FRC reports an “unacceptable deterioration” in KPMG audit quality

The latest Audit Quality Review published by the Financial Reporting Council (FRC) revealed declining audit quality across the Big Four, with KPMG’s audits being flagged up as particularly problematic.

The FRC said that there had been an “an unacceptable deterioration” in KPMG’s audit quality, with 50% of the firm’s FTSE 350 audits requiring more than just limited improvements, compared to 35% in the previous year.

The watchdog attributed the declining quality of Big Four audits as being due to firms’ “failure to challenge management and show appropriate scepticism across their audits.”

The FRC found that among FTSE 350 audits, 73% of audits required no more than limited improvements, a drop from 81% in 2016/17. The watchdog’s target for this figure is 90%.

As Big Four firms audit 340 of the FTSE 350 companies, as per information provided by Adviser Rankings, the FRC’s report will no doubt pour fuel on the ongoing debate around whether the Big Four firms should be broken up to increase competition.

Big Four market monopoly in the spotlight again

While Big Four audits showed an overall decline in quality, the report also looked at BDO, Grant Thornton, Mazars and Moore Stephens, whose inspected audits showed “general improvements.”

Earlier this year Grant Thornton announced its intention to exit from the FTSE 350 audit market, citing Big Four dominance that made it “extremely difficult to penetrate” the audit market in its current form.

Big Four audit shortcomings have continued to grab headlines this past year, with KPMG auditors being lambasted by MPs over failures relating to their audits of Carillion. MP Rachel Reeves said that KPMG auditors were “mere spectators” who were “at the mercy of reckless and self-interested directors.”

The joint parliamentary committee’s final report said that KPMG’s failures were “not isolated”, but rather “symptomatic of a market which works for the Big Four firms but fails the wider economy”.

Last week the FRC slapped PwC with a record £10m fine over its BHS audit work, the first time the watchdog levied the maximum possible fine for “seriously poor audit work”.

Stephen Haddrill, CEO of the FRC, commented: “At a time when public trust in business and in audit is in the spotlight, the Big Four must improve the quality of their audits and do so quickly.”

“They must address urgently several factors that are vital to audit, including the level of challenge and scepticism by auditors, in particular in their bank audits.”

In addition to highlighting bank audits, Haddrill set out an expectation to see improvements in group audits and audits of pension balances.

Earlier this year Haddrill called for the Competition and Markets Authority (CMA) to probe the possibility of breaking up the Big Four firms into audit and non-audit branches.

KPMG under pressure

Due to the findings of the report the FRC will scrutinise 25% more KPMG audits over the 2018/19 period and hold the firm’s new leadership to account for the improvement of audit quality.

Michelle Hinchliffe, head of audit at KPMG, said the firm was “disappointed” in its audit quality score decline. Hinchliffe affirmed a commitment to high quality audit work, bolstered by the introduction of the firm’s Audit Quality Transformation Programme in October 2017.

“Central to our new approach is greater support and challenge to engagement teams, increased central monitoring of audits at the planning, delivery and completion stages and the introduction of a new requirement for all senior promotion candidates to spend time working within the Audit Centre of Excellence as part of their progression to partner.”

She added: “It is important to note that the audit work appraised by the FRC for its 2018 AQR took place principally in respect of 2016 year ends, prior to commencement of this work. We cannot and will not be satisfied with these results and, as a firm, we are already working to put this right.”