Accountancy Age takes a look FRC's assessment of the audit quality provided by the top six audit firms
KPMG was pulled up over conflicts of interest and ethical issues relating to the provision of non-audit services to a client in the FRC’s latest audit quality inspections.
In all, two audits were flagged as requiring “significant improvement” while the FRC flagged “weaknesses in the testing of journals… in the majority of audits reviewed”.
That assessment included insufficient evidence supporting the journals selected for testing, insufficient procedures to ensure the completeness of the population of journals and insufficient testing in relation to certain fraud risk characteristics.
Communications with audit committees could still be improved in half of the audits examined, with areas including the presentation of significant risks identified, the involvement of the group audit team in the component audits and specific independence threats identified and related safeguards applied.
It continued to “identify cases where the audit report did not accurately describe certain procedures performed by the audit team”, although it noted there has been an improvement in the nature and extent of the matters identified.
In a statement, KPMG head of audit Adrian Stone said: “We are really concerned that the FRC’s inspection team rated two engagements as requiring significant improvement. However, we are also pleased that the FRC found a significant increase in the number of our highest rated engagements. We believe this is why we have won more audit tenders than any competitor since the audit rotation market shift began three years ago. Of course, we will never be satisfied with the inconsistency in our performance evidenced by the lower grades.
“We invest substantially in our audit business to ensure we are providing the highest quality reports. For example, we have more than doubled our investment in data and analytics in the last three years; we have invested in more senior quality and risk resource, resulting in an increased salary cost of 26% in the last three years and have increased the number of audit risk specialists by 15% over the last five years. Overall, our audit specialists are now receiving more training, more regularly.
“To achieve consistently high levels of audit quality there is still more to do to ensure our guidance is applied in every case. In some instances, we believe we have applied the correct approach, however, the FRC has disagreed. The AQR is therefore a useful vehicle for clarifying complex areas.
“We appreciate the FRC’s effort and constructive approach and welcome the external perspective provided by the feedback in their annual quality report. We will continue to invest in and improve our audit service so that we go beyond the FRC’s published aim that at least 90% of FTSE350 audits reviewed should require no more than limited improvements.”
Challenging clients’ assumptions was highlighted as the weakest area in PwC’s auditing according to the FRC’s audit quality inspection.
The extent to which the growth assumptions and related disclosures in impairment reviews had been adequately considered and challenged, including in situations where there were recent investments was flagged in particular.
On one audit, the procedures performed in relation to the short-term growth assumptions to support the carrying value of recent investments “appeared to focus mainly on discussions with management in respect of their plans”. In addition, while the audit team informed the audit committee that management had agreed to expand the disclosures regarding the key assumptions in the financial statements, the expanded disclosures “did not cover the short-term growth rates and related sensitivities”.
The extent of evidence to support long-standing tax provisions which had not moved for a number of years was also criticised. On two audits there was “insufficient evidence supporting a number of long-standing tax provisions and the original basis for the provisions”. On one of these audits, there was insufficient evidence that the audit team had challenged the judgments made for each exposure and jurisdiction.
PwC head of assurance James Chalmers said: “Audit quality is of paramount importance to the firm. We are pleased with the continued trend of improvement in our audit quality assessments from the FRC and continue to strive for improvements in all aspects of our audit work. We value the independent observations and recommendations provided by the FRC and are pleased it has recognised the steps we have taken in response to previous findings, reflecting the ongoing investment in our audit practice.
“I believe the FRC’s new style of report is a positive step in helping readers understand the key findings from the inspections and the actions we are taking in response.”
Challenging management’s judgement, particularly in relation to impairment reviews and judgmental valuations was highlighted as an area in which Deloitte ought to improve, the FRC found.
It also identified a need to “improve aspects of the firm’s audit approach in the areas of revenue and inventory”, while the regulator added Deloitte must “ensure high quality reporting to audit committees is achieved on a consistent basis”.
There were also calls for Deloitte to “strengthen its audit approach in relation to defined benefit pension scheme balances and disclosures”, and “strengthen its policies and procedures regarding the engagement quality control review process”.
Stephen Griggs, managing partner for audit at Deloitte, said: “We share the FRC’s objective to promote improvements in the quality of auditing and welcome this report. The report provides a balanced view of the focus and results of the AQR’s inspections and it is an accurate reflection of our efforts to improve audit quality across our practice over a number of years.”
It was also suggested EY should “improve the quality of written communications with audit committees in relation to key judgments and estimates” and make further improvements to the audit of revenue, “embedding key messages from the firm’s training and changes in [its] methodology”.
The FRC also called on EY to “ensure more effective audit procedures are performed to test IT controls and system generated reports which are relied upon”, and continue to strengthen the firm’s monitoring of compliance with its independence policies and procedures.
EY’s head of audit for UK & Ireland Hywel Ball said: “The results of the FRC’s inspection report reflect the significant level of investment EY has made to improve audit quality, particularly over the last two years.
“We are really pleased by the progress we have made to date. Audit quality is key to promoting confidence in the capital markets and we are committed to continuous improvement and innovation.
“We have established a long-term and wide reaching audit quality programme in the UK, which supports the steps we have taken globally, and continue to invest in new technology, data analytics software and training for our people. These investments are already being well received in the market.
“Audit quality remains an ongoing focus and absolute priority for EY. We welcome the independent perspective of the FRC and continue to listen and act upon their feedback, in addition to conducting our own reviews of EY’s audit practice.”
In Grant Thornton’s case, the FRC called for the firm to raise its audit quality benchmark for partners.
The regulator added it should bolster its audit quality monitoring arrangements and “improve awareness and monitoring of ethical and independence matters”.
It added it should “strengthen procedures related to the direction, supervision and review of group audits”, and improve the “accuracy or precision with which audit procedures are described in audit reports”. The quality of communications with audit committees was also earmarked for improvement.
Head of audit and assurance at Grant Thornton UK Sue Almond said: “We’re pleased with the overall improvement our AQRT and its consistency with other independent reviews and our own internal review process findings. It is a testament to the commitment and excellence shown by our teams who put quality at the heart of all we do. It also reflects our significant investment in systems and processes to continually improve our quality. It has been and remains a top priority for the firm.”
The FRC flagged up the adequacy of BDO’s substantive analytical procedures for improvement and added expectations “should be developed from independent sources, with explanations obtained and corroborated”.
In one audit, the source of the information was “not sufficient to develop the expectations adequately”, and in another audit there was “insufficient corroboration of management’s explanations regarding variations from expectations”.
Sufficiency of the substantive evidence was queried by the FRC, adding that in three audits “insufficient evidence was obtained” to confirm that revenue was recorded in the correct period. It added data analytics “can be an effective way of obtaining audit evidence when appropriately performed”. In one audit there were insufficient audit procedures for testing the completeness and accuracy of the source data used in the data analytics, it said.
BDO head of audit Scott Knight said: “Through its audit quality review team, the FRC rightly continues to challenge the profession to raise the standard of audit quality. We welcome its engagement and feedback on BDO’s audit work.
“We continue to put quality at the centre of our audit offering, and are pleased the AQR report identifies that none of BDO’s audits require significant improvements. We will continue to invest in our processes and audit tools to enhance audit quality. We have considered the root causes of the findings of the review and are implementing detailed action plans to address them.”