News

15th June, 2006

How is audit work distributed?

One has heard a number of stories about the Big 4 audit firms and their audit and consultancy domination. At one time, people compared their clout to what an international company in the personal computer space had about 20 years ago. By settling on this company, shareholders were convinced that they were being prudent. Over time, competition set in and the company became only one of the players in the market. Similarly, in the auditing profession, smaller firms cry hoarse about the lack of a level playing field, but nothing can be done in a regulated industry.

In the UK, the Financial Reporting Council and Department of Trade and Industry commissioned a consultancy, Oxera, to conduct some research on this topic. The result was an 87-page report `Competition and Choice in the UK Market', abbreviated to `the Oxera Report'.

The report does not say anything that is not known. Only one company in the FTSE-100 (the equivalent of the BSE-100) is not audited by the Big 4. If one expands the sample to the FTSE 250, only non-Big-4 firms find an entry. A new term called `quadropoly' is doing the rounds to describe this phenomenon. The report pins the limitation of choice on a process of merger and assimilation, which is continuing.

Entry barriers

The report does some loud thinking by talking about the barriers to entry. It visualises that if banks, consultancies, financial service companies and insurers decided to enter the market by creating an arm's length audit business, they would still not be as successful as the present ones. The primary reason for this is that a high degree of investment would be required.

Also, the fact remains that companies do not change their auditors the way stage artists change their clothing a survey revealed that only 3 per cent of the FTSE 350 switched their auditors.

Distant target

The model for profitability in the report shows that making money is a distant target for those that could meet fairly exacting goals for winning and retaining audit business. There is also the risk factor litigation in the accounting field is increasing and most new entrants feared a claim for millions of pounds just because the auditee tweaked the numbers in the balance-sheet.

The report does some crystal-gazing and says that due to rampant litigation, the Big 4 could become the Big 3, in which case there would be a better distribution of work to the mid-tier firms and this would exacerbate the problem of auditor choice. Regulators in the UK have already started taking the report seriously and are debating the next steps.

The situation in India is slightly different. The audit market here can be said to be fairly well-spread-out, while it is the lucrative market that appears to have been monopolised. Little can be done about this since there is no regulator as such for such a market. But it would be not be long before a desi consultancy firm builds up technical knowledge, high-quality people and the global scope to take on the big boys.

Mohan R. Lavi
(The author is a Hyderabad-based chartered accountant.)