The Big Four firm has been fined £2m and severely reprimanded for breaches relating to the audit of Mitie’s impairment testing of goodwill for the financial year ending 31 March 2016 (FY2016).
Due to Deloitte’s admitting the breaches and early payment, the financial penalty was reduced to £1.45m.
Audit engagement partner John Charlton was also hit with a severe reprimand and a £65,000 penalty (again reduced to £40,000 for early payment and mitigating factors).
The sanctions related to the audit breaches involving the impairment testing of goodwill in Mitie’s healthcare division. But the Financial Reporting Council (FRC) explained that the breaches were not intentional, reckless or dishonest.
“It is vital that audit work in relation to the carrying amount of goodwill is conducted properly and the disclosures are sufficient to enable investors to understand the position and have confidence in the numbers included in the financial statements,” said Claudia Mortimore, deputy executive counsel at the FRC.
Recoverability of goodwill
The regulator pulled up Deloitte over its failure to challenge management and exercise sufficient professional scepticism over the recoverability of the goodwill in the healthcare division.
The report noted that goodwill was highly material to Mitie’s reported financial position and the company’s FY2016 value attributed £465.5m to the value of goodwill. This was the single largest figure on the balance sheet and accounted for 37.5% of the total reported assets.
Deloitte identified the recoverability of the goodwill in the healthcare division as a significant risk and the audit report also detailed that the reduction in headroom in Healthcare goodwill was one of the material risks of misstatement that had had the greatest impact on their audit strategy.
The FRC emphasised in the report that clearly this was an area that required “robust and rigorous audit work”.
But Deloitte carried out a number of inadequacies in auditing Mitie’s impairment testing of Healthcare goodwill and the disclosures in the FY2016 financial statements.
These included failures to adequately document the audit work, a failure to obtain sufficient appropriate audit evidence to support the discount rate used by Mitie in the impairment model for Healthcare goodwill and deficiencies in its audit report.
The regulator said Deloitte should have concluded that “the headroom for impairment of the Healthcare cash generating unit (CGU) was materially overstated in the FY2016 financial statements. If [Deloitte] had complied with the relevant requirements, goodwill in the Healthcare CGU might well have been treated as impaired as at the end of FY2016 and deficiencies in the disclosures concerning Healthcare goodwill would have been detected.”
The FRC confirmed that since 2017 Deloitte has introduced a number of initiatives to improve the quality of audit work related to goodwill and impairment.
Deloitte remains committed to audit quality
A spokesperson at Deloitte said, “We regret that a specific part of our FY16 audit of Mitie Group plc, related to the impairment testing of goodwill in Mitie’s healthcare division, fell short of the standards expected.
“Both the audit partner and the firm have learnt from this process and have taken significant steps to address this issue. We remain committed to audit quality and its continuous improvement.”
Deloitte is one of the largest audit firms in the UK with a revenue of £3.7bn. The firm’s audit fee for the FY2016 audit was £766,000.
Today’s sanctions come a week after the FRC announced an investigation into Deloitte’s audit of Go-Ahead, which covers an unprecedented six financial years.
However, today’s £2m penalty pales in comparison to the Big Four firm’s £15m fine in September 2020 for its audit of software company Autonomy.
FRC flexes regulatory muscles
Paul Brehony, a partner at Signature Litigation, said that auditors could expect more “ugly (and expensive) headlines and for regulatory scrutiny to be ramped up further”.
This would be driven by new proposals from the FRC, which would see the regulator take control of audit registrations and impose new powers to strike off firms for not delivering high-quality audits.
The FRC further flexed its muscles last week with the unveiling of a new governance code. The aim of the code was to strengthen oversight of large firms and promote audit quality.
In addition to this, Brehony pointed out that the FRC’s enforcement division has grown 44% and the watchdog’s 2021 Annual Enforcement Review referenced 37 open audit investigations. He concluded that “further fines and disciplinary findings, therefore, appear inevitable”.
While the FRC has hopes of transforming the organisation into a “new robust, independent, and high-performing regulator” ahead of its transition into ARGA, critics have accused the watchdog of “rearranging the audit deckchairs”.
Richard Murphy recently wrote on AccountingWEB that the FRC’s new powers “are just another sticking plaster to cover the FRC’s continuing failure to act in the public interest”.