Changes to auditing regulations have Big 4 on alert

As the European Parliament debates the best way to produce growth, hands have been forced to constrict accountancy firms

 
November 8, 2011

It is no secret that new regulations are under consideration in a number of countries that will change the way auditing and consultancy firms operate. Proposals for change currently under consideration by the European Union are excellent examples. One of the more significant changes has to do with laws that preclude auditing firms from offering consultancy services to clients when they already audit their accounts. This new legislation will affect many, if not all, the member countries in the EU and additional changes to existing regulations, along with the imposition of new laws will make it necessary for the Big 4 to make a number of changes of their own.

There is a logical reason for limiting the ability of an auditing firm to offer a range of additional services to clients already using their auditing expertise. By entering into a contractual arrangement to provide those other services, there may be some temptation to be somewhat more lenient with the auditing process. This is because a somewhat harsh audit could jeopardise the income stream resulting from the peripheral services. By limiting auditing firms from also offering consultancy and other services to their customers, this temptation is eliminated and the chances of the audit being more thorough and accurate are improved.

Other changes are also in the pipeline that will impact the fortunes of Deloitte, PWC, KPMG and Ernst & Young, namely the requirement for customers to change auditors every nine years. The idea behind this regulation is that auditors and clients can become very ‘comfortable’ with one another, a situation that could lead to a little leniency. At the same time, the regulation is seen as a way to allow smaller firms to more effectively compete with the Big 4 and other major players within the industry, since some of those customers who would otherwise never look at another auditing company will be receptive to considering what those smaller firms have to offer. What this means for the Big 4 is that the chance to become entrenched with certain customers and possibly provide them with breaks that further deepen customer loyalty will be minimised.

Joint audits are another example of proposed changes that would impact the Big 4. This particular proposal would mean that instead of a single firm going over the books, a second firm would be employed to monitor both the accounting records of the customer and the level of efficiency exhibited by the primary auditing firm. The dual check is designed to keep everyone honest and ensure there is no preferential treatment.

While the changes appear to be negative on the surface, they also mean that the potential for auditors and others employed with the Big 4 are more likely to avoid internal situations that could enhance the chances of breaching company ethics, allowing a client company at least a degree of leeway, even if there are problems with record keeping. In the long run, these measures are designed to pave the way for keeping everyone honest and avoiding some of the scandals that have surfaced over the last several years.