AQI 2019: Deloitte shows ‘modest’ improvement in audit quality

Deloitte has shown ‘modest’ improvements in audit quality in this year’s audit quality inspection (AQI) reviews, but has performed better than other Big Four firms

Although the firm leads the Big Four in terms of having the highest proportion of audits assessed as requiring no more than limited improvements.

Of the 25 audits examined in this year’s review by Financial Reporting Council (FRC) audit inspectors, 21 were judged good or needing only limited improvements (84%), compared with 76% in 2017/18.  Three requirement improvements and one audit needed significant improvements.

Of the FTSE 350 audits reviewed this year, 75% were assessed as requiring only limited improvements compared with 79% in 2017/18.

The regulator said Deloitte needed to exercise greater professional scepticism in the audit of potential prior year adjustments and related disclosures in the annual report and accounts.

On two particular audits the AQI found the audit team concerned obtained insufficient evidence to support the conclusion that the prior period error did not have a material impact on the current or prior year’s financial statements, including the segmental disclosures. In these cases, the audit teams consulted the firm’s technical specialists but the evidence of these consultations was inadequate. The audit team should have challenged management further on the accounting treatment and the appropriateness of the disclosures in the annual reports.

 On one of these audits, the review identified weaknesses in audit work to quantify a potential prior year adjustment. The audit team’s reporting to the audit committee on these matters was not sufficiently clear on the basis for the auditor’s conclusions, and there were also concerns about how this was reported in the key observations section of the auditor’s report.

The review also found evidence of the need for Deloitte to strengthen the extent of challenge of key estimates and assumptions in key areas of judgement, including asset valuations and impairment testing.

In relation to the valuation of investments, on two audits, the audit team did not sufficiently assess certain key inputs used in the valuations, while on a third, there were concerns relating to the sufficiency of audit work over the valuation of pension scheme asset balances, including private equity investments.

The review identified three instances in which the audit team (or their specialists) used ranges in excess of audit materiality to assess the appropriateness of management judgements. This included judgements concerning property valuations, pension obligations and loan loss impairment. In each case the audit team obtained insufficient evidence to justify the ranges used.

There were also weaknesses in relation to impairment on two audits. In one case, there was insufficient challenge of key assumptions in management’s cash flow forecasts regarding growth rates, productivity and efficiency assumptions and the terminal value. In the other, the audit team did not consider sufficiently the adequacy of a contingency to cover estimation uncertainty in a restructuring plan used in a valuation based on fair value less costs to sell.

Consistency

While the review found evidence of high quality work on the firm’s audit of revenue, it said greater consistency was required. Issues identified included insufficient audit procedures on inputs to, and outputs from, a revenue system maintained by a third party, and a lack of assessment of third-party controls reports on these systems.

The previous year’s AQI reported weaknesses in the audit of the completeness and accuracy of provisions and disclosures relating to contingencies. This year’s review says Deloitte has taken action in these areas including developing further audit guidance and training.

Nevertheless, the current inspection identified weaknesses remained. These included the audit team failing to obtain sufficient audit evidence to demonstrate the completeness of provisions regarding uninsured claims, conduct exposures in a financial services entity and property related costs on three audits. The review stated that Deloitte should aim to achieve greater consistency in the audit of provisions and liabilities.

In its response provided in the AQI report Deloitte stated: ‘Whilst we are pleased that overall our quality record, as measured by external inspections, has improved from 76% to 84%, we remain committed to continuous improvement and achieving as a minimum the 90% benchmark across all engagements.

‘We are however, extremely disappointed one engagement received a rating of significant improvements required during the period. This is viewed very seriously within Deloitte and we have worked with the AQR to agree a comprehensive set of swift and significant firm wide actions on the critical area of findings relating to the assessment of potential prior period adjustments and conduct matters.

‘We are also pleased to see the impact of our previous actions on impairment, group audits and contingent liability disclosures reflected in the audits under review and there being limited or no findings in those areas. These continue to be a focus in our training and internal coaching and of our internal review programmes to maintain or increase the level of challenge our audit provides in those areas.’

Following release of the Deloitte AQI, Stephen Griggs, Deloitte’s managing partner audit & assurance, and deputy CEO, said: ‘Audit quality underpins everything we do and remains our absolute priority as we seek to achieve as a minimum the 90% benchmark across all of our audits. 

‘We are pleased our overall quality record has improved; we continue to transform our audit by investing in our firm wide processes and controls, which we also seek to develop globally. This ensures consistency in delivering high quality audits whilst ensuring engagement teams exercise professional scepticism through robust challenge.’

Deloitte has 411 audits within the scope of AQR inspection, including 24 FTSE 100 and 61 FTSE 250 audits.

FRC AQI report 2019 Deloitte

By Pat Sweet

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