The current economic downturn is encouraging issuers to review their audit arrangements with more pressure to delivery low cost audits says Ernst & Young’s audit chief, John Flaherty.

According to reports in Accountancy Age tendering activity is at its highest level since the beginning of the new millennium. ‘We are seeing more driven on the grounds of price and [potential clients] asking if we can reduce the audit cost.’ said Flaherty.

Audit relationships are generally very stable in the UK, something which critics of the auditing industry have raised as a governance concern in recent years. However this year a number of major UK issuers including IMI plc and Rentokil have announced changes to long standing audit arrangements.  IMI is switching from KPMG after 20 years of service, in favour of Ernst & Young.

Competition and downward cost pressure is fierce, according to Flaherty, leading some firms to offer new, cut-down offerings. KPMG sparked concern earlier this month when it was revealed its Rentokil audit would integrate internal and external audit functions. Flaherty has gone on record stating that he believes the KPMG package “runs close to ethical boundaries”.

‘The way they have packaged and described it has brought them closer to the line of what is acceptable and not acceptable…each of the firms needs to take its own view about where that line is,’ he told Accountancy Age.

Such a bundling of audit roles would be out of the question for companies with a dual listing in the US, thanks to the strict independence guidelines or ‘bright lines’ set down by the Securities and Exchange Commission (SEC). However, the UK audit profession may need to re-examine the industry’s ethical code which raises two main risks when internal and external audit are combined. The first threat, the “self-review threat”, warns against an external auditor relying heavily on its own internal audit work. The second threat, known as the “management threat”, warns against the internal auditors assuming the role of management.

Although auditing standards permit KPMG’s proposed bundling, many investors will see this approach as driving a coach and horses through best practice standards. In the UK is legally prepared for the shareholders, as opposed to  management and leading institutional investors have long-standing voting guidelines which monitor the ratio of audit to non-audit fee work on that basis that the non-audit activity could be a threat to the independence of the audit. 

While audit issues don’t tend to grab the headlines in quite the same way as executive compensation, this may yet change if the Walker and Combined Code Review take these concerns on board. The mainstream press seems to forget that our current corporate governance regulations took shape after the failure of numerous high profile audits, not high profile executive pay failures.

Last Updated: 21 August 2009