External Auditing of Companies: Deficiencies

Earl of Effingham Excerpts

Monday 14th October 2024 Lords Chamber

[The Earl of Effingham (Con)]

My Lords, during this debate we have heard references to the big four, which, as many in the House will recall, used to be the big five until 2002, when Arthur Andersen itself was dissolved as a result of accounting and auditing irregularities at Enron. We have heard about Carillion, BHS, Patisserie Valerie, London Capital & Finance and more. It is indeed an alarming statistic that of the 250 largest companies listed on the London Stock Exchange which defaulted between 2010 and 2022, only 25% had a going concern warning included by their auditors in what transpired to be their final set of accounts. However, what we must be crystal clear on is that if this was easy, we would not be having this debate. No one audit company caused any one collapse. What happened is that they did not see the dangers and either did not understand or underestimated the risks embedded in the firms they were auditing.

The noble Lord, Lord Sikka, and many others in your Lordships’ House will be well aware that these matters are extremely complex. Indeed, in 2013 the regulator itself—the FRC—approved the quality of KPMG’s audit of the Co-operative Bank during an annual review, shortly before it was discovered that there was a £1.5 billion capital shortfall at the lender. The FRC also approved the quality of an audit of Patisserie Valerie’s accounts six months before the company revealed the £40 million fraud and maintained that its

“routine monitoring of audits is designed to ensure the audit was conducted in a satisfactory manner and not to identify aspects such as fraud”,

which further illustrates the potentially challenging nature of audits.

The FRC did flag textbook failures in KPMG’s audit of Carillion, citing that:

“Many of the breaches involve failing to adhere to the most basic and fundamental audit concepts such as to act with professional scepticism and to obtain sufficient appropriate audit evidence”.


Independent judgment appeared in some cases to have been woefully absent. Conflicts of interest are apparent: Carillion was a very important and long-standing client for KPMG, generating £29 million in audit fees. This created a risk to objectivity, and on several occasions

“the audit team failed to adopt a rigorous and robust approach”

and agreed to

“the presentation of financial information that suited Carillion’s management”.

In the ensuing aftermath and investigation of the collapse, newspaper reports told of a 2016 extensive internal survey of staff and partners which suggested a lack of accountability or consequences for poor behaviour and a hierarchical culture that did not encourage junior employees to challenge their seniors. It is critical that we address the issue of external audit deficiencies in this country. Their failures cause immense pain to employees, society and shareholders. But it is also essential that we do it the right way.

We want the UK to be one of the best places in the world to do business. For that to happen, we must have clarity of intention. We must cut red tape for our amazing companies and not create it. We therefore seek answers from the Minister for the purposes of transparency and further debate, as some of the potential reforms require deep scrutiny.

Will the Government dictate the content of financial reports? Will they oblige FTSE 350 firms to appoint two audit companies? What will the legal and enforcement powers of the new audit, reporting and governance authority be? Will the Government force large UK-listed and private companies to produce an annual resilience statement, distributable profits figure, material fraud statements and triennial audit and assurance policy statements?

On company culture, how will the Government ensure that a culture of professional scepticism is built into the audit industry and guarantee training on forensic accounting, fraud awareness and the use and abuse of accounting rules in real-world situations? As we have heard about this from other noble Lords, what will the Government do to ensure that all companies of a certain size, not just auditors, focus on strong controls, sound corporate governance and accurate and reliable financial reporting to avoid future catastrophes?

The right package of reforms will increase investment in the UK economy. It will fuel the growth needed to make us the envy of the G7 nations.