AQI 2019: BDO must improve audit quality control processes

Revenue recognition and a failure to challenge management assumptions were flagged as ongoing issues with audit at mid-tier firm BDO, found this year’s FRC audit quality inspections (AQI) reviews

Audit inspectors from the Financial Reporting Council (FRC) said that BDO needed to strengthen audit procedures relating to the timing of revenue recognition, and improve the evidence of appropriate challenge in relation to valuation judgments. They also said they would be keeping a close eye on how the firm was dealing with independence and ethics issues flagged in last year’s AQI round.

The AQI reviewed eight audits at the firm, with seven assessed as requiring no more than limited improvements, the same as in 2017/18. One audit failed to meet the standard required and was given a 2 – ‘improvements required’. This was the same result as last year, and marks an improvement on 2016/17 when three audits failed to achieve the grade.

The FRC inspectors said that some of the firm’s agreed actions to deal with problems flagged in last year’s independence and ethics findings had still not been completed, and this remained an area of concern for the FRC, adding that ‘their completion should remain a key focus for the firm’.

As a result, the firm’s ‘quality control procedures have not been sufficiently effective to achieve the necessary improvement in audit quality’, the report said, showing that there was still a significant amount of work to do to achieve the 90% pass rate for audits, as expected by AQI inspectors. They also said that the firm needed to increase its focus on systemic issues behind the findings as well as the findings on each individual audit.

Challenging management

The FRC reviewed the audit of asset valuations and provisions on most audits inspected, due to the level of audit risk related to these balances and their impact on the financial statements. This identified recurring findings across the audits reviewed relating to the challenge of management and corroboration of key assumptions.

Inspectors highlighted an ongoing problem with the way BDO deals with client management and its confidence in robustly challenging management assumptions, pointing to a failure to show ‘evidence of appropriate challenge in relation to valuation judgments’.

Although BDO has taken a number of actions to address this issue since the last review cycle, the work was still ongoing and had not filtered through to the audits reviewed this year.

BDO was also told to improve the evidence of appropriate challenge in relation to valuation judgments.

There were a number of instances where BDO had failed to challenge management adequately, particularly with specific examples, including insufficient evidence or ability to challenge management on figures provided. These covered the level of provision applied to inventory and similar assets, and the reasonableness of costs to complete for significant property developments, including those highlighted as impairment risks.

It also warned that the firm needed to keep a closer watch on cash flow forecasts and related growth assumptions supporting management’s impairment assessment, as well as the volatility rates used by management to value share options.

Revenue recognition was flagged as a problem on audits, with the FRC warning that ‘accounting for revenue recognition may be susceptible to manipulation, particularly where entities perform significant amounts of variable work’.

The AQI inspectors told BDO: ‘Improvements are required to strengthen audit procedures relating to the timing of revenue recognition’. In one example, the audit team did not obtain sufficient, appropriate evidence that revenue was being recorded in the correct accounting period’.

The FRC said: ‘Given that no firm this year has met the FTSE 350 target, firms need to re-appraise whether their RCA accurately identifies the causes of our inspection findings and whether their actions are properly linked to those causes. In particular, the firms should increase their focus on systemic issues behind the findings as well as the findings on each individual audit.’

There were instances of good practice, including the use of data analytics and coordination with IT specialists in the audit of revenue, the group audit team’s oversight of component auditors, and collaboration with internal specialists to provide supporting audit evidence.

Firm’s response

In the report, BDO stated: ‘We are pleased with the results of the FRC review in relation to the firm for 2018/19 but nevertheless we are not complacent and we fully recognise the importance of continuing to focus on improving the quality of our audits.

‘We believe that our continued investment in root cause analysis (RCA) is one of the key drivers of continuous improvement.’

On the criticisms over failure to challenge management, the firm stated: ‘We acknowledge that we received a similar finding in our report last year. We have already undertaken a number of actions in this area (which we detailed last year) however, given the timing of these actions we will not yet have seen the full benefits reflected in audit files selected in this review cycle. However, we re-performed root cause analysis with the teams involved in order to ensure that there were no new causes arising.

‘As these are complex areas the reporting entity has not always formed their conclusions on the judgements at the planning stage of the audit hampering the team’s ability to finalise the audit approach. This often led to changes to the proposed approach during the audit and it is key to ensure that the file demonstrates how the approach evolves over the course of the audit.’

BDO LLP has 139 audits within the scope of AQR inspection, including four FTSE 350 audits.

Report by Sara White

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