The Financial Reporting Council (FRC), the UK’s regulatory body for auditors, has released its Annual Review of Audit Quality 2024. The report sheds light on crucial developments within the UK audit market, including market barriers to growth, the challenge of attracting new talent, and how audit firms increasingly offer other services to mitigate risk. As the audit profession continues to evolve, accountability and transparency have significant implications on the attractiveness of the UK as an investment destination.

Inspection Results: Tier 1 Firms

The FRC’s review of Tier 1 firms, which include those with the largest share of the UK Public Interest Entity (PIE) market, highlighted continued improvements in audit quality but also significant gaps between the top four firms (Deloitte, EY, KPMG, PwC) and others in the same tier (BDO and Forvis Mazars). The inspection results, in comparison to last year, are detailed below:

The Audit Market: An Incubator for Growth

The audit market plays a vital role in ensuring transparency, accountability, and trust in financial reporting. However, for the market to thrive, smaller firms must have opportunities to scale up and compete with larger firms. The report highlights that while the audit market is a potential incubator for growth, it faces challenges that smaller firms must overcome to succeed.

These challenges include:

Capacity Constraints

Smaller firms often lack the resources to manage complex Public Interest Entity (PIE) audits, limiting their ability to expand.

Regulatory Pressures

Complying with evolving audit standards, such as ISQM (UK) 1, requires substantial investment in systems and training, which can be particularly difficult for mid-market firms.

Technological Investment

The increased reliance on advanced technologies, including artificial intelligence, poses a challenge for smaller firms that may not have the capital to invest in the necessary tools and expertise.

While smaller firms face these hurdles, they also have an opportunity to play a larger role in the market. To support these firms, the FRC has introduced initiatives such as the Audit Firm Scalebox, which helps smaller firms develop and maintain audit quality as they enter and grow in the PIE market.

Smaller Firms Shifting Focus to Non-Audit Services

A trend identified by the FRC is that many smaller audit firms are increasingly shifting their focus toward non-audit services, which are often more lucrative than audit work. These services, which include advisory roles and tax consultancy, typically involve lower regulatory scrutiny and higher profit margins.

This shift is partly due to the complexities and challenges associated with audit work, which often requires significant resources and compliance with stringent regulations. As a result, many smaller firms find non-audit services more attractive from a financial and operational perspective. However, this diversion of focus away from audit services can affect the overall quality of audits in the market.

Larger Firms Engaging in De-Risking

Another significant concern raised in the FRC’s report is the practice of de-risking by larger audit firms. De-risking occurs when large firms resign from or decline to tender for complex, high-risk audits, pushing these audits onto smaller firms.

The FRC points out that this practice is problematic because many smaller firms do not have the experience or resources necessary to handle complex audits effectively. By transferring these challenging audits to smaller firms, larger firms may avoid potential risks, but the public interest is jeopardized when less-equipped firms perform audits of critical entities.

The Audit Profession’s Need for New Talent

Attracting younger professionals into the audit profession remains a critical challenge. The current pool of talent is insufficient to meet the demands of the future, and firms need help to recruit and retain the next generation of auditors. To address this, the profession must make concerted efforts to improve working conditions and present the audit profession as a rewarding career path.

Key factors affecting the audit profession’s ability to attract talent include:

Work-Life Balance

High levels of pressure and excessive working hours in some firms have been identified as a deterrent to new entrants. Improving the work environment is essential to making the profession more appealing to younger generations.

Career Development

Firms must invest in professional development programs that support continuous learning and mentorship, ensuring that new auditors are well-equipped to meet future challenges.

KNAV Comments

The trends identified by the FRC are omnipresent across global markets. The PCAOB in the US, the CPAB in Canada, and the NFRA in India have highlighted similar issues that present challenges to the growth of a more broad-based audit market in their respective jurisdictions. The success of a profession is deeply tied to its collective identity. A profession thrives when its community thrives, and this collective success enables individual professionals to prosper. The shared nature of the profession means that all participants, from the largest firms to the smallest, must collaborate to achieve long-term success. Larger firms cannot sustain themselves by disregarding the challenges faced by smaller firms, and the responsibility of retaining talent and preserving the profession’s image is a shared one. While regulators play their part, audit firms must seek collaboration and synergies to leverage each other’s strengths. Building a stronger, more resilient profession requires collective effort and mutual support, where firms of all sizes contribute to enhancing the overall quality and reputation of the field.