AQI 2018: PwC fails to adequately challenge management

The Financial Reporting Council (FRC) has highlighted concerns over PwC’s ability to challenge management, particularly when estimating future contract costs, and has also criticised the firm’s auditing of the mining sector, as part of the regulator’s 2017/18 Audit Quality Inspection (AQI), reports Amy Austin

The FRC reviewed 28 individual audits undertaken by PwC in 2017/18, of which the majority (82%) were ranked as good or requiring limited improvements, compared to 93% in 2016/17, while five audits (18%) required improvements, up from two the previous year, and zero required significant improvements, a level which has been maintained since 2015/16.

PwC’s inspection results have slightly deteriorated compared to last year, with 84% of its FTSE 350 audits reviewed as part of the AQI requiring limited improvements, this is down 6% on last year and falls below the 90% target set by the FRC for 2018/19.

The report states: ‘We are concerned at the decline in inspection results in comparison with the previous year.’

Management challenge

One of the main concerns raised by the FRC was that PwC failed to challenge management on a number of audits. The regulator noted that in two audits the firm failed to ensure that margins and costs had been appropriately estimated, including the testing of forecasting, in relation to future contract costs that impacted current profits.

In three audits the firm had insufficient evidence to support conclusions relating to the level of tax provisions and also failed to sufficiently analyse different elements of risk assessment, including certain cost assumptions.

In its defence PwC said: ‘Our teams endeavour to adopt a “challenge”, rather than “validate”, mindset when auditing estimates and provisions. Continuously applying professional scepticism is key to ensuring this challenge is appropriate on a consistent basis. This can be more difficult when no external data sources are available or relevant.’

The FRC also wants to see the firm’s group audit partner become more involved throughout the audit process as in one audit, although the group partner and their team visited the overseas head office, they failed to visit or review the audit working papers after year end.

Mining sector

The FRC reviewed three group audits where there were significant mining or oil and gas operations overseas. In two of these audits the audit team failed to sufficiently explain why reserves were not considered to give rise to a significant risk. On the third audit the team did not demonstrate that they had understood and evaluated the work undertaken by an expert regarding oil and gas reserves.

PwC said: ‘Reserves and resources are typically not a separately identified risk, but instead they may be a key input to one or more of the risks identified. Whilst our industry practitioners are well aware of this approach, the clarity with which this was articulated on the audits reviewed varied.’

Ethics

In 2016/17, on independence and ethics, the FRC highlighted insufficient monitoring of compliance with the firm’s independence policies and procedures.

Although the firm has revised its policies and procedures and has shown some examples of good practice there are still certain areas for improvement.

PwC does not ensure that all partners and staff are subject to periodic testing with the FRC suggesting that ‘the percentage of partners tested annually should be increased and testing extended to include those captured by the expanded Ethical Standard definition of a partner’.

The firm has also only recently started to test staff’s financial interests, an imperative part of testing personal independence.

PwC also does not centrally monitor the communication of ethical and independence breaches to audit committees. In response PwC said: ‘Ethical breaches are only one of many matters which are required to be reported to audit committees by engagement teams. The Ethical Standard is also clear this is the engagement leader’s responsibility. We have recently introduced an annual confirmation process requiring engagement leaders to confirm that required communications with audit committees have been made.’

Good practice

On a positive note, PwC was commended by the FRC on its effective use of data analytic techniques in the audit of revenue which enhanced the audit quality in a number of cases.

On certain group audits, the FRC identified good examples of involvement by the group audit team when reviewing work by component auditors, an auditor who is in a different location or network firm.

Hemione Hudson, head of assurance at PwC, said: ‘We set high standards for our audits and are committed to continual improvement in audit quality. We have reflected at length on this year's inspection findings and are using the FRC’s insights, together with our own reviews, to further improve our audit work, policies and procedures. 

‘The FRC has assessed 84% of our audits of FTSE 350 companies as good or requiring only limited improvement. While we are disappointed this is slightly down on last year's very strong results and recognise there is more we need to do, the FRC's assessments of our audit quality over the last five years show a consistently high level of audit quality.’

According to the AQI report, PwC has 586 audits including 33 FTSE 100 and 65 FTSE 250 audits.

Report by Amy Austin

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