Complex audits surge to smaller firms, ICAEW report finds

The Institute of Chartered Accountants in England and Wales (ICAEW) has released its comprehensive audit monitoring report for 2023/24, revealing significant changes in the audit landscape.

The report, published on Thursday, September 12, 2024, highlights a notable shift of complex audits from larger to smaller firms, presenting new challenges to market dynamics and audit quality.

Despite market changes, the overall quality of audits remains consistent with previous years. The report shows that 71% of audits reviewed were deemed good or generally acceptable, matching the result from 2022/23. However, this figure remains below the pre-pandemic average of 75-76%.

The results are based on nearly 500 audit monitoring visits carried out by ICAEW’s Quality Assurance Department (QAD) in 2023/24, reviewing a total of 761 audits. Importantly, reviewers were asked to select the audits considered to be the most complex and challenging, meaning the overall result is not necessarily representative of average audit quality, which is likely to be higher.

While there has been no deterioration in the overall result this year, it is slightly disappointing that overall performance has not improved. However, we recognise that different firms are reviewed each year which makes it difficult to make year on year comparisons,” said Rama Krishnan, Chair of ICAEW’s Audit Registration Committee.

Performance Across Different Firm Categories

Larger Firms Maintain Strong Performance

The report indicates a strong performance by larger audit firms, with 88% of non-Public Interest Entity (PIE) audits carried out by larger firms considered good or generally acceptable. This demonstrates the continued high standards maintained by established firms in the sector.

Specifically, the six largest audit firms (FRC Tier 1 firms) showed impressive results. Of the 50 non-PIE audit files reviewed across five firms, 88% were judged to be either good or generally acceptable in 2023/24. This is a slight decrease from the 95% achieved in 2022/23 but still represents a very strong performance.

Improvement in Mid-Tier Firms

Notably, there was a significant improvement in the performance of other PIE audit firms (FRC Tiers 2 and 3). The report shows that 79% of the non-PIE audits reviewed at these firms were considered to be either good or generally acceptable, up from 72% in the previous year. While the sample size was smaller (19 audit files across four firms), this improvement is encouraging.

Challenges and Opportunities for Smaller Firms

The movement of complex audits from larger to smaller firms is creating both challenges and opportunities. Krishnan noted, “There are indications that audit quality is being challenged by changing market conditions with an unprecedented movement of complex audits from larger to smaller firms which is requiring those smaller firms to move quickly to upscale their risk and quality processes.”

This shift is prompting smaller firms to rapidly enhance their capabilities and quality management systems. The ICAEW report suggests that this transition period may be contributing to the overall audit quality results not showing improvement.

Market Consolidation and Its Impact

The report also highlights increasing consolidation in the audit market, including new firms with private equity finance growing rapidly through acquisitions. This trend is expected to lead to the creation of dedicated risk and quality management teams and greater investment in training and specialist expertise.

However, the report notes that these ‘new firms’ with newly formed audit teams, working across multiple offices, will require a period of time to implement suitable whole-firm procedures. The ICAEW expects to do more work with these new firms in the coming years to ensure that appropriate quality management systems are implemented in a timely manner.

Implementation of ISQM1

A key focus of the report is the implementation of the International Standard on Quality Management 1 (ISQM1), which was introduced in December 2022. The ICAEW’s monitoring visits in 2023/24 included assessment of ISQM1 implementation, with about 90% of firms having implemented the new standard.

The report highlights that embedding effective root cause analysis for identified deficiencies in the system of quality management is seen as one of the more significant challenges as firms operationalize ISQM1. Some firms are planning to engage with training organizations to assist with this process.

Audit Quality Challenges

The report identifies several persistent challenges in audit quality, including:

1. Estimates and judgements, particularly in areas such as asset valuation, provisions, and cashflow forecasts.
2. Group audits, especially for UK holding companies with substantial foreign operations.
3. Audit team structure and resources, including involvement of responsible individuals and staff recruitment challenges.

Regulatory Actions and Penalties

In response to audit quality concerns, the ICAEW’s Audit Registration Committee (ARC) took several actions:

• Conditions or restrictions were imposed on the audit registration of 43 firms during 2023/2024.
• Over £140,000 in regulatory penalties were issued, with over £90,000 related to independence issues.
• Nine firms were referred to the Conduct Department for further investigation of independence issues.

Future Focus and Regulatory Changes

Looking ahead, the ICAEW emphasizes several key areas of focus:

1. Continued implementation and evaluation of ISQM1.
2. Preparation for changes in the Ethical Standard 2024, including new requirements for assessing fee dependency.
3. Monitoring the ongoing changes in the audit market, particularly the movement of complex audits to mid-tier firms.
4. A proposal to change Audit Regulations, requiring firms to report the acceptance of new audits falling within certain criteria.

Additionally, significant changes were made to the Continuing Professional Development (CPD) Regulations in November 2023, with new minimum requirements for ICAEW members and non-members who are regulated by ICAEW. Monitoring of compliance with these new regulations will transfer to the Quality Assurance Department in November 2024.