🤨 EY's Split to Bring Problems?

EY is finalising its split but it isn’t going to be a clean divide and could mean trouble for the company’s audit division.

Breakups may be messy and complicated but sometimes they are necessary to allow you to move forward.

And Ernst & Young (EY), which is one of the Big Four accounting firms, has realised this bitter truth.

So, it is splitting up its audit and consulting business.

But like any breakup, this split will come with its own challenges.Wondering what they are? ReadOn!

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🧐 Why is EY Breaking Up?

EY and the other Big Four firms (KPMG, Deloitte, and PwC) have been minting money by providing both advisory and auditing services to companies.

But both regulators and investors are not happy with this double role as they feel that these companies are going easy on clients while auditing to keep their consulting business booming (You can read more about this here). 

And this has led to a lot of companies failing miserably and investors losing loads of money.

So, for years, regulators have been trying to get these firms to break up by levying fines on them.

But so far these firms have been reluctant to change their operations.

Why is EY taking this first step?

Well, it feels breaking up could be more profitable.

Thanks to the pesky regulators and their laws, EY often can’t provide audit services to consulting clients and consulting services to audit clients.

This is a huge loss for EY.

So, it wants to split up and tackle both audit and consulting for these clients.

Its $18 bn audit arm is set to keep the EY name, while the consulting arm will get a new name and an IPO in which it will dilute 15% stake to external investors. 

The company expects an additional $10 billion in revenue just for its consulting services after the break up. 

But its audit arm could be in trouble.

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😥 Problems Facing EY

Even though EY is a reputed Big Four firm, its audit business has been facing trouble in the last few years. 

Especially since the Wirecard scandal.

Back in 2011, EY was appointed the sole auditor for Europe-based payments company, Wirecard.

This happened because investors were worried something sketchy was going on at Wirecard.

Spoiler alert: They were right.

The company had fake clients, inflated profits and was involved in fraud. Despite EY being its auditor, the firm could not figure out for over 10 years that this fraud was going on right under its nose.

And though such cases are not uncommon, EY's 10-year involvement with Wirecard soiled its good name. 

So, breaking up right now could be bad for the company's audit arm.

Plus, auditing compliances could go against the company.

Companies have to change auditors after they have served two consecutive five-year terms. 

Earlier, the consulting income was enough to keep it flush with money even when it lost auditing clients due to this rule. But now losing clients could have a much higher financial impact. 

EY could also face issues over the division of its tax team, one of its chief breadwinners. 

Right now, it handles both audit and consulting work.

Not only did the tax division generate $11.4 billion of EY's $45 billion in revenue, each tax employee generated 1/5th more revenue than the audit employees.

Now, the company faces the difficult task of how to split up this profitable division.

Which arm will get how many employees, who wants to work where, etc. will be supremely difficult to figure out. Especially because of the terms of the split.

You see, under the terms of the split, a lot of the money earned from the consulting arm's IPO will go to the auditing company, which has decided to keep the partnership structure. The partners and some employees under the consulting arm will get some stakes in EY.

This presents a huge dilemma for employees. Gains from the IPO could mean an instant raise if they stay with the audit firm. But stake in the consulting firm could mean much higher payouts later. It's not just the tax department that will face this problem: the valuation department, IT department and several other shared departments will have to make this difficult decision. 

And while EY is trying to sort out this mess, some companies could benefit from its confusion.

Like the other Big Four firms that are already preparing to poach tired EY employees. A lot of smaller firms could also stand to gain clients during this period. 

For instance, India has over 2,300 statutory auditors, but most clients rely only on Big Four firms. EY’s split could help some of these companies get the firm’s clients.

However, one aspect that isn't quite so clear is the impact of the split on India. 

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🇮🇳 Impact on India 

EY may be the third-ranked out of the Big Four globally, but things are different in India.

Here it ranks first.

Probably because it has already divided its audit and consulting arms in India.

Yes, in India its audit arm is called SRBC& Co. But this means the EY name will all but disappear from India. Huh?

You see, foreign companies are not allowed to audit in India. So, the global audit arm, which will have the EY branding, can't enter India. And the new consulting arm, which can exist in India, will not have the EY name.

Whether or not this will impact EY's operations, especially its audit arm, is unclear now.

For now, the company has to get the approval of all its partners, and regulators to go ahead with the split.

That's expected to take over a year. And after that is when the real upheaval will begin.

Whether this chaos will do good to the firm or not, we don't know yet. But EY's move will set the standard for what the other Big Four companies do next. 

So, we will have to closely wait and watch what happens.

P. S: Here's what some experts feel about the split:

An EY Partner who chose to remain anonymous:

Shriram Subramanian, Founder and MD at proxy advisory firm InGovern Research:

Amarjit Chopra, Ex ICAI Pres and Part-time member, NFRA:

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⚡ In a line: EY is splitting up in a bid to increase revenue and escape regulator scrutiny, but like all breakups this one too will be messy and come with a lot of baggage.

💡 Quick question: Will EY’s split actually benefit the company?

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