FRC finds audit failures in UK pension scheme reporting

Auditors have been called out by the Financial Reporting Council (FRC) due to problems found in almost half of the audit work around pensions valuations they have inspected this year.

The FRC’s annual ‘audit of defined benefit pension obligations’ report, published 26 July, explained it had examined the audit quality of pension balances and related disclosures among 51 of its overall inspections for 2017/18.

In nearly half of these, improvements needed to be made in at least one aspect of the audit work despite good practice being recorded in other areas.

The audit watchdog said valuation judgements and audits can be made harder by the existence of multiple pension arrangements and certain financial or risk management transactions, like liability-driven investment strategies and longevity swaps.

Melanie Hind, audit and actuarial regulation executive director said pension obligations valuation is complex and needs serious judgements and assumptions in which there is a risk of misstatement or manipulation.

Hind said: “Auditors need to understand the work of actuaries inputting to their work and pay attention to assets as well as liabilities.

“We hope to raise standards by highlighting good practice and areas for continuous improvement.”

The FRC’s warnings follow a number of high-profile scandals involving significant pension deficits at some of the UK’s biggest companies.

The watchdog’s analysis shed light on a wider review of 125 audits carried out earlier this year revealing significant failures in audits by big four firms.

Carillion’s collapse in January this year exemplifies the issues around how much support large corporates provide to their pension schemes.

In the seven years prior to its collapse the government outsourcing business made £280m of contributions to its pension fund but paid out dividends worth over £500m.

Approximately 28,000 members of Carillion’s 13 pension schemes are facing cuts to their benefits after the group collapsed with a pension shortfall that increased by almost double to nearly £1bn in three years.

The FRC’s current investigation into KPMG’s Carillion audit is looking at how the company’s pension fund was accounted for.

So what does the FRC’s report recommend?

Auditors need to assess the sensitivity of the valuation of changes in assumptions, and ensure they clearly demonstrate the work completed by actuarial experts and how exactly conclusions were reached.

They must also look at whether the source data used in calculating the valuation of the defined benefit obligation is totally accurate.

The report also suggests auditors should pay more attention to identifying categories of investment assets and gaining enough evidence to support the valuation of each.

In instances where businesses have significant pension scheme balances, the FRC’s expectation is that audit committees and auditors discuss the report findings and analyse whether the audit approach taken could be enhanced.