Original recommendation

The CMA study recommended an operational split between the audit and non-audit practices of the Big Four. (Source: CMA)

Proposal

The Government has taken account of the CMA’s recommendations alongside responses to the 2019 consultation and has reached the view that there is merit in taking steps to reform the balance of incentives and working culture within audit firms while maintaining their multidisciplinary structure. The Government proposes to require:

• the strengthening of governance within audit practices through the creation of independent Audit Boards within firms;
• Audit Boards to have oversight of audit partner remuneration and ensure it is linked to audit quality;
• the publication of a separate profit and loss account for the audit practice, accounting for cross subsidies between the audit practice and the rest of the firm through arm’s-length transfer pricing; and
• regulatory oversight of the remuneration of audit partners, with a view to supporting policies and practices that reward high-quality audits.

In terms of scope, the Government envisages that the measures described below will apply initially to audit firms who carry out statutory audits of 15% or more of the FTSE 350 by audit fees. This percentage could be reduced in future to create a level playing field for all audit practices in the market. Alongside these proposals, the Government intends to require the publication of separate financial profit and loss financial statements for audit practices. The final strand of the Government’s proposals is to provide powers for the regulatory oversight of audit partners’ remuneration structures to ensure that partners’ incentives are effectively aligned to audit quality.

Government response

The Government will legislate to give ARGA powers to require an ‘operational separation’ of the largest firms: this proposal will require enhanced governance of the audit practice with a view to promoting greater professional scepticism within multi-disciplinary firms.