Audit reforms risk backfiring, accountants warn

Plans by the UK government to increase significantly the number of companies subject to stringent governance standards risk straining audit firms and their new beefed-up regulator to breaking point, accountants have warned.

The government has proposed broadening the definition of “public interest entities” as part of a wide-ranging consultation on audit and corporate governance reform after a string of corporate collapses, including at Aim-listed café chain Patisserie Valerie and privately owned retailer BHS.

About 2,000 listed companies, financial institutions and insurers are classed as PIEs in the UK meaning that their audits are subject to more stringent regulation.

Ministers have laid out plans to widen the net to include large Aim-listed and private companies and are considering adding organisations of public interest such as universities and charities.

“If you double the number of entities, the system can’t absorb that,” said Iain Wright, a managing director at the Institute of Chartered Accountants in England and Wales, a professional body.

Hiring accountants from smaller firms would be the quickest way for auditors of PIEs to carry out the extra work needed, but this runs the risk that smaller companies would then be left unable to find an auditor as a result, he said.

“From a regulator’s point of view and from a market point of view, I think this will be strained to the point of falling over,” he added.

A too elastic definition of PIEs would create “a very long tail of companies within the regulatory system that dilutes the focus away from the systemically important companies,” said Anthony Carey, head of the UK board practice at accounting firm Mazars.

Asked last week whether the new regulator — the Audit Reporting and Governance Authority — would have enough resources to regulate so many audits, Sir Jon Thompson, chief executive of the FRC, said: “We would need additional capacity and capability.”

The FRC, which has roughly doubled its workforce to 350 since September 2019, would need to grow to 550-600 people if the government moved ahead with all of the proposals in the business department’s white paper on corporate governance reform, he added.

One of the two options in the white paper, published in March and open for consultation until July, would more than double the number of PIEs while the other option would lead to a rise of more than 50 per cent.

Auditors of PIEs are subject to more stringent regulation and will fall under the supervision of the new accounting regulator expected to replace the Financial Reporting Council in 2023.

Some auditors said they expect small accounting firms will resign as auditor of newly designated PIEs to avoid the costs and risks of additional regulation. Auditors are mostly prohibited from doing lucrative advisory work for PIE clients so could miss out on fees after the changes.

BEIS, the UK business department, defended the plans.

Increasing the number of PIEs would ensure there is oversight to mitigate the risk of avoidable company failures, safeguard jobs and strengthen the UK’s reputation for corporate governance, the business department said.

“The reforms are set to take place over a carefully managed, phased timeframe, enabling audit firms to take the proposed increase in PIEs as an opportunity for revenue growth,” it added.