U.K. parliamentarians called for an overhaul of the country’s audit sector on Tuesday as the industry faces scrutiny following several high-profile corporate collapses.
The Business, Energy and Industrial Strategy Committee proposed to break up the audit and consulting business units of the Big Four accounting firms into separate legal entities so that audit work is no longer subsidized by the firms’ other business, a move aimed at tackling conflicts of interest.
The suggestion goes beyond previous proposals by the U.K.’s competition regulator, the Competition and Markets Authority, to force KPMG LLP, Ernst & Young LLP, PricewaterhouseCoopers LLP and Deloitte LLP to separate the operations of their audit and nonaudit businesses.
Tuesday’s report also recommended imposing a cap on the number of listed companies that a firm can audit, trying out the use of joint audits and making companies change auditors more frequently. Under the proposals, companies would have to switch auditors every seven years and wouldn’t be allowed to assign their former auditor for nonaudit work during the first three years after the change.
The report also suggests expanding the scope of audits to make auditors focus more on potential future risks.
“The Big Four’s dominance has fostered a precarious market which shuts out challengers and delivers audits which investors and the public cannot rely on,” said Rachel Reeves, the chair of the BEIS Committee, in a statement.
The four firms accounted for 99% of audits of companies listed in the FTSE 100 index in 2016 and 2017, and for 97% of audits of companies in the FTSE 350, the committee said.
The CMA is expected to issue a final report to the government in a few weeks’ time. The report could include proposed legislation and may prompt action by the U.K. government.
The four accounting firms welcomed the idea of widening the scope of audits but rejected the proposal to break up their businesses.
“This will be detrimental to audit quality and could materially damage the U.K.’s competitive position as a leading capital market,” said Stephen Griggs, managing partner for Deloitte’s U.K. audit business in a statement. Deloitte audits 27 firms in the FTSE 100 and 88 in the FTSE 350, a spokeswoman said.
PwC, another Big Four company, said breaking up accounting firms would reduce audit quality, increase costs and cause disruption for businesses.
“We agree that audit firms and the regulator must focus on increasing trust in audit and the consistency of audit quality,” said Hemione Hudson, head of assurance at PwC U.K., in a statement.
A KPMG spokesman said “trust in audit is in urgent need of repair.” The company stopped taking on nonaudit related work for FTSE 350 companies that it already audits in October, and expects the majority of existing projects to finish by the end of this year.
KPMG, which audits 29 companies in the FTSE 100, signed off on the accounts of U.K. construction and outsourcing company Carillion PLC less than a year before the company entered administration in 2018.
Carillion was able to hide nearly half a billion pounds in liabilities due to lax accounting rules, Moody’s Investors Service Inc. later said. The company’s failure was one of the triggers for the current debate around audit quality.
KPMG is under investigation by the Financial Reporting Council, a regulator, for its audit work for Carillion. On Tuesday, the FRC announced an additional review of KPMG’s governance, controls and culture.
Mazars LLP, one of the smaller audit firms, backed the suggestion to mandate joint audits. In practice it “represents the most effective form of segmented market cap as proposed by the BEIS Select Committee,” said David Herbinet, the company’s global audit leader, in a statement.
Some critics said the new proposals may not necessarily improve the standard of audits. Joint audits could create gaps in oversight that a company’s management might exploit, said Fiona Czerniawska, managing director of Source Global Research, a research firm.
“If we want better audits, then we should look at the role of management and not just focus on the supply side, the auditors,” Ms. Czerniawska said.
Moreover, the new proposals don’t account for the impacts that automation and artificial intelligence may have on the audit industry, she added.
The U.K. government has sought to improve the reputation of the U.K.’s audit and accounting sector as the country prepares to leave the European Union. The industry in 2017 accounted for £8.9 billion ($12 billion) of tax receipts in the U.K.—1.5% of the total—and contributed £59 billion to Britain’s gross domestic product, according to a study by Oxford Economics Ltd. released in November.
As part of the changes, the Financial Reporting Council would also be folded into a new oversight body called the Audit, Reporting and Governance Authority.
Write to Nina Trentmann at Nina.Trentmann@wsj.com
