External Auditing of Companies: Deficiencies

Lord Shipley Excerpts

Monday 14th October 2024 Lords Chamber

[Lord Shipley (LD)]

My Lords, I thank the noble Lord, Lord Sikka, for enabling us to have this debate, which is timely. I thank him also for the forensic examination he has presented of some of the failures in the audit system. I have noted his concerns about the powers and responsibilities of accounting bodies and audit firms and their public responsibilities. We will need to debate many of his points when we consider the draft audit reform and corporate governance Bill.

In the debate on the King’s Speech in November last year, I questioned the absence of an audit Bill in that Session. I am pleased that this year’s King’s Speech has rectified that. Anything the Minister can say on the content and timing of the draft audit reform and corporate governance Bill would be useful to hear.

I have several times expressed concerns in this House about the state of audit and risk management in the public sector. The absence of proper and timely audits following the abolition of the Audit Commission has proved an increasing problem. I have concluded that it will require firm leadership from the Government to deliver improved standards.

The problems with audit in the private sector are equally well established. We simply must strengthen private sector audit and corporate governance. As the noble Lord, Lord Sikka, said, it is of great concern that, according to the Audit Reform Lab, three out of four of the largest 250 publicly traded companies in the UK that failed between 2010 and 2022 did not have an audit warning of that possible failure.

This means that the commitment in the King’s Speech to replace the Financial Reporting Council with the proposed audit, reporting and governance authority must be fulfilled. This will enhance enforcement powers both in investigations and in applying proper sanctions for the serious failures in both financial reporting and audit work.

In 2011, I was privileged to be a member of the Economic Affairs Committee when it reported on auditors and the concentration of the audit market on a very small number of audit companies. The report is worth revisiting by the present Government. It made many proposals, but the following brief extract is relevant:

“The Committee’s concerns about the Big Four’s oligopoly of large firm audit were intensified by their failure to give warning of trouble in the run-up to the financial crash. Clearly bank auditors cannot express concerns openly about banks’ finances without undermining confidence and risking a run. But the Committee was highly critical of the fact that, as our evidence revealed, confidential dialogue between auditors and bank regulators had fallen away before the financial crisis so that there was no pooling of information or concerns which might have given warning or allowed some action to mitigate the worst effects. This failure to maintain dialogue seems to the Committee a dereliction of duty”.


That was 2011, but much in the audit world has stayed the same. As the noble Lord, Lord Sikka, said, we need to separate audit services from other services provided to companies to avoid conflicts of interest.

We should note that over three-quarters of the revenue for audit companies comes from non-audit services, and there are clear risks to the audit process of firms generating most of their income from these other non-audit services.

This QSD is about restoring public confidence in corporate governance to ensure that investors and consumers can have confidence in the financial robustness of UK companies. When companies collapse, people lose their jobs, and the public purse can be called on to cover the costs.

Auditors exist to assess the financial health of companies and to report on risks. At present, the regulator has insufficient power to rectify failures. There is huge support for reform from the Institute of Directors, the Chartered Institute of Internal Auditors and the Institute of Chartered Accountants in England and Wales, among others.

I hope that the new regulator will have the enforcement powers it needs. I hope that it will be required to report annually to Parliament. I hope that auditors will be trained to exercise due scepticism as well as due diligence. I hope that directors of companies will be required to declare annually on capital maintenance decisions and on the legality of distributions and the effectiveness of resilience planning, as part of an annual report, in addition to a report on the formal accounts.

These are all core functions of an audit process. In creating a regulator with teeth, international investors, as well as domestic investors, will be able to have confidence that the UK is a safe home for their investments.