Director JS Penny Ltd
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Challenge audit culture to avoid fines

Poor audit culture is often to blame for fines and non-financial sanctions issued to firms. Julia Penny advises on ways to establish a better audit culture.

25th Aug 2020
Director JS Penny Ltd
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Audit concept
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In July the FRC issued their Annual Enforcement Review 2020. Whilst the title brings to mind gangsters, and the level of fines involved at £16.5m could certainly be regarded as punitive, the tone of the report is much more constructive.

It sets out the reasons that fines, and other sanctions, have been issued to auditors (or in some cases accountants) and so serves as a reminder as to what areas we should seek to improve to avoid being fined ourselves.

Biggest audit challenges

The six key themes identified by the report which caused most audit problems were:

  • Insufficient involvement of the audit partner including insufficient supervision and communication with the rest of the team
  • Disorganised work
  • Failure to step back and take an overall look at the financial picture
  • The auditor being too close to management
  • Failure to involve the audit quality assurance partner
  • Use of auditors’ experts and specialists without sufficient oversight or understanding of the work being done.

Whilst some of these might require specific training in order to improve performance, and such mandatory training has been part of the non-financial sanctions issued to firms, much of it is ultimately about a quality culture. If everyone in audit is committed to delivering quality above all other considerations, then ultimately quality will improve.  

If we take an example from the report, in one case, junior staff were left to do much of the audit work on an entity but were not made aware that the company was about to be sold. This changed risk significantly and meant that the going concern assumption was not looked at in the light of an imminent departure from the group. If there was a true culture of quality at the firm, the partner and senior manager would never have been happy to delegate virtually all the work to a junior team member, even more so when there was clearly a substantial change in risk due to the imminent sale.

Another example cited was with regard to the auditor being too close to management. With some very large audits the team can spend many months at the client and the enforcement division found that staff even started to refer to “our company”, “us” and “we” when talking about the audited entity. Whilst this may not occur in smaller audits there was also considerable focus on keeping the client happy, especially where the audited entity was significant for a particular office or region. It is vital that auditors remember that the real client is the ultimate user of the audit report, so primarily the company’s members, but also, to a lesser extent, other stakeholders such as employees and lenders.

So, if many of these failures are ultimately because of a poor culture, how can you improve your audit culture, to prevent similar problems?

As we saw in a another recent article, about the FRC principles for the operational split of audit in the Big Four firms, one way to help achieve an appropriate audit quality might be to develop a separate audit culture. Outside of the Big Four there is no need to create an operational split, but focusing on whether audit staff and partners have an appropriate culture for audit work might still be effective, so we will look at how you might do this.

Firstly, you might consider what culture or value-set your audit department currently has. If you ask partners and staff about what values they believe have been set (explicitly or implicitly) what sorts of answers will they give? Will it be quality, independence, ethical behaviour, and robust decision-making for example? Or perhaps it will include excellent client service, going the extra mile, or being nice? Why not have a Zoom meeting, or use survey monkey, slido or a similar app to ask what cultural values staff and partners feel they are working with?

How to establish a better audit culture

Once you know what your audit teams currently think you can address any attitudes that might need changing to create a better culture of audit quality. The table below shows some common attitudes regulators have seen within audit departments; the risks to audit quality from the attitude; and a more positive alternative.

Rather than attempt to impose an alternative attitude, try to work with the whole audit department to find ways to establish a better audit culture, along the lines of the right-hand column.

Current cultural attitude Risk to audit Alternative cultural attitude
We must maintain a good client relationship Lack of scepticism and challenge Always be courteous but challenge management and seek evidence to corroborate what you have been told, recognising that management may have made mistakes or there may be fraud in the financial statements.
We must keep the client because the fees are important A temptation to deliver a clean audit report when a modified one, or a going concern paragraph, is required. The firm regards independence as the ultimate requirement for audit and therefore if we lose a client due to having to issue a particular audit report, or because we need to ask awkward questions, so be it.
We must be nice to the client Being nice gets confused for not challenging what the audit team has been told, or trying to find a way around the rules to allow the result that management would like. Always be courteous but remind management that your job as auditor is to express an independent opinion and so you are obliged to ask such questions or are unable to help with achieving the desired result, as it would threaten your independence.
We must keep costs down for the client (especially a problem with charities)  A temptation:-not to ask for additional information, such as a valuer’s report, when required;

-not to spend enough time planning or testing, as it is seen as adding cost.

