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Clients Need to Evade Grasp of Big 4 Auditors

Although the independent audit proceedures in the UK and US had some part to play in the economic downturn, the banking crisis has not claimed a Big Four accountancy victim. But, it's a risk that worries international regulators.

Yet the fault lies with clients rather than the Big Four -- if directors were bold they could appoint a smaller firm and help create a fifth force in auditing.

But 99 percent of the FTSE-100 companies use a Big Four auditor, some paying £50m for their services. Even among the next 250 biggest companies, only six percent use auditors outside that quartet.

And this is not only a UK monopoly -- PricewaterhouseCoopers, Deloitte, KPMG and Ernst & Young dominate the international market so British companies cannot even choose a large foreign firm.

Even 80 per cent of companies in the FTSE Small Cap index are audited by the Big Four; only among the Alternative Investment Market companies do the accounting minnows have a majority and that is part of the reason larger companies choose the larger accounting firms.
Not only do big groups need an audit practice big enough to handle their affairs, if they are paying for an independent firm to endorse their accounts they want a firm whose prestige at least equals their own.

Choosing a firm that mainly audits small companies associates the client with those small companies. Both big and small companies thus opt for large audit firms to avoid that association and if it fools the bankers, shareholders and suppliers, the higher fee pays for itself.

Auditor choice is thus a viscious circle with the smaller accountants' fees falling while the big firms' revenue rise. Even within the Big Four there is polarisation: PwC, Deloitte and KPMG have increased their share of top clients in recent years to produce a Big Three.

Proposals from the UK's Financial Reporting Council have failed to break this monopoly and the chartered accountants at the ICAE&W have yet to finalise a code that might influence clients.

The rule that audit firms rotate partners every five years to remain independent of clients has been extended to seven for small accounting firms, but more dramatic change is necessary if the Big Four are to loosen their hold.

  • On the supply side, changing the rules on owning audit firms might allow a newcomer to join the market.
  • On the demand side, barring clients from giving their auditors any other (non-audit) work might force big companies to spread tasks over a wider range of firms.
The Big Four might choose to keep the valuable consultancy and project work, allowing smaller accountants to take on the audits. If boards are not brave enough to break the big firms' monopoly, the answer may be to force them away from the Big Four.

(Pic: hotnuts21 cc2.0)

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