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Smaller firms need more audit support after ‘unacceptable’ results | accountingweb
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More audit support after ‘unacceptable’ results

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The accountancy watchdog has revealed new supervision measures to support smaller audit firms after over 60% of tier 2 and tier 3 audits assessed required improvements or significant improvements.

13th Dec 2022
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In the recent Audit quality inspection and supervision report, the Financial Reporting Council (FRC) inspected 51 audits at tier 2 and tier 3 firms from 2016/17 to 2021/22 and the result was “clearly unacceptable”. 

The significant shortcoming in audit quality with these smaller firms has prompted the FRC to introduce new support measures for smaller audit firms as their market share grows.

Improvements needed

The FRC discovered that a paltry 36% of these audits needed no more than limited improvements. This number looks even more unacceptable when compared to the 73% of audits for tier 1 firms that only needed limited improvements.

Elsewhere, 33% of the 51 individual audits were assessed as requiring improvements and 31% were assessed as requiring significant improvements. 

The spotlight on the audits of these smaller firms comes as the FRC reports that 22 firms in tier 2 and tier 3 now audit 9% of the entities falling within the FRC’s scope.

The FRC noted that the impact of tier 2 and tier 3 firms on the public interest is relatively low, but also noted that “it is increasing”.

The watchdog reported that the tier 2 and tier 3 firm’s share of FRC-scope audits has risen to 13%. Tier 2 and tier 3 muscling in on their share of the audit market coincides with large tier 1 firms de-risking their audit portfolios as they face greater scrutiny and competition in the market.

Unacceptable audits

The audit inspection of the larger firms published earlier this year criticised BDO and Mazars for “unacceptable audits” after the duo picked up higher risk audits dropped by their larger peers and this led to the firms growing too fast. 

Similarly the FRC provided similar advice for the smaller firms that had “unacceptable audits”, noting in the report that higher risk entities “must be audited by audit firms with the appropriate resources and robust quality control procedures to deliver a high-quality audit”. 

Support for smaller firms

The FRC acknowledged that some smaller firms have addressed their findings and the watchdog has seen some progress with these firms. But this has led the FRC to conclude that as tier 2 and tier 3 firms face more challenges in conducting high-quality PIE audits, these smaller firms need more support. 

The main support given to these firms as they grow is the creation of the new audit firm scalebox initiative.

The FRC described the intention of this scalebox as providing “bespoke measures to help smaller firms taking on PIE audits and those scaling up the number or complexity of PIEs they audit.”

The aim is to help tier 2 and tier 3 firms understand regulatory expectations and be able to meet high-quality standards when they take on PIE audits and to develop more robust quality control systems. The FRC recognised that smaller firms are at a disadvantage compared to larger firms as they have fewer central resources and access to the regulator.

The FRC intends to share resources dedicated to these smaller firms with advice on “what good looks like”.

The regulator will also further cement expectations through more face-to-face engagements such as roundtables and briefings. 

Common mistakes

These new initiatives for smaller firms come as the report concludes that a key finding in audits requiring improvement or significant improvement was a lack of professional scepticism on the part of the auditor. The FRC said this skill is “essential given that estimates and judgments are subject to significant management input and potential management bias”. 

However, the most common findings among these smaller firms are in relation to the audit of estimates and judgments including impairment.

Other issues arising from the audits include insufficient challenge of the assumptions used by management, Inadequate sensitivity analysis and insufficient challenge of management’s experts.

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By Duggimon
14th Dec 2022 10:16

I'd like to know what proportion of the audits from smaller firms fall into the "criminally negligent" and "tantamount to bribery" categories that the bigger boys seem to keep landing in.

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By Paul Crowley
14th Dec 2022 15:35

I suspect not many
The big boys have a monopoly on that

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