Doomsday for Big Four Firms Getting Close?

Michelle Remo, “Big 4″ observer
September 28, 2011 /

The Big Four accounting firms will undergo a massive shake-up as the European Union has proposed changing the business models of auditors to increase competition in the industry.

The lack of competition in the audit industry has been partly blamed for the global financial meltdown four years ago, with Ernst & Young, Deloitte, PricewaterhouseCoopers and Deloitte receiving so many criticisms for overlooking the red flags that could have alerted financial institutions of the imminent crisis.

Responding to these criticisms, the EU is trying to cut the tight bond between companies and their audit firms through a proposal that would increase competition in the audit industry currently dominated by the Big Four.

According to critics, one of the many problems seen in the industry is the auditors’ lenient treatment of their clients’ books for fear of losing revenue by destroying their relationship. There is a compromise between the need to be skeptic and the urge to gain profit, the EU stated in its proposal.

“We find ourselves in a situation where a large number of audited companies have effectively become comfortable with their auditor, which clearly seems a refutation of the very essence of independence,” according to the draft document.

Michel Barnier, the commission’s internal markets chief, is proposing a new model that would ban audit firms from offering a range of financial services to their clients, including book-keeping, accounting, tax advice and legal services.

Companies will be forced to change their auditors after every nine years., while the largest firms will have to tap the services of more than one auditor to encourage competition.

“This will provide the opportunities for the smaller firms to get exposure, demonstrate their capability and build reputation over time so that they become real competitors to the current biggest audit firms,” the draft proposal says. The Big Four now audit more than 85% of big companies in a majority of EU nations, the EC said.

A spokesperson for the EC said the legislation will be released in November after going through the EC’s internal review process. Then the proposals will have to be approved by the European Parliament and national governments at the European Council, where thousands of employees of the Big Four abound.

But opponents to the proposal argue that preventing the Big Four from combining non-audit services with audit works could send one of the firms leaving the industry, which would reduce the competition further. It would also reduce the pool of potential graduate recruits.

“I used to do audit about 1,000 years ago and I did other things as well and I would have been less enthused about joining a firm where audit is all there is. You get less variety and the nature of audit is you have to specialis,” Tony Bromell, head of integrity and markets at the Institute of Chartered Accountants in England and Wales (ICAEW), said.

The audit industry, specifically the Big Four firms, raised its hands against mandatory joint audits, 10-year limits on audit relationships and limits on auditors providing other financial services to their clients.

In a statement, Deloitte said “any changes to the audit market must not be detrimental to audit quality and should not harm the capital markets or the critical focus on economic growth.”

According to James Doty, chairman of the Public Company Accounting Oversight Board, the European proposals are “a timely consideration of important issues” for the audit industry.

Last month, PCAOB issued a concept release seeking public comment on ways that auditor independence, objectivity and professional skepticism can be enhanced, including through mandatory rotation of audit companies.

Mandatory audit firm rotation means that the number of consecutive years for which a registered public accounting firm could serve as the auditor of a public company would be limited.

PCAOB Chairman James Doty said, then, “One cannot talk about audit quality without discussing independence, skepticism and objectivity. Any serious discussion of these qualities must take into account the fundamental conflict of the audit client paying the auditor.

“The reason to consider auditor term limits is that they may reduce the pressure auditors face to develop and protect long-term client relationships to the detriment of investors and our capital markets.”

PCAOB proposes the creation of an “Auditor’s Discussion and Analysis” section that would supplement the main audit opinion in a company’s annual report to broaden the information an auditor discloses to a company’s investors.

The PCAOB will release a formal proposal in 2012 on such potential improvements to auditors’ “reporting model.”

 

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