Audit time

Proposals adopted by the European Commission this week could end what many view as a "cozy" relationship between audit firms and their clients.

The Commission, the executive arm of the European Union, has finalized plans to ban audit firms from offering non-auditing services, such as financial and legal consulting, to avoid conflicts of interest and boost competition in a market dominated by four major companies.

The regional arms of KPMG, PricewaterhouseCoppers, Ernst & Young and Deloitte - the so-called Big Four - have a market share that exceeds 85 percent in the majority of EU member states, according to the Commission.

Lucrative consulting work

That dominance, officials in Brussels argue, has made it tempting for these firms to go easy on audit services in return for more lucrative consulting work.

Following the collapse of Lehman Brothers, critics have pointed to fundamental problems in the auditing industry's business model that led auditors to ignore risks at banks and other firms before the global financial crisis hit.

The EU has been reviewing its auditing rules ever since and feels it's now time to act.

"Investor confidence in audit has been shaken by the crisis and I believe changes in this sector are necessary," said EU Internal Market and Services Commissioner Michel Barnier in a statement. "We need to restore confidence in the financial statements of companies."

In addition to a clear separation of auditing activities from non-auditing services, Barnier's proposal calls for large companies to rotate their auditors every 10 years.

Toughest in the world

The US government is also considering a reform of its audit industry. But its proposals are not as sweeping as those proposed by the EU – which some believe would be the toughest in the world.

Accounting executives, however, are urging Brussels to move with caution.

"Audit quality is best provided by multi-disciplinary firms," Rolf Nonnenmacher, head of KPMG's European operations, wrote in an email response to Deutsche Welle. "The capability of firms to provide quality audits will be diminished if auditors are separated from wide-ranging advisory expertise including, crucially, risk management in the financial sector."

Nonnenmacher added that KMPG is also opposed to the mandatory rotation proposal, which he argued "would cause serious disruption to major (corporations) and have no positive effect on audit quality."

David Sproul, chief executive of Deloitte, shares those views. "Further restrictions on non-audit services, creating audit-only firms and mandating rotation will result in unnecessary disruption and cost, and will not address the objectives of improving audit quality," Sproul said in a statement.

'Detrimental effect'

In addition to increasing the complexity and costs for global companies, the measures would have a "detrimental effect" on audit quality for all sectors but, most severely, for financial institutions, he said.

The proposed legislation still needs to be approved by the European Parliament and national governments in the European Council, where it is likely to face strong opposition from the UK – home to thousands of the Big Four's European employees .

Author: John Blau
Editor: Stuart Tiffen