FRC shout for independence, viability and higher quality in the UK audit market

In the last few years the UK has seen a decline in audit quality, with significant cases like those of BHS and Carillion paving the way for some much-needed change in the sector.

The Financial Reporting Council (FRC) have responded by releasing their Developments in Audit report this week, reviewing the state of audit in the UK and announcing their strategic programme of work to make sure that, going forwards, audit standards better serve the public interest.

The FRC’s deputy director of audit policy, Mark Babington, has shared some in-depth insights into the state of audit now and what the long-terms aims of the report involve.

“The report points to some of the key themes that have led to a deterioration in audit quality in the last year.”

Babington points to several key causes of audit failures, including professional scepticism and auditors’ ability to appropriately challenge management on issues.

“Sometimes we have quality issues with an audit because we don’t feel that appropriate evidence was gained in support of a conclusion the auditors have drawn.

“All the firms we’ve looked at have got examples of very good work and good practice in what they do. It’s just not always executed consistently and where it’s not executed consistently is when we get quality failings.”

What does the report say?

The FRC’s report is divided into key areas which need improving, one particular area of focus being the independence of the auditor.

Public confidence in the audit will only gain ground once people trust the independence of the auditor.

Sometimes we have quality issues with an audit because we don’t feel that appropriate evidence was gained in support of a conclusion the auditors have drawn.

As part of its review of the 2016 ethical and auditor standards, the FRC will test the effectiveness of these rules on independence and decide whether further actions are needed to prevent auditor independence ever being compromised, such as consulting work for companies on top of audits being banned.

Babington said: “A lack of independence is still something of significant concern to stakeholders, particularly the worry that auditors are sometimes more motivated by the contractual relationships they might have than acting in the public interest and delivering high quality work.”

The FRC have also proposed the strengthening of requirements on auditors when considering whether an organisation is a going concern.

“We’ve had some well-publicised examples of where businesses have failed because they have received an unqualified audit opinion.

“Therefore, we have this requirement where the directors are qualified to make an assertion that an entity is a going concern and then the auditors have to gather evidence to see whether or not they agree with the assertion made by the directors

The question comes down to whether we need to do more to determine whether an entity is viable, and therefore whether a set of financial statements is signed off. Babington gave the example of the 2008 crash.

“If we go back ten years to the financial crisis, no one ever thought that the banks would stop being able to lend money. It’s not just thinking about the obvious and seeing whether there is evidence out there, but it’s looking at that which might challenge the statements being made.”

As well as the given considerations, entities should think about whether there are any outside events or conditions which could impact negatively on their business model.

The FRC’s report also homed in on audit quality, with the time taken to conclude a case at the forefront of highlighted issues.

“You also have to remember that in many instances a case will ultimately go to tribunal and it is then out of our control, but our focus has been in investing in and building our capability to be able to respond more quickly and use the new powers we gained in 2016 to deal with some of the impediments we previously faced.”

The FRC have been investing in their enforcement capabilities with the aim of solving these cases more quickly, increasing the number of lawyers they have and expanding their in-house team of forensic accountants.

They have also been looking into improving the current penalties system, with a high court judge conducting an independent review of their sanctioning powers.

“We then consulted on changes to our sanctions regime, which mainly gave us flexibility to be able to impose higher penalties in the most significant cases but also allowed us to look at non-financial sanctions.”

The BHS case, for example, resulted in, as well as cash penalties, a series of non-financial conditions.

Overall, the FRC hope to introduce “a broader range of potential sanctions, a higher penalty we can impose in very significant cases, like BHS, but also the ability to facilitate the settlement of cases where the problem has been acknowledged and recognised.”

The proposed changes will be implemented at a varying rate, hopefully with some, such as the going concern project, taking place in Q1 or Q2 of 2019.

What might the changes mean for accountants?

The suggested actions come following a long year of big audit scandals and questions about the quality and reliability of the UK audit market.

Put plainly, the changes will be put in place to prevent the number of audit failures around the country but also the severity of them. With promises of increased sanctions, for instance, there is hope these mistakes will be avoided.

Debates about audit quality have also led to discussions about the Big Four’s influence in the audit market.

Currently 95 percent of FTSE 350 companies are audited by one of the Big Four firms.

Babington said: “The FRC share the concerns about the level of concentration in the audit market. Our CEO Stephen Haddrill highlighted the fact this is an issue the Competition Markets Authority need to address.

“We are aware the CMA is giving further thought as to what steps on competition might be appropriate and obviously we will be very happy to provide input and support to the CMA once they have finalised plans.”

The current debate goes to a deeper question as to the purpose of audit and its value to stakeholders.

Stephen Haddrill, CEO of the FRC, said: “This comprehensive reform programme addresses fundamental issues underlying falling trust in business and the effectiveness of audit, whilst also looking to ensure that the requirements on what companies say about themselves are fit for the future needs of stakeholders.  If stakeholders are to have confidence in audit, they also need to have confidence in audit rules and regulation.”

Haddrill explained that the FRC will also use proposals from Sir John Kingman and the CMA to take their suggested changes to the audit market forwards.

Deloitte’s head of audit, Stephen Griggs, added: “The current debate goes to a deeper question as to the purpose of audit and its value to stakeholders. This needs a wider discussion to consider what the role of audit can, and should, be in the future, especially as large companies continue to grow in scale, become increasingly technology-driven and complex, and global in their outlook and requirements.

“Our relentless focus has been, and continues to be, audit quality – any measure for reform must support high quality audits and ensure they are fit for the future.”