Audit quality is paramount, so we should be efficient and effective, including spending enough time to plan and conduct the audit.
We will work to the client’s deadlines, even if they don’t work to our deadlines An inability to plan properly, because we haven’t yet got the necessary information or an inability to conduct testing until the last minute, might mean that short-cuts are taken We will set clients clear expectations as to when we need which pieces of information. If the client still does not stick to the deadlines, we will be robust in moving signing deadlines or in asking for more fees if costs have increased.
The expert is always right Experts can still make mistakes, or lack independence, so taking everything they say at face value risks an incorrect audit opinion. Everyone makes mistakes and some people deliberately mislead so we must still be sceptical and gather evidence to support what an expert has told the audit team.
The partner is always right An incorrect approach, lack of scepticism or technical error might not be challenged even where other members of the team have doubts. We value challenging and inquisitive minds. If you see something that you are not sure is right discuss it, either with the individual concerned or the ethics partner.
The partner expects the manager and team to do all the work and does not want to be bothered with questions Insufficient direction and supervision by the audit partner mean the very person who is supposed to have the skills to look at the big picture, is not engaging in the audit, so risking that something big is missed. Set a culture of quality with an appropriate “tone at the top” which is then lived up to by the partners. 

 

Audit staff and partners should be rewarded, whether with money, promotion, or kind words, for their contribution to quality. You could even consider a monthly audit quality certificate for someone who has exemplified your audit quality culture. Ultimately, your audit culture must reflect the fact that audit is there to benefit the members and other stakeholders, not management.

Replies (10)

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By Munch
26th Aug 2020 10:06

I think I would add to this

Pressure on cost of running audit (more significant then mentioned I feel)
Pressure to sell the client additional services

As with banking we now see that firms are being forced to split audit away from other services. The audit profession at the top end has taken a hammering over many years now and the regulators have been very slow in reacting. I am not convinced that they go far enough. There needs to be clearer regulation on what other services can be offered. This was always seen as the way to make an audit client profitable. I have been there.

However, clients, must also bear the brunt and pay a commercial fee. I remember well the absolute nightmare in trying to fit the budget where the client simply was never going to go there. Again. I would like to see for large clients (plc and others) a tighter regime in agreeing budgets and putting out to tender.

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By ShayaG
26th Aug 2020 15:35

I think with the contraction of firms willing to get involved, this is increasingly a seller's market. Audits with unrealistic budgets are an absolute killer because they can go on and on. They are fundamentally different to accounts preparation. It's all very performative, but boxes must be ticked - budget is key.

You could not get a compliant audit for a completely dormant company done for less than a grand.

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7om
By Tom 7000
26th Aug 2020 13:33

I do wonder whether anyone reading this actually does auditing any more as most of the comments on aweb are usually accounts and tax related.

I will start off I have 25...
1 International large group
6 residents assocs
5 chartiies
11 regular companies ( 2 large)

And it more or less takes one FCA a year to work his way around them all.

Our issues come into play when you are a sole practitioner and you have self review threats.

How do you RIs deal with that?

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By ShayaG
26th Aug 2020 15:35

Not sure I understand the premise. Why are you any more conflicted by the fact that you earn your daily bread by taking management's money to report back to them if they are lying to you then a big 4 partner?

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By Tom 7000
26th Aug 2020 15:47

I was thinking more along the lines of preparing accounts and tax computations for small companies and then auditing them, when you are a sole trader, as opposed to a partnership where another partner would do this and an audit partner would then audit them. Nothing to do with the fees involved, more the regulatory position under ESPASE. Sure you can have 2 different FCAs act at manager level and we actually have one FCA do the accounts and tax another one check it and then yet another FCA audit it before it arrives on my desk ( in very simple terms) But ultimately there I am at the top of the pyramid. despite there being 3 FCAs underneath

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By ShayaG
26th Aug 2020 16:44

I see your point and I think your concern is sensible and well founded, notwithstanding that your arrangement would likely comply with the ethical standard.

For this reason, I would advocate a split firm approach for us SME auditors, where one firm acts as the outsourced FD, helps out with the technical side of the audit (for example, doing the cashflows to justify going concern, and justifying the accounting estimates), and does the tax and accounts without worrying about independence, and the second firm does a pure audit.

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By ShayaG
26th Aug 2020 16:59

I would also add that apart from self-review threat, I don't think there's anything particular about *non-audit* services which impair independence more than the provision of *audit* services. If a sizable chunk of your portfolio is with client A that will be a real challenge to your independence whatever work you do for that client.

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By Tom 7000
27th Aug 2020 09:27

That's all right all 25 Audit clients are only about 7% of the whole firm taken together. Got no worries about that side.

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7om
By Tom 7000
26th Aug 2020 13:34

.

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By ShayaG
26th Aug 2020 15:40

At the medium firm end, I think a model the regulators should encourage is where one firm takes on the "accounting" role and prepares the tax and finstats for the company as a kind of outsourced FD, and assists in the audit without having their hands tied behind their backs by ethical and independence constraints, and another firm does a pure audit.

I suspect it will be a more effective audit and a better service to the client overall.

For example, accounts prep and corp tax for a straightforwards service business with t/o of £30m and would be 5k - £10k, and you could get a decent audit done for £8k. If one firm did both, I suspect the fee would exceed £15k.

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