Big seven audit quality hits the buffers in latest FRC report

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Poor quality work in audits carried out by the UK's largest accounting firms remains "unacceptably common" amid a litany of poor results and missed targets, according to the UK’s accountancy watchdog.

The Financial Reporting Council’s (FRC) annual audit inspections found that EY, KPMG, Deloitte and PwC, and Big Four challengers BDO, Grant Thornton and Mazars had all failed to hit the quality target for their FTSE 350 audit work.

There was a slight improvement in overall results, with 75% of FTSE 350 audits reviewed by inspectors meeting the FRC’s ‘good or required no more than limited improvements’ standard compared to 73% in 2017/18.

However, the results fall short of the regulator’s stated objective of 90%, and a second year of missed targets will only encourage the government to continue with the audit market shakedown prompted by recent accounting scandals such as Patisserie Valerie.

In order to tackle high-profile audit bungles, earlier this year the government announced plans to dismantle the FRC in place of a new body with wider legal powers, billed as the Audit, Reporting and Governance Authority (ARGA).

Results ‘not acceptable’

Commenting on the results Stephen Haddrill, the FRC’s outgoing CEO, stated that at a time when the future of the audit sector is under the microscope, the latest results were “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.”

Haddrill outlined that for 2019/20, the FRC plans to extend its 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.”

Entire profession must improve

Grant Thornton came in for particular flak from the report, with only 50% of reviewed audits judged ‘good or required limited improvements’, compared to 75% last year. The report went on to state that over the past five years 26% of the firm’s reviewed audits have required ‘significant improvement’.

A spokesperson for the firm commented: “This FRC report makes clear that the entire profession must improve the quality of its work and Grant Thornton is no exception.”

While some of Grant Thornton’s past audits for large listed firms had “fallen short of the standards we expect,” the statement continued, “we have proactively responded by taking significant steps to strengthen audit as a specialist practice.”

The FRC has announced that it will increase its scrutiny of Grant Thornton, which includes requiring a new audit quality improvement plan and increasing the number of audits to inspect in 2019/20.

PwC was also tagged for an “unsatisfactory deterioration” in inspection results, with the number of ‘good’ audits of FTSE 350 companies dropping from 84% to 65% and the FRC urged the firm to take “prompt and targeted action”.

KPMG remains on the FRC naughty step and subject to increased scrutiny despite their results improving over the past 12 months, with 80% of audits achieving the regulator’s standard compared with 50% in 2017/18. “While the results have shown an improvement from last year, this was from a low base and below our target for FTSE 350 audits,” read the firm’s report.

Judgmental issues

The FRC found cases in all seven firms where auditors had failed to challenge management sufficiently on “judgmental issues”, a recurring finding over a number of years.

Contributory factors listed by the watchdog include:

  • The mindset of audit teams, especially an absence of professional scepticism in evaluating evidence presented by company management.
  • Tight reporting deadlines and the complexity of the judgments involved.
  • Familiarity arising from long-standing audit relationships, particularly if the company comes to be considered as “the client” for the auditor, rather than the shareholder or investor.

In the report’s judgment, audit firms need to work harder to solve these issues, and the watchdog is undertaking detailed work to assess how the audit firms are responding to this.

Each firm has committed to specific actions to enhance its audit quality including, for the worst performers, detailed audit quality improvement plans. The FRC stated that it will assess the success of these initiatives and take further action if necessary.

The report also emphasised that all audits assessed as requiring improvements or significant improvements are considered for enforcement action. Over the past two inspection cycles, across all firms inspected, 16 audits have been referred for possible action, while investigations have so far been opened in eight cases.

‘Deeply concerning’

PKF International CEO James Hickey told AccountingWEB that it was “deeply concerning” to see the UK’s biggest firms struggling to get to grips with audit quality.

“While other accounting networks and associations don’t have the depth or structure to undertake the biggest audits, conflict concerns would be eased if more services moved away from the biggest auditors,” said Hickey.

Simon Bittlestone, CEO of financial analytics firm Metapraxis, commented that while the FRC’s findings don’t make pleasant reading, they’re hardly surprising either.

“We’ve seen high profile accounting and auditing misses continue to hit the headlines over the course of the last few years,” he said. “Whilst the problem doesn’t start and end with audit, it does continue to show systemic failure in representing business performance properly.”

About Tom Herbert

Tom is editor at AccountingWEB, responsible for all editorial content on the site. If you have a story that might interest us or wish to comment on the site's coverage get in touch via the site's private message function or Twitter DM (@AWebTom)

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By tedbuck
11th Jul 2019 11:26

Well no surprises there but it's a bit thick to blame it all on the actual auditors. A lot of the 'misses' are directly due to misrepresentation by the Directors and their accounting delegates. In the computerised world in which we live it is very easy for naughty people to hide things from sight and much more difficult for the auditors to spot it. The sheer volume of figures suggests that it is becoming an impossible task. I recall that Carillion foundered because an in house accountant blew the whistle on some shortcomings. I also recall that she had been there about 3 months. This implies that 3 months involvement in the Company threw up shortcomings but how would auditors spot that in 3 weeks of an audit.
It's all very well for the MPs and the FCA to throw up their arms in horror but they have no idea of the problems faced at ground level and like most people in such positions they talk off the top of their heads.
I am not an apologist for the big firms but I do think that the arguments are a bit one-sided. The whole system of audits needs to be rethought and viewed from a totally different perspective. The MPs and FCA will not help by trying to be clever when they are not.

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11th Jul 2019 11:42

Tolerant mindset, tight deadlines, complex judgements, familiarity? As one who lectured on auditing, this is old stuff, and all the vaunted changes in auditing standards and regulation appear to have made no difference. The auditing firm's bottom line and competitive edge remain paramount, and the only important risk assessment seems to be the danger of getting found out! It's no surprise that ARGA is being formed to chastise naughty auditors. The profession is headed toward loss of self-regulation altogether.

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11th Jul 2019 18:22

It seems to me that if the big audit firms and indeed the 'entire profession' are all falling short, then there is something more fundamental here and there needs to be a rethink and some honesty about the purpose and limitation of audit.

The usual kneejerk response of piling on more regulation just means that there are more boxes to tick, more forms to fill in, and less time to do any actual auditing, so more corners are cut. And at the same time audits firms are expected to compete for business.

I have some difficulty with the statement "Familiarity arising from long-standing audit relationships, particularly if the company comes to be considered as “the client” for the auditor, rather than the shareholder or investor". Sorry - but the shareholder or investor doesn't in reality appoint the auditors and they don't pay the bill so they are not the client. Perhaps its this elephant in the room that needs to be addressed first.

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12th Jul 2019 16:14

I wonder if a detailed examination of the 'nitty gritty' of the failures would reveal some sort of pattern.

The Patisserie Valerie case seemed to revolve around borrowed funds being embezzled. It is difficult to see how these were not secured on something. Perhaps there is a case for lenders to ensure that any charges on assets are reported directly to CoHse. Alternatively, perhaps some sort of reporting facility directly to the auditors for certain types of transactions.

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