Raymond Doherty 19 Jun 2018 11:21am

FRC criticises “unacceptable” quality of KPMG audits

KPMG has been singled out by the UK accountancy watchdog and will now face greater scrutiny
Caption: KPMG was specifically criticised for an “unacceptable deterioration in quality”.
It is not only KPMG that “must act swiftly to reverse the decline” in audit quality but also its fellow Big Four firms, PwC, EY and Deloitte.

In its annual review of audit quality across the big firms the Financial Reporting Council (FRC) found that the fall in standards was due to a failure to challenge management, a lack of scepticism and poor bank audits.

KPMG, however, was specifically criticised for an “unacceptable deterioration in quality”.

The review found that the overall decline in quality of KPMG’s audits is “unacceptable and reflects badly on the action taken by the previous leadership, not just on the performance of front line teams.”

KPMG is the firm at the centre of the Carillion controversy and has been auditor of the collapsed construction company since 1999 – through profit warnings and subsequent collapse earlier this year.

The firm was singled out in a report by a joint committee of MPs for failing to question Carillion’s financial judgements, information and for being “complicit” in the company’s “questionable” accounting practices. It is currently under investigation by the FRC for its work on Carillion.

The FRC this year found that 61% of KPMG’s audits were assessed as requiring “no more than limited improvements”, compared with 65% in 2016/17. In addition, 50% of KPMG’s FTSE 350 audits required “more than just limited improvements”, compared to 35% in the previous year.

As a result, KPMG will be subject to increased scrutiny by the FRC. This includes inspecting 25% more KPMG audits over its 2018/19 cycle of work and closely monitoring the implementation of the firm’s Audit Quality Plan.

Overall, Deloitte had 76% only requiring limited improvements, compared with 78% in 2016/17. The FRC said it was “concerned at the lack of improvement”.

EY fell from 88% to 67%, which was “a disappointing outcome in comparison to the progress made in the previous two years,” said the FRC. PwC, meanwhile, dropped from 93% to 82%. The other firms were told the standard of their audit work was improving.

Stephen Haddrill, FRC chief executive, said, “At a time when public trust in business and in audit is in the spotlight, the Big Four must improve the quality of their audits and do so quickly. They must address urgently several factors that are vital to audit.”

He added, “Firms must strenuously renew their efforts to improve audit quality to meet the legitimate expectation of investors and other stakeholders.”

Michelle Hinchliffe, who was appointed KPMG head of audit last year, said, “We are disappointed that our overall audit quality score for our 2016/17 audits has decreased by 4% and that the steps taken in previous years have not resulted in the necessary improvements to audit quality. We are taking action to resolve this.”

“This is why, after taking up my role in October 2017, I commenced a programme to transform our approach to audit with the full support of our Executive Committee and Board,” she added.

As well as KPMG, the rest of the Big Four were accused by MPs of “feasting” on the “carcass” of Carillion after receiving a combined total of £71.6m in fees.

The FRC itself was criticised for being “far too passive” in relation to Carillion’s financial reporting. MPs said the collapse exposed the “toothlessness” of the regulator and its reluctance to aggressively use its powers.

In March the FRC called for an inquiry into the case for breaking up the Big Four into separate parts. Haddrill said the Competition and Markets Authority should look into possibility of “audit only” firms in a bid to enhance competition in the sector.

Last week the FRC handed out the biggest fine in its history to PwC and one of its partners over the audit of BHS.