Moving up the audit food chain

LAST WEEK’S REVIEW by the reporting watchdog’s audit inspectors of the audit work of four mid-tier firms was largely positive, yet there were enough criticisms to leave the results open to interpretation.

Of the 20 audits scrutinised by the FRC’s Audit Inspection Unit only one was found to be in need of ‘significant improvement’. The remainder were found to be either good, but in need of limited improvement, or acceptable with improvements required.

The AIU’s findings pointed to an overall increase in the quality of audit work carried out by PKF, CCW and Baker Tilly, which all showed a marked improvement from the previous inspection results published in 2010. Mazars was inspected by the unit for the first time.

“We have evidently encouraged firms to do better. With [the findings] being in black and white it encourages firms to improve the standard of public interest audits,” says AIU director Andrew Jones. “Firms have been focussing on audit quality and it shows through in this cycle.”

The issues flagged up by the AIU included a lack of evidence to back key judgements, a need to improve professional scepticism and failings associated with the audit of impairments. These bear a striking similarity to issues raised by the AIU when it published its inspection into the audit work of the Big Four last year.

Like PKF, PwC was found to have gathered insufficient evidence when gauging client’s goodwill impairments, while Baker Tilly and Ernst and Young were both told to improve the application of professional scepticism to their audit work.

For mid-tier firms talking up their chances of taking a slice out of the Big Four’s monopoly of FTSE 350 audit work, the AIU findings are vindication of their belief that they are capable of delivering high quality audit work in this space.

“It does suggest that if you look at the mid-tier that the work is of high quality and I think it is of a level that is equally high quality to that of the Big Four,” says Richard Bint, senior partner at PKF.

With the Competition Commission’s report into the audit market expected later this year, the likes of Mazars and PKF are hoping this will improve their chances of competing with the Big Four for FTSE 350 audit work.

“Transparent public reporting by the AIU is very helpful to mid-tier firms in establishing a case as a credible alternative to the Big Four. The AIU reports are growing as a source for audit committees when audits go out to tender,” Bint adds.

It is worth noting that the AIU findings are based on a relatively small sample of audits, which it admits are not necessarily indicative of any overall change in audit quality at the firms inspected. While firms are happy to talk the results up, if the results had gone the other way the same firms would have no doubt pointed out how small the samples are as a reason for them not to be taken as a true reflection of their overall quality.

And not everyone inspected is hailing the findings as a gold stamp of their credibility as alternatives to the Big Four for the audits of FTSE 350 clients. One problem that appeared synonymous with three of the four firms was the need to give increased focus and attention to ethical matters and compliance with ethical standards.

In the case of Baker Tilly there was found to be confusion around whether its ethics partner has ‘appropriate authority at leadership level within the firm to effectively perform the role’, while CCW was advised to give ‘increased focus and attention to ethical matters, including the monitoring of business relationships and timelier updating of the firm’s ethical policies and procedures’.

“That confusion is unlikely to happen at the Big Four,” said AIU.

Fiona Hotston Moore, partner at CCW, agreed that in mid-tier firms a lot of ethics work is being fulfilled by client-facing partners.

“For me there is a question of just how much the mid-tier can play in this market. Do they have sufficient resources for the sort of audits that fall in the AIU’s remit? You have got to acknowledge the size and resource within the organisation and audit what is appropriate,” she says.

With the AIU’s annual report of the audit market set to be released next month, in addition to the publication of its findings into the audit work of the Big Four, BDO and Grant Thornton, the main event is still yet to come.

Those hoping to pick up some juicier audit contracts will hope it offers promising conclusions about their ability to compete, rather than exposing delusions of grandeur among the mid-tier.