At Last, a Small Step to Fix Audit’s Conflict of Interest

(Bloomberg Opinion) -- One of the Big Four accounting firms has taken a welcome step to improving the credibility of the financial statements published by London-listed companies. But KPMG LLP’s plan to stop doing almost all consulting work for the FTSE-350 clients it audits should be only the first step in addressing the profession’s wonky economics.

KPMG’s British arm is anticipating regulation rather than being bounced into it. U.K. trustbusters are already probing the audit market, and the Financial Reporting Council, the industry’s regulator, is the subject of a government review. KPMG is under particular pressure to show it can improve the quality of its work: It signed off on the accounts of Carillion Plc shortly before the construction firm collapsed. The firm was also called out by the FRC over the reliability of its audits earlier this year.

The importance of audit quality cannot be overstated. Reliable numbers are the foundation of investment decisions. Accounting firms combine audit and consulting services, and the risk is that the vital task of stress-testing company numbers is treated as no more than a loss-leader for more lucrative consultancy projects. This potential conflict of interest may undermine an audit partner’s ability to challenge a company’s chief financial officer on their preliminary figures.

KPMG LLP is “working towards” discontinuing consulting work for the major British companies it audits, Sky News reported on Thursday. It still wants to combine audit and consulting in one firm — sometimes experts from one side will be able to help out on the other — without providing the two services to the same client.

At Last, a Small Step to Fix Audit’s Conflict of Interest

True, consulting boosts KPMG LLP’s revenue from audit clients by only 40 percent, the smallest uplift among all the U.K.’s major accountants, according to FRC data. It may be more costly for rivals to follow, but they should.

If audit fees have to rise, so be it. The economics of audit are tough and margins low. Scale economies count. The reality is that quality audits of multinational companies require global firms, and there can only be so many.

Addressing the audit-consulting conflict shouldn’t be the end of the matter. The next target should be the remuneration of the audit partner. The quality of their work only becomes apparent over time, so pay needs to be made long-term, too. The Big Four are all partnerships and so don’t have publicly listed shares, but it can’t be beyond their intellect to devise equity-like programs that tie a proportion of partners’ pay to their three- to five-year performance. After all, these people are more than happy to advise their clients on long-term incentive plans. They should think about their own.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

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