AQI 2018: EY bank audits under fire as AQI score falls

The FRC’s Audit Quality Inspection has criticised EY’s audit of provisions at its financial services clients, together with pension scheme assets and liabilities, as the firm’s percentage of audits needing improvement has jumped, reports Philip Smith

EY has seen its overall level of audits classed as good or only requiring limited improvements plummeted from 88% last year to 67% in this year’s AQI report, and for the first time in three years one audit was classed as requiring significant improvement. This marks a 21% fall year on year. The FRC has set a target of 90% ‘good or limited improvements required’ for the year.

The firm’s results for its FTSE 350 audits were better than the overall figures, but at 82%, the percentage of audits that were good or required little improvement was significantly below last year’s 92% result.

Overall, 12 audits were considered to be good or requiring limited improvements, five required improvements and one (a FTSE 350 client) was marked down as requiring significant improvements. Among its FTSE 350 clients two out of 11 required either improvements or significant improvements.

Hywel Ball, EY’s UK head of audit, said: ‘We are disappointed that our results have declined since 2017, including that 82% of our FTSE 350 audits were assessed as requiring no more than limited improvements compared to 92% in 2017. We remain firmly committed to meeting and consistently achieving the FRC’s audit quality target for 2019.’

The firm’s auditing of banks was highlighted as an area of particular concern, with the AQI pointing to a lack of evidence that the firm was challenging management over loss provisions judgments. This will be a worrying finding for the firm as it seeks to grow its number of large bank audits, having taken over at troubled bank RBS in 2016.

The FRC said it had reviewed the audit of provisions for three financial services entities, where it identified insufficient evidence of challenge, assessment and corroboration of management’s key assumptions in estimating conduct provisions. The report said there was insufficient evidence of challenge over the potential impact of actions by third parties such as regulatory investigations, and a lack of justification or challenge over the appropriateness of inputs and assumptions used to calculate provisions such as claims rates. In addition, there were insufficient audit procedures to assess the accuracy of key database information or whether the information used had been extracted correctly.

The report said: ‘Auditors need to demonstrate an appropriate level of challenge and professional scepticism when considering management’s assumptions used in the estimation of these provisions.’

Responding to the criticisms, EY said it would continue to focus on the audit of conduct provisions in its training programme for 2018. ‘We will also remind our bank audit teams that the audit workpapers must sufficiently evidence all of the key matters they considered. Not placing sufficient emphasis on this was one of the key areas identified by our root cause analysis,’ the firm said.

It was a similar story over the firm’s audit of loan loss provisions at the three financial services groups, where the AQR team identified weakness in the testing of the loan impairment models and assumptions for collective provisions. EY committed to providing training for its specialists and audit teams in this area.

The report also identified shortcomings in the way EY audited pension balances and disclosures, saying: ‘The firm’s audit approach to the valuation of pension assets was not always sufficient or appropriate, particularly for harder-to-value assets.’

The AQR team found that EY did not always test the valuation of pension scheme assets to sources that were independent of the entity, and did not always confirm valuations directly with investment managers. At the AQI’s request, EY amended its guidance so that it did not use smaller sample sizes than those required for other audit testing.

The AQI also found that the firm’s actuaries’ reports, prepared for audit teams, did not always provide sufficient detail on how they had evaluated, challenged and concluded on certain aspects of the actuarial assumptions.

EY has since enhanced the standard reporting template and amended the related guidance issued to audit teams.

The firm said: ‘We will incorporate into our 2018 audit training detailed reminders on the responsibilities of the auditor when using the work of an expert to avoid the over reliance which was a theme identified in our root cause analysis.’

Looking more widely at general policies, the AQI report told the firm to amend its policy and guidance on hospitality in light of the revised ethical standard that became effective during the year. ‘The permitted levels of hospitality for audited entities did not, in our view, meet the new requirement to be “trivial or inconsequential” from the perspective of an objective, reasonable and informed third party,’ the report said. The firm subsequently approved changes to its hospitality policy following the inspection.

EY was also cautioned for not centrally monitoring the approval of the provision of non-audit tax services to public interest entities (PIEs) that are permissible only if a specific exemption, based on criteria requiring significant judgment, applies.

However, the regulator did report improvements in relation to the key findings highlighted in last year’s report, such as the audit of revenue, communications with audit committees and staff appraisals.

Ball said: ‘We continue to make significant investments in audit quality and established a long-term audit quality programme and a dedicated Audit Quality Board in the UK four years ago, which are aligned to the steps we have taken globally.

‘We continue to invest in new technology, data analytics software and training for our people, as well as performing detailed ‘root cause’ analyses of our best audits and areas identified for improvement. We are also embedding the findings of a study of our highest performing audit teams, in order to help coach our people and replicate their behaviours in our business.’

The AQI reviews were carried out between March 2017 and February 2018. EY has 347 audits that fell within the scope of the AQR inspection, including 14 FTSE 100 and 41 FTSE 250 audits.

Report by Philip Smith

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