Lack of audit scepticism trips E&Y

ERNST & YOUNG'S audits were weakened by lack of scepticism and evidence to support auditor findings, the Audit Inspection Unit has concluded.

Of 13 audits inspected, just five were found to be "good with limited improvements required" - down from seven last year - while one needed "significant improvement", up from zero in the 2009/10 report.

Performed by members of the Financial Reporting Council's Professional Oversight Board, it found issues with group audit, finalisation procedures and the annual employee appraisal process.

E&Y's response was brief, focusing on audit quality and the "common aim" of the firm and the AIU.

Lack of evidence to support audit findings is a recurring shortcoming in relation to the impairment of goodwill and other assets, revenue recognition and fraud risks.

Failure to challenge management assumptions also dogged the report; in one audit of a financial institution, client judgements on impairment provisions were not subject to robust examination in two out of 40 products reviewed.

Group audits triggered a major alarm bell at the AIU, with referral instruction or overseas communication "weaknesses" in four of the 13 cases. In the audit of one financial institution, an overseas network firm carried out much of the work but UK files made it impossible to determine whether there was sufficient evidence to support financial statements at the UK entity.

Questions were raised over the assessment of the quality of component members' work on group audits and in one case the group audit partner did not visit the main overseas location, despite it being a requirement of E&Y's methodology.

Failure to follow International Financial Reporting Standard 8, operating segments, is potentially embarrassing for the firm, as on three audits those responsible may not have applied the standard.

Year-on-year, E&Y's progress was mixed. It "did not appear to have taken effective action" to address recurring problems with goodwill impairment assessments, and the audit of revenue remained of concern.

Despite these shortfalls, the firm's improvement was described as "generally good" and procedures in particular have been tightened up. The number of internal quality reviews has risen, a recommendation to remove target percentages for outsourcing audit work was accepted and staff appraisal documentation was completed in a more timely and compliant manner.

E&Y may have reason to worry about a few isolated yet glaring errors; in two cases the auditor's report was signed before the review had been completed, and undetected clerical errors in the accounts went unchecked, including on mistake in the disclosed audit fee.

The firm said it is pleased that this year's report reflects some of its "significant investment" in audit services, concluding: "The AIU report does identify some areas for improvement for all firms. We are responding positively to the recommendations made to us and are taking the necessary action as agreed with the AIU."