What goes wrong when accounting firms become consultants

What business are accounting firms really in?
What business are accounting firms really in?
Image: REUTERS/Mike Stone
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At the big accounting firms, consulting is the tail that wags the dog.

It’s an open secret in the accounting industry that the biggest audit firms no longer get the bulk of their business from auditing. At Deloitte Touche Tohmatsu, for instance, only 22% of global revenues came from audits in fiscal 2019, compared with 60% from consulting and other advisory services. That’s a reversal from a decade ago, when it was 46% auditing versus 33% consulting. Deloitte’s global consulting revenue rose 13% in 2019; auditing revenue was flat.

Deloitte and the other Big Four firms—PricewaterhouseCoopers, KPMG, and Ernst & Young—have all increasingly emphasized and invested heavily in consulting in recent years. It’s easy to understand why: It’s lucrative, virtually unregulated, and offers greater potential for growth than the more-mature audit field. Advising companies on digital transformation and management is less structured and offers greater creative challenges than verifying their numbers.

But that trend comes with plenty of concerns. The shift toward consulting can lead to conflicts of interest which could cause the firms to go soft on holding their audit clients to account. Critics fear the emphasis on consulting may mean the firms aren’t paying as much attention to their core auditing business, which could hurt the quality of audits.

“Does how they manage the firm change their focus? I have to believe the answer is yes,” said Jack Ciesielski, president of R.G. Associates, an accounting-research firm.

The firms maintain it actually makes their audits better when they offer consulting as well. They say the “multidisciplinary” approach, as they call it, gives them in-house expertise and technology from the consultants that they wouldn’t have otherwise.

“It’s more important than ever that audit clients have the full breadth and depth of the audit firm’s expertise,” said Julie Bell Lindsay, executive director of the Center for Audit Quality, which represents public-company auditors.

The Big Four are benefiting from companies’ appetite for advice on how to cope with a changing global economy and the shift toward a digital world. Figures compiled by Monadnock Research, which specializes in consulting-industry research, show the Big Four’s non-tax consulting and advisory revenues have risen 124% since 2010; audit revenues are up only about 21%. At EY, the consulting workforce has grown by 40% in the last three years, versus 14% in auditing.

In part, the push into consulting is a case of “everything old is new again.” Consulting by audit firms drew harsh criticism during the Enron scandal. Enron’s auditor Arthur Andersen took in more in fees from non-audit services for Enron than it did for auditing, and most of the Big Four sold or spun off their consulting businesses around that time. The Sarbanes-Oxley Act that followed the scandal barred auditors from providing many types of consulting to audit clients in the US.

But the firms later rebuilt their consulting arms—in part, ironically, by advising companies on how to adopt Sarbanes-Oxley. All four are now among the world’s biggest consulting firms.

The SEC requires an auditor to be “independent,” avoiding relationships that could compromise its ability to perform a tough, skeptical audit. Auditor independence is “extremely important, it’s fundamental,” SEC Chairman Jay Clayton said at an accounting conference in December.

The concern with consulting for audit clients is that in their eagerness to win consulting business, auditors might pull their punches in reviewing a company’s books and refrain from criticisms that might upset company executives.

“Absolutely that’s a driving force,” said Michael Shaub, a Texas A&M University accounting professor. “They’re really reticent to give up a revenue stream.”

The Sarbanes-Oxley restrictions on consulting are supposed to prevent such conflicts, but they still happen. In September, PwC agreed to pay $7.9 million to settle SEC allegations that it improperly provided non-audit services to 15 audit clients, including designing and implementing software for the clients’ financial reporting. The firm didn’t admit or deny the SEC’s findings.

PwC said in a statement that it takes auditor independence seriously, and has “robust policies and procedures in place” to identify and address anything that could jeopardize it.

Even when the SOX rules are followed, consulting still poses a concern, critics say. Accounting firms can still consult for companies other than their audit clients, and today’s audit client could be tomorrow’s consulting client. That could give auditors another reason to pull their punches.

“It makes it harder to go after a company for an audit problem because if you’re a stickler for audit details, they may not give you the consulting contract in the future,” said J. Edward Ketz, an associate professor of accounting at Penn State University. “That’s in the back of your mind.”

Consulting can also pose a problem for audits by limiting competition. If a big company wants to change its auditor, it really has only the other three Big Four firms to pick from to begin with, because only they have the scale and resources to audit the biggest multinationals. If one of those firms is consulting for it and thus precluded from auditing the company also, that limits its choice even further.

The trend toward consulting can even discourage Big Four firms from pursuing a company’s audit business at all, because having it would block them from richer consulting work. So when a company seeks bids for its audit account, “there’s a lot of non-participation,” said Mark O’Connor, Monadnock Research’s CEO. “It tremendously complicates it.”

Still, in December the SEC proposed relaxing some aspects of its conflict-of-interest rules. In some situations, the commission indicated, the current rules trip up companies on technical grounds where there isn’t a real conflict that jeopardizes an auditor’s impartiality. For instance, the changes would make it okay in some circumstances for an audit firm to audit a private company about to go public even if the auditor also provides non-audit services to another company in the same investment fund’s portfolio.

In the UK, prompted by a series of botched audits and concerns over conflicts and competition, officials are considering separating the firms’ auditing business from their consulting units; some of the Big Four in the UK have already said they’ll stop consulting for their audit clients. European Union countries limited auditors’ non-audit services for their audit clients starting in 2016.

Even if there aren’t direct conflicts, some fear the firms’ focus on consulting runs the risk of diverting their attention from their core auditing responsibilities. “They’re not recruiting and paying the best for the audit side, they’re recruiting and paying the best for the consulting side,” Ciesielski said.