The 2015 Audit Fees Survey

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THE UK’s largest companies shelled out more in fees to the firms that vet their accounts in the past year, despite the market becoming “madly competitive” as accountants and their clients try to get to grips with sweeping reforms that have fundamentally altered the market.

Total fees paid out to the six firms that audit the FTSE 350 – PwC, KPMG, Deloitte, EY, BDO and Grant Thornton – breached the £1bn barrier in the past financial year, according to data compiled from companies’ 2014/15 annual reports by Financial Director. Around £685m was paid out in audit fees – compared to £694m during the previous year – while fees for audit-related work also slipped to £93.2m from £112.8m.

The 8.1% rise in cumulative fees – an increase from £978m in last year’s audit survey – was supported by an uptick in fees paid for non-audit work as corporates have engaged in renewed merger and listing activities.

Panos Kakoullis, Deloitte UK audit managing partner, says work on M&A deals and IPOs has gone up for firms as a result of the more “buoyant economy” but warns that the amount of non-audit work available will become increasingly thin on the ground as new rules, which prevent the provision of a whole raft of non-audit services, start to take hold.

“The trend has been to move away from big IT consultancy and tax work,” Kakoullis explains. At the same time, new EU regulation – currently being transposed to the UK by the Financial Reporting Council – prohibits the provision of certain non-audit services by auditors of public interest entities through a ‘black list’ and places a limit on permitted services.

Nevertheless, auditors continue to hoover up lucrative non-audit work before the regulatory hammer falls. A total of £278.9m was paid out to auditors for non-audit work, which included corporate finance transactions, mergers and acquisitions, tax advice, tax compliance and other assurance services – up 2.5% from £272.1m in the previous year.

At £62.8m, tax advice remains the biggest earner for the firms, while businesses paid a further £37.9m for tax compliance work, compared to £56m and £50m paid out, respectively, for the two service lines in 2013/14. Under the EU’s so-called ‘black list’, tax advice has been banned altogether, and while companies may be unhappy that they need to look elsewhere, tax advice has become a real hot potato for accountants. PwC has been accused of promoting corporate tax avoidance on an “industrial scale” by Public Account Committee chairwoman Margaret Hodge, though PwC disagrees with the PAC’s conclusions.

Look out for the fallout

Hodge’s invective on tax avoidance should arguably of be less concern to PwC, which remains the most prolific auditor of the FTSE 350, than the fallout from its audit of Tesco after the retailer became embroiled in a very public accounting scandal. PwC was paid £4.3m for auditing Tesco’s 2014 accounts and picked up a further £4.9m for non-audit work, but it is the revelation that Tesco overstated its profits for the first half of the year by £263m that hangs heaviest on the firm.

Since Tesco revealed that its commercial department had booked huge payments from suppliers into the wrong accounting period, the Serious Fraud Office launched a criminal investigation into the accounting practices at Tesco and the FRC has started its own probe into the preparation, approval and audit of Tesco’s financial statements.

The period in which the overstatement appears is unaudited, but the noise that surrounds such a prominent British business is indicative of the fact that many look askance at audit. And PwC is hardly alone in being under scrutiny. In February, KPMG was hit with £390,000 in fines for breaching ethical standards for auditors in two separate cases of misconduct that date back to 2010 and 2011, when it was working as auditors of telecoms giant Cable and Wireless Worldwide and car dealer Pendragon.

Spot the mistake

Attention has been directed to the profession’s seeming inability to spot glaring holes in their clients’ accounts – most noticeably in those of the UK’s banks prior to the emergence of their need for a state bail-out – as well as perceptions that they were too cosy with company management and were unwilling, or unable, to effectively challenge management assumptions. This has sparked a slew of market probes and inquiries that culminated in a new form of audit and audit committee reporting in annual accounts and strict new rules about audit tendering that require companies to tender their audit contracts once every ten years.

From being labelled as the “dogs that didn’t bark” by former chancellor Lord Lawson because of their failure to spot the liabilities building up on banks’ balance sheets, auditors are now more akin to the dogs of war as they scrap over a feast-like number of contracts – once held for decades at a time – that will come pouring onto the market as companies try to exhibit good corporate governance.

According to Deloitte’s Kakoullis, the changes have led to “ferocious competition” among the top firms. “Some people talk about this being a once-in-a-generation event but that’s not correct. This has never happened before; it’s the first time we have had to contend with anything like this,” he says.

And although the new regulations “may not have had the outcome they originally meant to” – they were partly aimed at breaking the Big Four’s dominance of the FTSE 350 – they have served to drive more innovation and a greater focus on quality.
“We now have to work out how to demonstrate high-quality audits,” says Kakoullis, who explains that this has led to a greater use of analytics and technology to demonstrate a “leading edge”.

The changes have also led to finance directors taking a back seat in the appointment of auditors. Audit committee chairs are now held accountable for the selection process. This has already been fairly prevalent at large FTSE companies over the past four years, according to Kakoullis, but it is now “more commonplace” for audit chairs to take leadership of the process. Although FDs still get the “right of veto”.
“Ultimately, the chief financial officer needs a good working relationship with the auditor,” he says. ?

The Financial Director audit fees survey has been produced using data based on disclosures in 2013/14 annual reports (or 2013 annual reports when no data was available at the time at which the information was compiled). Constituents of the FTSE 350 are correct as of November 2014.