Audit reform urgently needed to remedy “glacial” progress

Audit reform urgently needed to remedy “glacial” progress

FRC audit quality scores reflect "unacceptable" performances from some firms and reinforce need for government reforms

Audit reform urgently needed to remedy “glacial” progress

Several years of poor audit quality scores and a lack of substantial progress paint a worrying picture for the profession and reinforce the urgent need for reform, according to market participants.

“The Financial Reporting Council (FRC) has consistently found that external audits needed improvement, and progress in this respect has been fairly glacial,” says Gavin Hayes, head of policy and external affairs at the Chartered Institute of Internal Auditors (CIIA).

The FRC’s audit quality inspection scores for 2020/21 paint the industry in a familiarly disparaging light, with nearly a third (29 percent) of audits requiring ‘improvement’ or ‘significant improvement’.

The latest review scores largely mirror that of last year’s in terms of the level of improvement required, but represent a downturn since 2019, where around 25 percent were found to be “below an acceptable standard”.

“The findings of the FRC’s latest review are yet more evidence of the need for the government to urgently get on and implement audit reform in months not years,” says Hayes.

“This must include putting the audit regulator on a statutory footing with the legal powers it needs to do its job effectively, so it can enforce stronger action for audit firms to improve.”

Liz Sandwith, the CIIA’s chief professional practices advisor, argues that the forthcoming reforms could be a turning point for audit quality.

“I think the BEIS whitepaper has a phenomenal role to play in restoring trust, not just in audit, but in corporate governance across organisations,” she says.

“The importance of the FRC being revised and given increased authority in this space has got to be the way forward.”

Following a four-month consultation period, the government’s audit reform proposals, which include a series of measures to increase regulatory scrutiny of the industry, are now in the process of being formalised. Most notably, the FRC is set to become the Audit, Reporting and Governance Authority (ARGA), and will be handed stronger powers such as overseeing larger unlisted companies and ordering companies to resubmit accounts.

“It’s crucial that those who consider the performance and impact of the largest companies have access to high-quality, focused, transparent and reliable information,” said John Boulton, technical policy director at the Institute for Chartered Accountants in England and Wales.

“This is why we strongly support the government’s objective. After all, we must ensure the UK’s world-class reputation in corporate governance is maintained.”

However, while reform will be crucial in improving audit quality, certain other measures should be taken in the meantime, Boulton added.

“Any changes to legislation, regulation and auditing standards arising from the government’s proposals in the white paper will take time to put in place, but there are steps that can be taken now to improve audit quality.

“Ultimately, it’s audit firms that own audit quality, and they will be thinking about its behavioural aspects and the structural drivers behind it, including oversight and reward, transparency reports and the role of investors and technology.”

Sandwith also weighs in on this, drawing from her experience of internal audit and arguing that human capital, skills, and the disruption of coronavirus are “hugely significant” factors.

“There are vacancies all over the place – people are crying out for internal auditors and looking for experienced candidates. And that’s partly because of financial constraints across a number of organisations,” she says.

“Budgets have been cut, and training budgets are probably included in that. It’s meant that organisations are now looking for experienced internal auditors rather than those they train and are struggling to recruit.”

KPMG’s “unacceptable” performance

But while the economic climate and the need for industry reform may be significant factors, the FRC’s denouncing of certain firms as part of its annual inspection was clear and direct.

KPMG’s audits of banks and similar entities were found to be particularly problematic. Overall, the Big Four firm was labelled the worst for audit quality of the seven reviewed, with its performance being called “unacceptable”.

“Audit quality is our number one priority and we will not be content until our scores reflect our commitment,” said Cath Burnet, KPMG UK’s head of audit in an email.

“We are committed to delivering high-quality audits and are already working hard to make the necessary changes the FRC has highlighted.”

BDO and Mazars were also among the worst for performance, with the FRC declaring that “improvement measures are expected” from them.

Mazars’ head of audit David Herbinet said: “We have analysed the findings from the FRC and these have been incorporated into our Audit Quality Plan.

“We welcome the FRC’s ongoing review, challenge and support, which we see as an invaluable tool for learning, developing and improving.”

BDO declined to comment.

However, PwC, the UK’s largest audit firm, received the strongest overall score. It registered the highest number of audits with ‘good or limited improvement required’ (16), with none requiring ‘significant improvement’.

“We are encouraged by the results and by the FRC’s recognition of improvements and good practices in our audits,” said Hemione Hudson, head of audit at PwC UK.

“Strengthening the quality of our audits remains a top priority for PwC through our ongoing programme to enhance audit quality. We remain committed to performing consistently high-quality audits and will act upon the recommendations in this year’s findings.”

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