FRC warns auditors over ethical failings

AUDIT FIRMS ARE FAILING to adhere to ethical standards or exhibit appropriate levels of scepticism, the UK’s accounting watchdog said in a report that found the number of seriously flawed audits increased on last year.

The Financial Reporting Council reported a general improvement in the quality of audit work in its latest inspection of the nine-largest audit accounting firms. The number of high quality audits rose to 59% from 46%, with significant improvement in the audits of FTSE 350 companies.

However, the FRC also reported that the number of audits in need of “significant improvement” rose to 15% from 10% and identified several areas of concern, which included a lack of professional scepticism when auditing client’s accounts, cost cutting measures harming audit quality and failures to maintain appropriate ethical procedures.

These failures included references to targets for the cross-selling of non-audit services to audited entities and instances where shareholdings in audited entities were not disposed of on a timely basis.

“We’re a little bit disappointed to see examples where partners and staff have sought to gain credit be selling non-audit services,” Paul George, executive director, conduct, at the FRC, told Accountancy Age.

The audit report cites the example of a former executive of an audited entity who on re-joining the firm as a partner had a significant shareholding in that entity – this goes against the standards, which do not permit partners to hold any direct financial interest in an entity they are auditors of.

While the FRC noted that professional scepticism was becoming more embedded within audit work, it raised concerns about the way auditors applied scepticism to impairment testing of goodwill and other intangibles.

Auditors were also warned about the extent of their cost cutting measures in response to pressure of audit fees. The FRC said its findings “called into question” the sufficiency of the audit work performed and instructed forms that pursue off-shoring of certain audit procedures to make sure staff “are sufficiently integrated into the audit team and possess sufficient knowledge to able to identify matters that are significant”.

The audit of financial institutions in general was found to be lacking, with the FRC raising particular concerns about the auditing of loan loss provisioning and the testing of banks’ IT controls. Of the 15 audits inspected, two smaller building societies and one insurance company were found to require significant improvements. However, no audits of major lenders were found to have serious defects.

One emerging issue identified by the FRC related to the audit of companies that are registered in the UK but whose management and operations are based elsewhere. The FRC said it identified a number of instances when the auditors of so-called “letterbox” companies were insufficiently involved in the control, supervision and review of the audit work.

“Audit makes a vital contribution to investor confidence in financial statements. We are pleased to see in this year’s results that firms’ efforts to address our concerns on professional scepticism are bearing fruit, particularly in the FTSE 350. It is important that further improvements are more uniformly and consistently achieved across all entities and by all firms,” said George.

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