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Auditors failed to raise alarm before 75pc of UK corporate collapses

London, May 21, 2024 

Audit firms failed to raise the alarm before three-quarters of big UK corporate collapses since 2010, according to research, raising concerns that auditors are failing to perform one of their core functions.

Three in four audit reports failed to provide alerts that companies risked going bankrupt by providing a “material uncertainty related to going concern” in the year before collapse, according to a report published this week by the Audit Reform Lab, a think tank at the University of Sheffield.

EY gave going-concern warnings for just one in five British companies it audited in the year before they failed, the lowest out of the big four. Fairfax

Auditors are required to include a going-concern warning if they believe there is a risk that the company may go bankrupt, rather than making a prediction that it will.

The research, which analysed the audit reports of the 250 largest publicly listed companies that collapsed between 2010 and 2022, found that EY gave going-concern warnings for just one in five companies it audited in the year before they failed, the lowest out of the big four. PwC, Deloitte and KPMG gave warnings in 23 per cent, 36 per cent and 30 per cent of their cases, respectively.

Auditors outside the big four performed even worse, providing warnings for just 17 per cent of collapsed groups.

Meanwhile, average partner pay across the big four rose by nearly a third to £872,500 ($1,654,900) between 2020 and 2022, the report found.

‘Serious concerns’

“There are serious concerns that auditors are not challenging enough,” the report said. “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.”

The report was published days after the UK accounting watchdog imposed multimillion-pound fines on PwC and EY for failures in their audits of London Capital & Finance, the defunct investment group at the centre of one of the biggest retail savings scandals in recent years.

A spate of high-profile corporate failures – such as at retailer BHS, outsourcer Carillion and travel group Thomas Cook – prompted the government to plan tougher rules for the audit sector, but these have been mired in delays.

Establishing the Audit, Reporting and Governance Authority (ARGA), a new, more powerful accounting and boardroom regulator, has also faced setbacks.

Richard Moriarty, chief executive of the Financial Reporting Council, warned in March that he was “sheriff for only half the county” and was forced to “beg” for funding without long-delayed legislation to create a stronger audit regulator.

‘Insufficient deterrent’

Although the FRC, the UK’s audit watchdog, has significantly increased the total level of fines it has levied against firms in recent years, the Audit Reform Lab report said the penalties were too small to “materially affect partner pay – providing an insufficient deterrent, and enabling firms to continue to be rewarded for failure”.

“Until the culture of audit is reformed and a new and more effective regulator is in place, partners at audit firms will continue to reap huge financial rewards, despite continued audit failures that harm business confidence and our economy more widely,” the report said.

EY, PwC, Deloitte and KPMG declined to comment. The FRC did not immediately respond to a request for comment.

[Financial Review]

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