AQI 2019: EY outperforms Big Four on audit quality target
EY has demonstrated improvements in audit quality in the latest round of audit quality inspection (AQI) reports and is the Big Four firm which came closest to meeting the Financial Reporting Council (FRC) target of 90% of FTSE 350 audits requiring no more than limited improvements
10 Jul 2019
Overall, the FRC assessed 78% of the firm’s audits that it reviewed as requiring no more than limited improvements, compared with 67% in 2017/18. The review considered 18 audits in total, of which 14 were considered to be good, while three required improvements and one audit was found to need significant improvement.
Of the FTSE 350 audits reviewed this year, 89% achieved this standard compared with 82% in 2017/18, the nearest any Big Four firm came to hitting 90%. However, one of the nine FTSE 350 audits was judged to require significant improvements.
Specific areas of concern flagged up in the review include the need for EY to increase the challenge and corroboration of management assumptions in relation to intangible assets.
The FRC reviewed the audit of intangible assets including capitalised product development costs on the audit of six entities. On two audits, the review identified cases where audit teams obtained insufficient evidence to conclude on the appropriateness of development costs capitalised or that further impairments were not required.
Among the issues raised were insufficient corroboration of key forecasts used to support the carrying value of selected projects or other intangible assets, as well as insufficient investigation or corroboration of the reasons for differences identified in the items selected for testing. There was also an inappropriate reliance on audit evidence from prior periods and walkthrough testing.
In its response to the AQI’s findings, EY said its root cause analysis suggested this situation was down to insufficient senior resource following changes in audit timetables and complex issues that arose during the audits. This was exacerbated by one key team member being involved in both audits simultaneously, creating time pressures which meant that the detailed review that is routinely conducted and would detect inadequacies in the testing was not performed in sufficient depth.
EY stated: ‘We have controls in place which are designed to detect when individuals are working hours that are above our expectations so that EY management can intervene and act if the individuals have not raised the fact they are under time pressure. Those controls did not prevent this situation arising.
‘We are reviewing the design of these controls to ensure that any similar situations are detected and dealt with on a timely basis. We will also continue to reiterate the importance of all our people seeking further support when they require it.’
One area of focus for the 2018/19 inspection was the audit of financial services entities and included assessing the involvement specialists to support the audit teams. EY generally scored well in this respect, but the review noted that for two non-life insurance entity audits, the reporting from actuarial specialists did not provide sufficient detail for the audit partner to conclude on the appropriateness of the provision for claims outstanding.
The AQI report noted that EY needs to improve reporting from the firm’s internal specialists on the key assumptions underpinning the estimation of provisions.
Similarly, while overall the review found examples of good practice in relation to group auditor involvement, the FRC said EY should do more to ensure consistency of the group audit team’s oversight of component audit teams.
On three audits, there was insufficient evidence of the nature and extent of the group audit team’s involvement, while on another audit, analytical procedures on ‘not significant components’ were insufficient to ensure all movements in balances in excess of materiality were investigated.
Other issues identified as driving lower quality audit assessments on individual audits included insufficient audit procedures to confirm the completeness and accuracy of data used in the analytical procedures applied to audit revenue in an entity with high volume and highly automated transactions, and insufficient assessment and challenge to conclude on forecast profits supporting the recovery of deferred tax assets.
As well as highlighting EY’s good practice in group audit work, the AQI stated: ‘We reported last year that the firm needed to demonstrate an appropriate level of challenge and professional scepticism when considering management assumptions used in the estimation of conduct provisions in financial services entities.
‘On the banking audits we reviewed, we identified examples of good practice where the audit teams obtained good corroborative evidence supporting the audit of conduct provisions and loan loss impairment. This demonstrated strong challenge of management assumptions.’
There was praise for EY’s effective quality control procedures, clear reporting of audit judgements and conclusions in areas of significant risk, and deferring the signing of the auditor’s report until the audit team had obtained and reviewed key audit evidence and ensured that robust control procedures had been completed. It also conducts regular monitoring of consultations on high risk entities on a quarterly basis and investigates where no consultation has occurred.
In its response published in the AQI document, EY said: ‘We are pleased that the results of this year’s FRC inspection show an increase in both the overall percentage of all audits and the FTSE 350 audits inspected by the FRC graded as good or requiring no more than limited improvements.
‘However, we are disappointed that one of our FTSE 350 audits was identified as requiring significant improvements meaning 89% of our FTSE 350 audits met this standard against the FRC target of 90% and we recognise the further efforts that we need to make to deliver consistent high audit quality and achieve the new targets that the FRC has set.
‘Our root cause analysis of the FRC’s findings and our own quality reviews continue to be important inputs into our Sustainable Audit Quality Programme and we intend to increase significantly our investment in it for 2019/20 and beyond.’
EY has 324 audits within the scope of AQR inspection, including 15 FTSE 100 and 44 FTSE 250 audits.
By Pat Sweet