Julia Irvine 14 Feb 2017 02:04pm

FRC detects lack of scepticism among larger audit firms

The larger audit firms are not sufficiently sceptical in identified areas of significant risk, according to the Financial Reporting Council (FRC)

And concern is growing among investors that not all audit firms are “demonstrably serving their interests” in dealing with conflicts of interest.

In its February Developments In Audit Update, the audit regulator reveals that despite improvements in audit quality generally, its reviewers are still coming across examples of insufficient audit scepticism, particularly where the assessment of potential impairments and judgments concerning material accounting treatments are concerned.

The firms, it states, should take action to enhance their audit of impairments while audit committees should be seeking clear evidence from the auditors of the quality of their impairment testing and their challenge of management.

It points out that firms can use root cause analysis and data analytics to accelerate audit quality improvements, both areas on which it has published thematic reviews during the 2016/17 audit monitoring cycle.

Audit firms will face greater pressure to ensure that the quality of their audits is high, in any case, now that the FRC has decided on a quarterly basis to publish a list of the companies whose audits it has reviewed.

“As a result of this increased transparency,” it says, “we expect to see increased reporting by audit committees on our findings and increased investor scrutiny of audit quality.”

As well as greater transparency, confidence in audit quality will also be reinforced by speedier and more effective audit enforcement.

The FRC points to the fact that it has already concluded four audit-related cases since last July – involving PwC and Cattles and Deloitte and Aero Inventory – which resulted in sanctions of £6,525,600.

It has also begun its first investigation under the new audit enforcement procedure in connection with the audit of Sports Direct International (following reports of an arrangement between Sports Direct and Barlin Delivery which was not disclosed as a related party in the company’s financial statements). And it is currently carrying out enquiries into audits relating to Rolls Royce and BT Group.

As far as conflicts of interest are concerned, the FRC does not go into much detail apart from stating that investors have flagged concerns about whether or not the auditors are acting in their interest, given that they are the ultimate clients of the audit.

Under the new ethical standard, auditors are required to consider conflicts of interest “from the perspective of an objective, reasonable and informed third party”.

With this in mind, the FRC says, auditors and audit committees are developing practice, particularly to deal with difficult judgments, including seeking input from the audit firm’s independent non-executives.

Nevertheless, in order to speed up improvements in audit quality which, it says, requires strong leadership and the right culture in audit firms, it has announced that it will launch a review in 2017/18 of governance and the culture of the eight firms that have currently adopted the audit firm governance code.

“The FRC is determined to make a success of our competent authority status and, in liaison with the professional bodies for audit, will promote further improvements in audit quality,” said Melanie McLaren, the FRC’s executive director of audit regulation.

“In doing so, we will work with auditors, audit committees and investors to highlight good practice and advocate continuous improvement; keeping pace with, and accelerating changes in, audit and its use of technology in improving effectiveness and quality.

“In doing so we will continue to challenge and hold the leadership of the audit firms to account.”

Finally, the FRC reveals that the results of its annual survey of FTSE 350 audit committee chairs were overwhelmingly positive, with all the ratings improving over the year except one which stayed the same.

The most improved metric was satisfaction with the communication and interaction between the audit committee and the auditor.

All the audit firms covered in the survey received a score of six or seven (top score seven).

The survey also revealed that 49 of the 192 companies responding said that they had held an audit tender in the past year. Nearly 70% of them had changed their auditor as a result and 18% of them thought there had been a “significant change for the better in audit approach and quality”.

ICAEW, which is a recognised supervisory body for the purposes of audit, welcomed the update and said it was pleased to note the continuing improvement in the audit committee chairs' survey on audit quality.

"We look forward to working with the FRC as an improvement regulator, together with our members and firms, to continually improve confidence in audit quality, helping to ensure that the UK is the best place to do business in the world."