It has been a tumultuous 18 months for the UK audit market with the scandal surrounding Carillion’s collapse, which sparked a wave of government and public scrutiny of the profession, resulting in a raft of reviews and investigations.
However, in the Financial Reporting Council’s (FRC’s) annual review of audits performed by the biggest firms this year, it found that “poor quality audit work remains unacceptably common”.
There was a slight improvement on the previous year: 75% of FTSE 350 audits reviewed were good or required no more than limited improvements, compared to 73% in 2017/18, but no firm achieved the FRC’s audit quality target of 90% for the FTSE 350.
Grant Thornton and PwC were singled out for criticism by the regulator. PwC was flagged for an “unsatisfactory” deterioration in inspection results for its audits of FTSE 350 clients, while Grant Thornton was put under “increased scrutiny” after a fall in standards.
Stephen Haddrill, the FRC’s outgoing CEO, said, “At a time when the future of the audit sector is under the microscope, the latest audit quality results are not acceptable. Audit firms must identify the causes of their audit shortcomings and take rapid and appropriate action to improve quality. Our latest results suggest that they have failed to achieve this in recent years.
“The latest review also reinforces the importance of work being undertaken by the FRC and others to bring about quality improvements across the sector.”
“For 2019/20, we are extending our 90% quality target for FTSE 350 audits to all audits inspected. We will set a new target for audit firms, for 2020/21 onwards, that 100% of audits inspected should require no more than limited improvement. In other words, starting from June 2019 financial statement year ends, we expect no audit to be assessed as either a 2B or a 3.”
The FRC added that over the two past years of inspections, six audits have been referred for possible enforcement action, with investigations opened in eight cases so far.
The latest Audit Quality Review inspection reports published today by the FRC underline the need for urgent and early action on audit reform, according to ICAEW.
Vernon Soare, ICAEW’s chief operating officer, said the review results are “disappointing” and underline the need for urgent action on audit reform.
He added, “We cannot be satisfied with these results. ICAEW feels strongly that early and urgent action to address public concerns regarding audit - alongside wider issues of corporate governance and management accountability - is vital to maintaining confidence in business. As a profession, chartered accountants acknowledge that we face a watershed moment and we are ready to be willing partners in change.
"Audit is undergoing an unprecedented level of scrutiny, and in coming months the challenge will be to integrate the outcomes of the three current major reviews - and the recent select committee inquiry - into a coherent, comprehensive and proportionate programme of reform. ICAEW has already welcomed Sir John Kingman's vision for a strong and credible new regulator - the Audit, Reporting and Governance Authority (ARGA) - and today's reports reinforce the case for the government to implement this without delay. Once established on a firm statutory basis, ARGA should apply fresh thinking to how we improve quality in the audit market and must not be constrained by targets and methods bequeathed to it by the FRC.''
The FRC said that deterioration from 84% to 65% in the results for PwC’s FTSE 350 audits inspected is “unsatisfactory and the FRC has required the firm to take prompt and targeted action to address this decline”.
It acknowledges that last month PwC announced an action plan to strengthen its focus on audit quality.
Of PwC’s audits reviewed, 77% required no more than limited improvements, compared with 82% in 2017/18.
According to the review, PwC needs to improve: the audit team’s challenge and supporting evidence in relation to the audit of long-term contracts; the consideration and challenge of growth assumptions in relation to the impairment of goodwill and other assets; the consideration and challenge in relation to management’s estimation of certain provisions; the audit work performed for aspects of revenue and inventory for retailers; and the firm’s systems and procedures relating to non-audit services approval.
In response, Hemione Hudson, head of audit at PwC, said, “We are disappointed that the results of the AQR inspection are below the high standards we are committed to achieving on all of our audits. Last month we launched a wide-ranging audit quality action plan to ensure we consistently deliver high quality audits.”
The firm was put under increased scrutiny last year and has showed improvement, albeit from a “low base”, said the FRC.
More than three quarters (76%) of KPMG’s audits required no more than limited improvements, compared with 61% in 2017/18. Of the FTSE 350 audits, 80% achieved this standard compared with 50% in 2017/18.
The increased scrutiny will continue “until KPMG has demonstrated a sustained improvement in audit quality”, the regulator said. “The FRC scrutiny will cover the impact of KPMG’s recently announced changes to governance of their audit practice, as well as on key aspects of the firm’s audit improvement plan, including the firm’s central review process and new audit guidance.”
KPMG still needs to improve: the quality of the audit of the valuation of financial instruments in financial services entities; the audit of loan loss provisions in financial services entities; the consideration and challenge of cash flow forecast assumptions in relation to the impairment of goodwill; and the consideration and challenge of management’s estimation of provisions.
Like KPMG last year, Grant Thornton’s audits have been put under “increased scrutiny” after the reports showed a fall in standards.
The watchdog revealed that, of the Grant Thornton audits the FRC assessed this year, just 50% were good or required limited improvements, down from 75% last year. Over the past five years, 26% of Grant Thornton’s inspected audits have required significant improvement.
In response, the FRC “increased its scrutiny” of the UK’s sixth largest firm, with steps including a new audit quality improvement plan and increasing the number of audits to be inspected in 2019/20.
The firm has come in for criticism recently for its audit work on café chain Patisserie Valerie and earlier this month announced an overhaul of its audit business.
The FRC review said that Grant Thornton “has made senior management changes in the past year and must now take urgent action to enable audit teams to improve audit quality significantly. The firm has recognised that the quality of its audits must improve and has shared details of the actions it intends to undertake. We have met the firm on a number of occasions to discuss the plan. We do not consider that the plan is, at present, sufficiently developed or detailed to deliver the firm’s objectives.”
It outlines the areas that require improvement as: the extent and rigour of challenge of management in areas of judgement; the consistency of audit teams’ application of professional scepticism; and the effectiveness of the audit of revenue, going concern, and the completeness and evaluation of prior year adjustments.
Deloitte performed relatively well this year, with 84% of audits reviewed requiring no more than limited improvements, compared with 76% in 2017/18. There was slight drop in the quality of FTSE 350 audits - 75% compared with 79% in 2017/18. The FRC noted only “modest improvements in audit quality”.
The Big Four firm still needs to improve several areas, including: greater professional scepticism in the audit of potential prior year adjustments and related disclosures in the annual report and accounts; the extent of challenge of key estimates and assumptions in key areas of judgement, including asset valuations and impairment testing; the consistency of the quality of the firm’s audit of revenue; and greater consistency in the audit of provisions and liabilities.
EY improved its top line figures, with 78% of the firm’s audits requiring no more than limited improvements, compared with 67% in 2017/18. It almost made the FRC’s target in the FTSE 350, with 89% reaching this standard compared with 82% in 2017/18.
The firm noted that its “key individual review findings related principally to the need to:
• Increase the challenge and corroboration of management assumptions in relation to intangible assets.
• Improve reporting from the firm’s internal specialists on the key assumptions underpinning the estimation of provisions.
• Ensure consistency of the group audit team’s oversight of component audit teams.”
Seven out of eight audits reviewed were assessed as requiring no more than limited improvements – the same as in 2017/18.
The FRC said that BDO needed to strengthen audit procedures relating to the timing of revenue recognition and the evidence of appropriate challenge in relation to valuation judgements.