Evidence from the big four accounting firms shows cost overruns in up to 50% of audits

The big four accounting firms are failing to charge some of the UK’s largest companies the full cost of inspecting their accounts, raising fresh concerns that the auditing industry is failing to scrutinise leading businesses properly.

The information has been released by the Commons business, energy and industrial strategy (BEIS) select committee, on the eve of the publication of its report into the “future of audit”, which was prompted by a wave of accounting scandals at stock market listed companies such as Carillion, Tesco and Patisserie Valerie.

UK public companies are required to have their annual accounts audited. An auditor is appointed by a company and is supposed to be confident that financial statements are “free from material misstatement, whether due to fraud or error”.

On Monday, the BEIS select committee released correspondence with PWC, Deloitte, KPMG and EY, which showed evidence of how the full cost of auditing company accounts was not always charged to clients; information that appears to support industry critics who argue that accounting firms can use auditing as a “loss leader” to gain more lucrative work from clients.

The letters showed that half of audits in the last five years at Deloitte and PWC ended up costing more than 10% more than originally budgeted. EY said it had cost overruns on 32% of audits, while KPMG said it did additional work 16% of the time.

In some cases, the increased costs were not always recouped, the correspondences showed. Of the audits incurring these significant cost overruns, the big four negotiated an increased fee in between 60% and 83% of cases, with Deloitte also disclosing that in only 24% of cases did the fee increase fully cover the overrun.

“The BEIS committee’s inquiry looked at audit fees and examined concerns that audits may be not resourced properly and also that competition may be potentially undermined by underbidding [charging lower than cost],” the committee said.

The frequency of scandals has prompted Sir John Kingman, who led last year’s independent review into the Financial Reporting Council (FRC), to suggest that a new watchdog should appoint auditors on behalf of companies.

Writing to the business secretary, Greg Clark, in December, Kingman said: “A regulator, with duties to promote quality, would have clear incentives to ensure that fees are not cheese-pared and are set in a way that is consistent with audit quality being properly resourced.”

The figures released on Monday were given by the firms to Rachel Reeves MP, the chair of the committee, who had written to them asking for details on how they billed audit clients. She will unveil her committee’s full report into the future of audit on Tuesday, having already stated that the “audit market is broken” after launching an inquiry in November.

At that time, Reeves said: “Misleading audits have been at the heart of corporate failures over recent decades. Recent accounting scandals at BHS, Carillion, and at Patisserie Valerie have shown accounts bearing closer resemblance to works of fiction than an accurate reflection of the true financial performance of the business. Repeated accounting failures have contributed to the collapse of major businesses and undermined public and investor confidence.”

As part of the reaction to the scandals, Kingman’s independent review last year recommended the abolition of the FRC, amid accusations that the regulator has been too cosy with firms it is meant to regulate. The government subsequently followed through on that recommendation.

Separately, the big four accounting firms escaped the threat of a breakup after the Competition and Markets Authority (CMA) stopped short of calling for radical action against them. There have been calls for the four to be broken up, amid growing concerns over their dominance and conflicts of interest between their business divisions.

Accounting firms have consistently argued that radical change is not required within the audit sector.

A KPMG spokeswoman said: “Our number one priority is to deliver consistently high quality audits. We do not allow profitability considerations to compromise quality.”

Deloitte said ethics went to “the heart of our business”, while EY said audit quality was fundamental to the firm’s purpose.

Audit committees of companies, which tend to appoint the auditors, understand additional fees “to ensure quality throughout the audit engagement”, said PWC.