Lack of improvement in audit quality ‘disappointing’ – report

The Financial Reporting Council has made a scathing attack on the quality of UK audit in the latest 2019 Audit Quality Inspections reports, with one in four audits inspected requiring significant improvement, reports Accountancy Daily.

Despite attempts to raise the standard of audit and the profession facing severe criticism over a number of high profile audit failures over the last 12 months, 25% of audits inspected were rated as below standard, and required improvements, with six audits singled out as requiring ‘significant improvements’, having failed to meet even the basic standard expected.

The quality of audit has barely changed since the last inspection cycle with 25% of assessed audits described by the FRC as below ‘acceptable standard’, compared with 23% in 2017/18. At the same time, the number scoring the lowest rating of ‘3’, where the audit required significant improvements, had deteriorated, with six audits failing, compared with only four in the previous year.  No firms achieved the FRC’s audit quality target for 90% of FTSE 350 audits to meet this standard, with FRC threatening to raise the level to 100% for audit standards by 2020/21.

‘Stakeholders rightly demand high quality work on all audits and they would expect, we believe, that all audits subject to our review should require no more than limited improvements. For 2020/21 onwards, we will set a new target for audit firms that 100% of audits should require no more than limited improvements.’

Out of 98 Big Four audits reviewed, four audits were given the lowest mark with a C rating, requiring significant improvement, up from only two in 2017/18, while 17 audits needed improvements, compared with 24 last year. This is worse than last year when only 13 audits out of 90 required improvement, with a further two marked as requiring significant improvement. In total, 106 audits were reviewed over the 2018/19 period.

For the first time in four years, PwC was flagged over two audits which failed to pass inspection and received the lowest grade, with ‘significant improvements required’, while four of its audits ‘required improvements’ with a 2B grading.

Deloitte and EY each had an audit marked down at ‘3’, while Grant Thornton, which has been put into ‘special measures’ over its audit practices, failed to pass the grade for half the audits inspected, with a steadily declining five-year performance.

‘They are disappointing results and it is not good enough that one in four audits do not make the standard,’ said Mike Suffield, executive director of audit at the FRC. We are taking stronger action at Grant Thornton, and still watching KPMG as we were last year, and PwC to a degree. Where we find a poor audit we will refer it to the enforcement team.

‘We do have concerns over Grant Thornton, the fact that 50% of their audits are below standard is concerning enough; if you look back over five years of audit inspections, 26% of their audits have needed significant improvement.

‘Grant Thornton continue to be in a bad place compared to their peers especially as over a five-year period too many of their audits have required improvements with 65% falling below the standard expected. We are working closely with them on their quality action plan.’

‘The statistics are that too many audits have required significant improvements – one in four audits reviewed – and only 50% met the standard expected in the current year.

The mid-tier firm has gone through significant upheaval in recent months, with senior management changes and the appointment of a new head of audit, the second in one year. ‘We are working closely with the firm to develop an appropriate plan to address our quality concerns. We need to give the new head of audit time to lay out her plans,’ added Andrew Meek, AQR director at the FRC.

‘We were equally surprised and disappointed by PwC where there were certain areas that needed improvement, including the audit of long-term contracts. PwC recently announced various measures to improve its audit practice and we will be monitoring this closely.’

There are signs of a turnaround at KPMG after heavy criticism in the last few audit inspection cycles.

Suffield said: ‘We are absolutely encouraged by the results at KPMG this year. They have invested a lot in their audit practice. There is more for them to do, but we are encouraged that they are heading in the right direction.’

Management challenge

The FRC inspection team flagged a number of issues of ‘significant concern’ with the quality of auditing at the Big Four and largest mid-tier firms, particularly the failure to challenge management, ongoing issues with a lack of auditor scepticism and problems with audit of financial services entities.

Meek said: ‘There is a failure to challenge management at firms and an absence of scepticism about the information presented by management. We need to change the mindset of auditors – they need to think about challenging the companies and to understand that the real client is the investor.

‘Long-term contracts and revenue are other issues. They are another of those recurring findings and it is frustrating that the firms are still having an issue auditing these areas.’

Audit fines

The audit profession is under intense scrutiny over a litany of audit failures and is facing increasingly harsh fines and sanctions following investigations by the FRC’s enforcement body. The FRC confirmed that audits which are given a ‘3’ are automatically referred to the enforcement team.

In the last 12 months there have been multimillion fines for bad audit practice at KPMG over the Lloyds syndicate, Equity Syndicate Management, as well as Ted Baker and Co-op Bank audits; Grant Thornton was given a £4m fine over lack of independence relating to Nichols plc and University of Salford audit, while PwC was fined £6.5m over misstated accounts at Redcentric as well as a record-breaking £10m fine for the BHS audit, via its parent company Taveta Group. Most recently Deloitte was handed a £6.5m fine over auditing issues at Serco Geografix.

There are numerous ongoing FRC investigations into audit firms, including KPMG over collapsed outsourcer Carillion, while Grant Thornton is being probed over Patisserie Valerie and Interserve audits.

Audit restructure

PwC and Grant Thornton have both announced fundamental reviews of their audit teams, with the Big Four firm planning a £7m investment in resources, including audit hires and training in the next year to support its audit team, while mid-tier Grant Thornton has appointed a new head of audit and is planning substantial investment in its audit provision in a bid to get the firm back on track.

‘The firms are having to take a step back and a lot of them are looking at their resourcing models. It is a pretty competitive market to get people and it is going to be a challenge to achieve some of the numbers in terms of qualified audit staff,’ Suffield said. ‘They are going to have to look at their training models as well. This could feed into higher audit fees.’

The resourcing issue is going to be a major issue for firms in the next two to three years. ‘When you are bringing in so many people rapidly there is going to be some risk. It is actually going to be very difficult for some of these firms. Although they are looking at more technology-based solutions and the use of offshoring, the fundamental problems with audit at the moment relate to judgment, challenge and scepticism. These issues do not relate in any way to technological advances, but there is no doubt that appropriate technology should allow them to do a more effective audit, but this is not the trend it was a few years ago.’

Report by Sara White, Accountancy Daily

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