AQI 2020: Deloitte best performer of Big Four

Deloitte leads the Big Four as having the fewest audits judged to need improvements in the Financial Reporting Council’s (FRC’s) latest review, and is the only firm to have hit the regulator’s target of 90% of FTSE 350 audits meeting the required quality standard

The FRC reviewed 17 of Deloitte’s audits for this year’s audit quality inspection (AQI) cycle and assessed 13 (76%) as requiring no more than limited improvements. Of the ten FTSE 350 audits reviewed, all bar one (90%) achieved this standard.

Deloitte’s response to the previous year’s report included focused training and standardising the firm’s audit work programmes, which the FRC said had paid off. There were improvements, for example in the audit of potential prior year adjustments and related disclosures, and good practice in a number of areas, including effective group oversight and robust risk assessment, and in the firm-wide procedures, including the firm’s milestone program, with expected dates for the phasing of the audit monitored by the firm.

However, the FRC marked Deloitte down for recurring issues related to the extent of challenge over cash flow forecasts for the impairment of goodwill and other assets, which was the problem in the one audit judged to require significant improvement, and said the firm needed to strengthen its monitoring of audit quality initiatives.

Goodwill impairment

On four audits, the FRC said there was insufficient assessment or challenge of management’s cash flow forecasts. On one of these audits, there was insufficient evidence for the appropriateness of the cash flow assumptions, including the impact of historical forecasting inaccuracies and errors in the cash flow models.

The issues on the other audits included the impairment assessment not being undertaken at a sufficiently granular level, insufficient support for forecast contract renewals and inadequate justification for the level of cash flows used as the basis for the remaining forecast period.

On two further audits the FRC raised issues about the extent of audit evidence supporting the audit team’s conclusions on the level of impairment or available headroom.

In one of these audits, the audit team modelled a number of potential scenarios, including factoring in more pessimistic industry forecasts, but there was insufficient support for the weighting placed on the different scenarios. In another case, the audit team did not sufficiently demonstrate to what extent the downside risks in the forecasts could be mitigated by other revenue streams.

In addition, on one of these audits, there were differences between the forecasts underpinning the impairment review and those used in the going concern assessment; the audit team did not reconcile the impairment and going concern cash flows.

Audit of revenue

The FRC found Deloitte’s use of substantive analytical procedures is higher than is typical at other firms, and cautioned it may be placing too much reliance on this type of audit procedure, in particular when no controls reliance is being obtained or when it is difficult to set an independent expectation.

On four audits, the FRC raised issues regarding the sufficiency of evidence to support the appropriateness of the audit team’s independent pricing expectations. On two of these audits there was also insufficient evidence over the reliability of sales volumes data used to set the expectation. For these audits, substantive analytical review constituted the main substantive procedure and there was generally no reliance on internal controls.

On another audit, the group audit team did not sufficiently justify the adequacy of the component audit team’s follow-up of variances identified between the independent expectations set and the actual results of certain revenue streams.

The FRC also identified control issues, reporting that on one audit, insufficient testing was performed to ensure recorded revenue reconciled to cash and other sales transactions, while on another there were questions about the sufficiency of testing of a key cash reconciliation control.

Other issues raised included insufficient procedures to test management’s estimate of unbilled revenue, inadequate testing over the completeness and accuracy of certain online revenue streams and insufficient evidence to provide assurance over the accuracy of revenue cut-off.

Challenge of estimates

In relation to estimating expected credit losses under IFRS 9, on two audits the FRC said there were insufficient audit procedures or evidence retained to assess the reliability of some of the models used to calculate the provision and the appropriateness of certain assumptions.

For the audit of a life insurance entity in which there was no controls reliance, the audit team performed insufficient procedures to confirm that the actuarial models functioned as intended.

In relation to assessing the recoverability of deferred tax assets, on one audit there was insufficient evidence obtained to support the appropriateness of the recovery period with reference to probable future taxable profits.

On two audits the audit team did not sufficiently justify ranges used in assessing estimates for a conduct provision or pricing differences on commodity testing.

Overall, the FRC commended Deloitte for good practice in its procedures for staff appraisals and promotions, and for its acceptance and continuance procedures.

However, the regulator highlighted recurring inspection findings relating to challenge of management, which it said indicated that the firm has not sufficiently embedded a culture of challenge into its audit process.

There should be more emphasis on challenge of management in the values and expected behaviours of audit teams, and the FRC said Deloitte also needed to increase the level of resources to perform full in-flight reviews, during the audit, and increase the number of those reviews, as these lag behind some other similar sized firms.

Deloitte response

Stephen Griggs, deputy CEO and managing partner audit & assurance at Deloitte UK, said: ‘Audit quality remains our number one priority and we are relentlessly committed to it.

‘We are pleased that 90% of our FTSE 350 audits were assessed as good or needing limited improvement.

‘We do however acknowledge that we must continue to improve to ensure we consistently deliver the highest quality audits.

‘A key element of this is the transformation of our audit product by investing in firm-wide controls, technology and processes. We have also been consistent in our support for comprehensive reform, including measures that enhance audit quality, improve choice and restore trust.’

AQI report on Deloitte

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