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Audit ‘challengers’ in watchdog’s bad books as they take on Big Four

Grant Thornton has broken the Big Four auditors’ monopoly over the FTSE 100 for the first time in more than two years.

The UK’s sixth-largest accounting firm is auditor to Darktrace, the cyber security group promoted to the blue-chip index last month.

But the milestone of having a “challenger” accountant back among the FTSE 100 companies — the Big Four of Deloitte, EY, KPMG and PwC still check the accounts of the index’s other 99 companies — has been overshadowed by a flurry of sanctions and investigations against Grant Thornton and other mid-tier accountants.

A damning report by the UK accounting regulator in September exposed a litany of failings in Grant Thornton’s audits of cake seller Patisserie Valerie, which went into administration in January 2019. The Financial Reporting Council fined the UK’s sixth-largest accounting firm £2.3m for failing to provide reasonable assurance that the accounts were free from material misstatement.

In the six weeks since the Patisserie Valerie sanctions were announced, the FRC has hit Grant Thornton with another £1.2m in fines and costs for flawed audits at Interserve, a collapsed outsourcer. It has also launched investigations into work by three of its fellow challengers: BDO, Mazars and Crowe.

The challengers insist they can provide high quality audits of large listed companies but the recent probes threaten their credibility.

The enforcement blitz has come at a delicate time for the smaller firms, as ministers weigh whether to proceed with plans for “managed shared audits”, which would require large UK-listed companies audited by a Big Four firm to hand a portion of the work to a challenger.

Some of the errors by Grant Thornton at Patisserie Valerie were “just so basic that it’s difficult to see any value in any other audit work they’ve done”, said Tim Bush, head of governance at Pirc, a UK shareholder adviser.

Mistakes uncovered by the FRC included failing to investigate the “dubious provenance” of “bank statements” that were in fact spreadsheets and “invoices” with missing logos, misspellings and incorrect addresses.

Grant Thornton has said its audits have improved following investment and declined to comment further.

The challengers argue that their recent problems should not derail the push for competition, which remains stunted even in the mid-cap FTSE 250 where they now audit 25 companies, up from 10 five years ago, according to Adviser Rankings.

A small number of recent FRC probes into challengers should not be “an excuse to cling on to the status quo”, said Scott Knight, head of audit at BDO, the largest challenger.

“As numerous high-profile audit failures have shown, audit firm size isn’t necessarily correlated to quality,” added Knight, whose firm is under investigation over its audits of collapsed construction company NMCN.

The FRC has fined the Big Four and their partners £42m for botched audits in the past three years. The firms are still under investigation for audits at Carillion, NMC Health, Thomas Cook, London Capital & Finance and Mitie.

Proponents of shared audits believe they will help challengers gain expertise to compete more meaningfully. Government modelling predicts the plan will help them win up to 12 per cent of FTSE 350 audit fees within a decade, giving them a fighting chance of filling the void if a Big Four firm were ever to exit the market, as Arthur Andersen did in the wake of the Enron scandal two decades ago.

But the Big Four have refused to back the plan, while BDO and Grant Thornton are reluctant to play second fiddle to larger rivals. Companies’ audit committee chairs have questioned whether the additional cost would deliver better audits.

The Audit, Reporting and Governance Authority, a more powerful regulator that is set to replace the FRC, could also be given the right to cap the number of audits a single firm can undertake, a solution favoured by Deloitte, EY and BDO.

After years of industry lobbying against change “it’s now time for regulation under ARGA to be sharpened and for competition to be opened up”, said Knight.

A Patisserie Valerie cake store.
A Patisserie Valerie cake store. Grant Thornton has been fined more than £2.3m for a ‘serious lack of competence’ in its audits of the UK café chain © Simon Dawson/Bloomberg

However, the results of annual FRC quality inspections do not help the challengers’ case.

Almost half of Grant Thornton’s audits inspected in 2020 required improvements though the firm received the best score out of the seven biggest firms this year.

Most BDO audits reviewed this year fell below the required standard while three of the seven Mazars audits inspected required improvement. Mazars is under investigation for its audit of retailer French Connection.

BDO and Mazars have been expanding their audit practices and winning larger, more complex audits. BDO has overtaken PwC as auditor to the largest number of London-listed companies, and has grown its FTSE 350 client list to 16 — more than the other challengers combined, according to Adviser Rankings.

Mazars’ UK and global head of audit, David Herbinet, said the challengers can comfortably grow at a rate that would give them a meaningful share of the FTSE 350 market within five years — but managed shared audits must give them enough good quality work so they can attract auditors to join from the Big Four.

The quality scores should be looked at over the longer term and larger firms have received weaker results in the past, he added.

KPMG, whose overall scores were barely better than Mazars’ this year, has been criticised repeatedly by the FRC over its banking audits, for example.

As the government considers how to boost audit competition and quality, the challengers will hope ministers’ memories of the Big Four’s past failings will outweigh any doubts raised by their own recent travails.

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