Audit quality review (AQR) inspections of the seven largest audit firms over the past year have revealed that this is the issue where auditors most often fall down, particularly when it involves areas of judgment like long-term contracts, goodwill impairment or the valuation of financial instruments.
These areas may be harder to audit, the regulator says in its annual report, Developments in Audit, but “too often audit teams appear prepared to accept what management tells them rather than questioning its plausibility and drawing on specialists to form their own view”.
As a result, it was forced to conclude that audits are still not consistently reaching the necessary, high standards required to provide confidence in financial reporting. Too many are still requiring significant improvements.
In July the FRC revealed that the overall inspection results of the seven firms were unsatisfactory: only 75% of the FTSE 350 audits reviewed were classified as good or requiring no more than limited improvements. This was way behind the target for 2019 of 90%.
Challenging management wasn’t the only area where auditors proved deficient. FRC inspectors reported instances of auditors failing to perform routine procedures to a consistently high level. Auditing revenue seems to be particularly problematic but they also found inconsistencies in the way internal controls were tested, and in auditors’ work on other information (the front half).
Firms were also failing when it came to planning the audit. Year-on-year familiarity with an audited entity, the report says, can result in the same approach being adopted even when changes in the business or trading environment called for an alternative strategy, while audit teams too often take on unrealistic deadlines which then result in inadequate work and significant shortcomings.
“At a time when the whole audit market faces reform, we expect audit firms to make audit quality their number-one priority and to have effective programmes of work to deliver consistently high standards,” said David Rule, the FRC’s executive director of supervision.
“Inconsistent quality erodes confidence in the profession, which can lead to diminished trust in business. Stakeholders and investors rightly demand high-quality work on all audits.”
The deficiency rate among the four smaller to medium-sized audit firms the FRC reviewed was even worse. Only 29% of audits reviewed were classified as good or requiring no more than limited improvements.
A primary area of weakness was the auditors’ work around going concern but the inspectors also identified problems with audit teams obtaining sufficient and appropriate audit evidence.