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EC’s audit rules risk quantity over quality

Wednesday 7 December 2011 – by [email protected]

The European Commission’s proposals to reform the audit market were released last week causing shockwaves in the sector, particularly among the big four who remain unconvinced that the new rules will achieve what they intend. Andrew Hickley investigates.

“If the current auditor is the best auditor, why shouldn’t the company be allowed to keep them?” asks PwC’s head of public policy and regulatory affairs, Pauline Wallace.

“Why should an investor be disadvantaged because the company is no longer allowed to use an auditor that is doing a really good job?”

Wallace’s concerns relate to the European Commission’s audit proposals, released at the end of November, which would see clients forced to rotate their auditor firm every six years.

Research has shown that the biggest risk of an audit failure comes within the first two years of having a new auditor on board, she says, which is one argument against mandatory rotation.

The EC’s proposed measures aim to boost audit quality – following problems identified in these processes during the financial crisis – as well as break the oligopoly in the sector, allowing smaller players a look-in. One of the most controversial measures is the requirement for large auditors to divide their consultancy and audit services into two separate legal entities.

Combine this with a provision banning the consultancy staff from working on an audit, and PwC says it would no longer be able to rely on its separate actuarial, tax or valuations practices to contribute to the audit process. This, Wallace says, would inevitably result in a lower standard of audit.

She says the proposals are “clearly aimed at the big four” group of auditors – consisting of Deloitte, Ernst & Young, KPMG, and PwC – given that they only ban these activities for firms that make more than €1.5bn a year in audit-based revenues.

“When I look at the impact assessment I am struggling to understand what it is that they think is the problem here that they’re trying to solve,” she says. “I am actually seriously concerned that it will impact quality.

Wallace adds: “If you look at the AIU [Audit Inspection Unit of the Financial Reporting Council] reports on the firms, not this year but I think it was 2010 report, it explicitly said in that report that the quality of audit was higher when audit firms had in-house specialist expertise they could refer to rather than going externally to specialist expertise. None of us can afford to have specialist expertise that just sits around waiting to be used on an audit.”

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