AQI 2016: FRC audit inspection reports flag revenue recognition as problematic

Poor reporting of revenue recognition and problematic interpretations and analysis of complex supplier arrangements in the retail sector are the biggest problems highlighted in the latest audit inspection reports into the Big Four and mid-tier audit firms, released by the Financial Reporting Council. Sara White talks to executive director for audit Melanie McLaren about the regulator’s take on the latest batch of inspection reports

In a surprise move, the Financial Reporting Council (FRC) released individual firm inspection reports for PwC, Deloitte, KPMG and EY, as well as the two mid-tier firms BDO and Grant Thornton, without providing any over-riding analysis and recommendations about the quality and effectiveness of the respective audit firms or recommendations for the future development of effective audit.

In the latest 2015/16 audit inspection reports covering 104 audits in total, under the new inspection report format each firm was given the opportunity to respond to criticisms of each critical issue. The inspection series provides a detailed report  into audit performance at each of the six firms, reviewing a number of audits from a selection of major listed and unlisted audits handled by the UK’s largest audit firms.

Some 89 Big Four firm audits were inspected over the course of the annual inspection period, with two KPMG audits being flagged as requiring significant improvements. On the mid-tier, the FRC reviewed 15 audits for the two firms, BDO and Grant Thornton. In total 104 audits were reviewed in detail compared with 109 last year.

In a significant improvement on audit quality, this year's review only singled out two audits for significant improvement, compared with nine in last year's reporting cycle. But a quarter (24%) of audits fell below the acceptable standard of a good or limited improvements only tag, although this was better than last year, where 29% of audits required improvements or significant improvements.

However, the FRC will not give a breakdown the audits which received a clean bill of heath and were rated as Category 1. These figures are mixed into Category 2A which means that it is not possible to analyse top performance critically (see table below).

There are signs that the FRC may be reconsidering a review of the way the results are published in bandings rather than as single categories, although the FRC told Accountancy: 'The FRC’s 2019 target for audit quality of 90% relates to Good and Limited Improvements combined. This year’s reviews were conducted on that basis as we make progress towards that target. Hence the split between Good and Limited Improvements in each firm was not published for this or previous years. However, we are giving further consideration as to how the split between Good and Limited Improvement is determined and considering if this can be published in future years.'

FRC confirmed that ‘”limited improvements” indicates that the audit work we reviewed was of an acceptable overall standard’.

The reports show that progress towards achieving the 90% target for has been made since last year.

The FRC has set the audit profession a target of achieving 90% clearance on audit standards by 2019, with only 10% of inspected audits falling below an acceptable standard where only minor improvements are required. 

Summary report delayed

The reason for the delay the summary report is down to timings around FRC’s appointment as the competent authority for audit this June. The introduction of the EU Audit Regulations and Directive into UK law means that from 17 June the regulator will take on additional powers and wanted to avoid publishing duplicate reports.

Melanie said: ‘In mid-June we take on the new status of competent authority – we have taken the decision to shortly thereafter issue the report. It will be part of a wider report that will include much of the same data we have  included before, but it will also review the audit market, tendering trends and try to bring in a lot more information’.

Commenting on the overall findings of the annual FRC audit quality inspection reports, McLaren said: ‘It is important not to treat these reports as

‘You cannot identify trends as such – we carry out risk-based reviews, that is very important to consider. The number of audits [requiring improvement] in each firm is not statistically important.

‘The point we are trying to make is that there is more to looking at audit quality than engagements. In the majority of the reports we didn’t find audits that need significant improvements.’

KPMG was flagged over two audits which needed significant improvement, up from one in the last cycle of FRC inspections in 2014/15.

The other five inspected firms were also criticised over audits, a number of which required improvement while many of those audits inspected did not get a clean bill of health. PwC, who had 25 audits reviewed, only achieved four audits which did not require any level of improvement at all.

The FRC stressed that the number of audits reviewed in each firm is not statistically important but it does give a flavour of audit practice and quality.

McLaren said: ‘The major things we’ve done this year is to let the firms publish their preferred action plans in their reports, giving the firms the opportunity to feedback on criticisms and offer a proposal about how they will deal with these issues.

‘This varies from tackling particular areas across the firms.’

‘In one of the firms highlighted, on the provision of non-audit services we had concerns that this had not been properly considered.

‘At a number of firms, there were also concerns about the treatment of revenue recognition and dealing with complex supplier agreements, particularly across retail audits. This is causing ongoing problems and there are still reporting problems.’

Quality of data improves

In terms of the overall improvement in audit quality and effectiveness, McLaren was cautious to single out any particular strengths.

‘I wouldn’t highlight any one firm as having made significant improvements. Across the firms we have observed that the quality of data is more important. There is also a demand for extended auditor reporting from companies, and more scrutiny from audit committees.

‘We have though, in terms of balance, put into each report where we think improvements have been made.’

With the new audit rules on non-audit service restrictions, audit committee powers and compulsory tendering, which come into force next month, McLaren said that the legal landscape for audit is complicated and the FRC itself will take on the new status of competent authority.

‘With the new regulatory regime from 17 June, we’re determined that we don’t miss a beat,’ added McLaren.

Total audits reviewed 2015/16

  • PwC 25
  • Deloitte 22
  • KPMG 22
  • EY 20
  • BDO 8
  • Grant Thornton 7

Assessment of quality of audits reviewed 2015/16 versus 2014/15

Firm2015/16 total audits inspectedGood or limited improvements 2015/16Good or limited improvements 2014/15Improvements required 2015/16Improvements required 2014/15Significant improvement required 2015/16Significant improvement required 2014/15
Grant Thornton7631203

Note: 109 audits were reviewed in 2014/15 inspection cycle

FRC AQI rating system


2ALimited improvements required
2BImprovements required
3Significant improvements required

FRC AQI report links

The FRC Audit Quality Inspection reports are here

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