'Why the principle of capital maintenance and the definition of distributable profits matter' - new note OUT NOW! auditreformlab.group.shef.ac…

Big thanks to Lord @premnsikka for tabling such an important debate. The government’s upcoming Draft Audit Reform and Corporate Governance Bill needs to be ambitious and comprehensive to properly address the UK's audit crisis.

On Monday, the House of Lords held a debate on UK audit failure. Fantastic to see Audit Reform Lab research mentioned - particularly our 'Reward for Failure' report, which finds that auditors failed to raise the alarm in 3 out of 4 large corporate collapses in the UK, 2010-22.

Our research on 'reward for failure' in the audit industry was cited a few times in yesterday's House of Lords discussion, led by @premnsikka . You can view the whole session here: parliamentlive.tv/event/inde…

The King's Speech yesterday put the case for audit reform front and centre. Here's a quick news story from the @theipaper quoting our director @AdamLeaver1 on why its so important inews.co.uk/news/business/ne…

Another excellent editorial in the @FT on the need for more sceptical auditors, which draws on our 'Reward For Failure' report finding that 3 in 4 companies that go bust do so without receiving a going concern warning. ft.com/content/0519dc1a-f956…

The UK government set out plans to introduce a new audit regulator, but then kicked the can on audit reform down the road, wasting huge amounts of parliamentary and civil service time. Read our recommendations for reform here: auditreformlab.group.shef.ac…

The UK’s ineffective regulatory, oversight and sanctions system, and the limited liability for audit partners (under the Limited Liability Partnership business structure used by Big Four firms) provides little disincentive for this model to change.

However, auditors are currently incentivised to maintain good client relationships, rather than apply the principles of professional scepticism and enforce prudence.

Audit is an essential service that ensures the integrity of company reporting, and if done properly, would help to boost confidence for shareholders and other users of company accounts.

Between 75% (KPMG) and 85% (Deloitte) of revenue at Big Four firms comes from non-audit services. Focusing resources on consultancy rather than audit services in this way could undermine audit quality and create potential conflicts of interest.

From 2015 and 2022, regulatory fines for poor audits were on average just 0.16% of revenue and 0.85% of profits for Big Four firms. These small fines are not material enough to affect partner pay and disincentivise reward for failure problems.

We also analysed partner pay at Big Four firms and found that from 2020 to 2022, the average pay for partners at the Big Four firms rose by 31%, reaching £872,500. In the most recent fiscal year, partners at Deloitte earned over £1 million on average in pay.

Of the 250 liquidated companies, 38 declared dividends in their last set of accounts. Ten of these did so despite making a loss, and two did so despite reporting a loss and having a negative net asset balance, which is a strong indicator of insolvency risk.

Of the Big Four auditors, EY performed worst – warning of going concern risks for just 20% of collapsed firms. PWC provided warnings in 23% of cases, Deloitte 36% and KPMG 38%. Auditors outside the Big Four performed even worse – providing warnings for just 17% of collapsed firms

We analysed the audit reports of the largest 250 publicly traded companies that collapsed between 2010 and 2022 and found that only 1 in 4 received a going concern warning in the year before going bust.

The report examines poor performance and high pay as two sides of the same coin. We show the extent of ‘reward for failure’ in the Big Four empirically, and explain why these two features arise simultaneously auditreformlab.group.shef.ac…

Out today, and covered by @Simon_Foy in the @FT : 'Reward for failure: The paradox of audit partners’ record payouts amidst poor audit quality' ft.com/content/14a63c36-ba27…