AQI 2018: decline in audit quality at Big Four firms

One in four listed audits require improvements while a failure to challenge company managements about future forecasts and scrutinise financial decisions is undermining the value of audit by Big Four audit firms according to the latest FRC Audit Quality Inspection (AQI) reports, reports Sara White

In the latest round of annual Audit Quality Inspections (AQI) 2017/18, conducted by the Financial Reporting Council (FRC), 25.5% of Big Four audits have been marked down as requiring improvements, with all Big Four firms performing much worse than the 2016/17 cycle when 14.4% of audits were pulled up for improvements.

Overall results from the most recent AQI inspection round showed that 27% of Big Four audits required limited improvements, up 7% on the 2016/17 AQI cycle, where the overall percentage of audits categorised as requiring improvement was 20%.

The FRC has set a target of 90% of audits requiring limited improvements and this year’s results highlight a sharp decline in audit quality. This year, with the figure of 73% acquiring the acceptable standard, there are concerns about the level of trust in auditors.

Mike Suffield, director of audit quality at the FRC said: ‘It is a disappointing drop and the main reasons for this is the fundamental lack of challenge to management and a lack of consistent delivery. There are also more isolated issues about how the firms deliver the audit of complex groups. The net result is that the overall number of audits requiring improvement has risen. It is fair to say that we were not expecting this; in recent years there was an upward trajectory and the results this year are disappointing. It is going to be a real challenge to reach our 90% target with the drop.’

This raises questions about whether a 90% bar for audit is a realistic or achievable goal. Suffield said: ‘Absolutely it is a challenging target, and we now need to think about whether we can increase this target. Even if you turn it around, it is still one in ten audits that are failing to achieve the goal.’

The latest results come in the wake of the levying of multimillion fines by the FRC for a series of audit failures by the Big Four firms, although the audit regulator is keen to stress that the sanctions process does not reflect the quality of audit or the selection of the audits for annual review.

Once again this year, the FRC refused to split out the number of audits given a good score from those requiring limited improvements, which means there is a lack of transparency about the percentage of audits which were actually scored as ‘good’. Out of 94 Big Four audits reviewed, 24 were singled out as requiring improvements with two further audits identified as requiring significant improvements. This is worse than last year when only 13 audits required improvement, with two sub-standard.

Suffield said: 'We need to look at the transparency around the numbers and we will do for next year's AQIs.'

Audit quality inspection reports 2017/18 year-on-year comparison by Big Four firm

 Total audits inspectedGood or limited improvementsImprovements required Significant improvement required 
Firm2017/182016/17 2015/162014/152017/182016/172015/162014/152017/182016/172015/162014/152017/182016/172015/162014/15

Source: FRC AQI, Accountancy analysis

KPMG slated

This year KPMG has come under heavy fire for the quality of its audits, with the firm slated for an unacceptable decline in quality of audit, while the former senior management team, which was replaced in 2017 by Bill Michaels who came in as chairman, came in for heavy criticism.

KPMG’s performance was described by the FRC as ‘unacceptable and reflects badly on the action taken by the previous leadership, not just on the performance of front line teams. Our key concern is the extent of challenge of management and exercise of professional scepticism by audit teams, and more generally the inconsistent execution of audits within the firm’.

Eight of KPMG’s audits were flagged as requiring improvement, the same as last year, showing no overall improvement, although it was only pulled up over one audit requirement ‘significant improvements’.

The overall results of KPMG’s AQI review showed that 61% of its audits were assessed as requiring no more than limited improvements, compared with 65% in 2016/17. Of the FTSE 350 audits reviewed this year, the FRC assessed that only half of the audits achieved this standard, compared with the regulator’s 90% benchmark.

‘The KPMG results have been pretty disappointing,’ said Suffield. ‘We think their results are unacceptable. There is new management in there and it looks like they are looking at addressing these issues. It is not something that is going to change overnight - we are not necessarily going to see an immediate improvement, but we do want to see some significant improvements in the short term.’

Banking audits at EY

Another area of focus this year has been banking audits, with EY being singled out as needing to improve. ‘We looked at a number of bank audits and there are areas where EY needs to improve,’ Suffield said. There are also questions around EY’s ability to deliver, with overall performance across the 18 audits inspected down 21%, with only 67% assessed as requiring no more than limited improvements, compared with 88% in 2016/17.

The FRC identified concerns about EY’s audit of aspects of provisions in financial services entities and the audit of pension scheme assets and liabilities, as was insufficient evidence and challenge of management’s assumptions on the potential impact of actions by third parties, for example, regulatory investigations.

Stephen Haddrill, CEO of the FRC, said: ‘At a time when public trust in business and in audit is in the spotlight, the Big Four must improve the quality of their audits and do so quickly.

‘They must address urgently several factors that are vital to audit, including the level of challenge and scepticism by auditors, in particular in their bank audits.

‘We also expect improvements in group audits and in the audit of pension balances. Firms must strenuously renew their efforts to improve audit quality to meet the legitimate expectation of investors and other stakeholders.’

FRC AQI rating system

Category - assessment (FRC merges category 1 and 2A, and does not publish separate figures)

  • 1 - Good
  • 2A - Limited improvements required
  • 2B - Improvements required 
  • 3 - Significant improvements required

Report by Sara White

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