate around audit ignores the fact that audit almost always goes right. The FRC notes that "confidence in audit has fallen" and points to failings uncovered in the audit quality review programme. The FRC also points to high-profile business collapses in which the auditor has been criticised. However, there is no public voice for the vast majority of auditors who are highly competent and professional people with sound fundamental values, and who do a good job. There is an imbalance in how the (non-specialist) media comments on the quality of audit, and this is harming both the audit profession and the public's confidence in the financial sector. Individual failings, including those of corporate management, should not be used to bludgeon auditors generally. A small number of enforcement cases should not detract from that wider truth. This needs addressing.

Authors

Richard Highley

Richard Highley

London - Walbrook

+44 (0)20 7894 6470

Julian Bubb Humfryes

Julian Bubb Humfryes

London - Walbrook

+44(0)20 7894 6137