AQI 2020: KPMG needs faster progress on audit inconsistency

The Financial Reporting Council’s (FRC’s) annual review has criticised KPMG for failing to achieve high audit quality consistently, and called for the firm to make improvements more quickly, including strengthening its culture of challenge

In this year’s audit quality inspection (AQI) cycle, the FRC reviewed 18 individual audits carried out by KPMG and assessed only 11 (61%) of them as requiring no more than limited improvements, compared with 76% with this rating the previous year.

Of the twelve FTSE 350 audits reviewed this year, only seven (58%) achieved this standard.

The FRC said the firm had taken steps to address the key findings from its 2019 inspection, and it had identified improvements, for example in the audit of goodwill impairment, a key finding last year. However, the recurring findings that most contributed to the deterioration in results were the quality of audit work on banks and building societies and the levels of challenge and professional scepticism, with the regulator highlighting aspects of firm-wide procedures which should be improved, including strengthening the culture of challenge within the firm’s audit process.

Last year the FRC placed KPMG ‘increased scrutiny’ and is continuing to monitor the firm’s Audit Quality Transformation Plan.

The FRC stated: ‘We have seen considerable focus on audit quality at the top of the firm and there have been a number of improvements to the audit practice as a result.

‘However, our inspection results show that high audit quality is not being achieved consistently and this report identifies key areas where the firm must make improvements more quickly.

‘The overall inspection results therefore remain unsatisfactory and we expect the firm to take specific action to address this.’

Financial services entities

The FRC said KPMG should improve, as a matter of urgency, the quality of audit work on banks and building societies, in particular, audit work on the valuation of financial instruments and the allowance for expected credit losses for loans and advances to customers.

On one audit the FRC identified insufficient testing of management’s methodologies and assumptions relating to the fair value of derivative financial instruments, as well as a number of issues with the audit of key aspects of the entity’s allowance for expected credit losses for loans and advances to customers under IFRS 9, a new accounting standard implemented in the year.

On another audit, there was insufficient evidence that individual provisions on impaired loans had been appropriately assessed, including limited evidence to confirm the reliability of the property valuations used.

The FRC said: ‘The firm should take urgent action to improve the quality of its audit work, including revising aspects of its audit methodology particularly in relation to IFRS 9. Given certain findings are similar to last year, the firm should closely monitor the progress of its audit quality initiatives to ensure the required improvements are implemented quickly.’

Professional scepticism

The FRC report said KPMG must take further steps to ensure audit teams apply appropriate levels of challenge and scepticism, particularly on high risk audits.

Examples where this had not been the case included the audit procedures performed on the sales forecasts used in management’s going concern assessment, which the regulator said were insufficient to adequately assess whether a material uncertainty existed. In addition, there was insufficient audit evidence to support the appropriateness of additions to product development costs due to weaknesses in both the sample testing and substantive analytical review procedures performed.

On another audit, KPMG failed to obtain sufficient evidence of the assessment of the accounting treatment and adequacy of disclosures relating to a material contingent consideration payment and, in particular, whether or not there should have been a restatement of the prior year financial statements, while in a third example there was insufficient evidence of the audit team having adequately considered the potential audit implications of an identified risk of non-compliance with laws and regulations.

Revenue

The FRC highlighted several examples where its inspection found audit work on revenue recognition was inadequate. On one audit, where long-term contract accounting was being applied, the audit team did not sufficiently assess or challenge the level of contingency applied within the contract accounting.

In another instance, insufficient audit procedures were performed on the revenue transactions that could not be matched to cash receipts by the  data analytic tool used by the KPMG team. The data analytic and cut-off testing were the main substantive procedures on revenue and there was no reliance on internal controls.

On another audit, there was insufficient evidence that the audit team’s procedures had adequately addressed the fraud risk identified in relation to bill and hold sales.

Audit Quality Transformation Plan

The FRC had previously said KPMG’s audit quality transformation plan should focus more going forward on improving the quality of financial services audits and the robust challenge of management, and during 2018, the firm undertook key initiatives in time to affect 17 out of the 18 audits inspected in this year’s cycle.

However, the regulator concluded the results of the 2019/20 inspections cycle indicate that these initiatives were not always effective.

It also commissioned a separate review of KPMG’s approach, and now says that the firm should aim to strengthen the culture of challenge in the audit process. The FRC said KPMG’s newly appointed Head of Audit Culture should develop an audit culture plan with more emphasis on scepticism and challenge of management in the values and behaviours of audit teams.

The FRC said the firm should also extend its milestone program to improve project management at each stage of the audit with a continued focus on driving the right behaviours to ensure high quality work.

KPMG response

In its overall response to the FRC’s findings, KPMG acknowledge the firm’s challenge is to achieve consistent application.

KPMG said: ‘We have strengthened the foundations of audit quality as a result of our significant investment over the past three years. Our focus is on achieving consistent application of our new procedures.

‘We are disappointed with the results seen in this cycle but note that comparison with year-on-year results is difficult considering the small sample size, and other important variables such as the large percentage of higher risk audits inspected this year. We are pleased that no engagement files were rated as requiring significant improvements and also to see a number of areas of good practice highlighted.’

The firm said it has launched a Culture Change Programme under the leadership of its Audit Head of Culture using support from behavioural specialists and targeted at embedding the behaviours exemplified by the highest performing teams across all teams. In addition, KPMG has launched a full review of its methodology and approach to banking audits.

KPMG stated: ‘Our primary actions responding to this report (a number of which are already in progress) relate to culture and behaviours to facilitate consistent application of our tools, training and guidance.

‘We have continued to increase resourcing across our audit practice which has grown by 700 people in the year to April 2020, and by over 2,000 people since our transformation programme began in October 2017.

‘We are also continuing to develop our coaching and project management programmes and maintained a focus on reviewing skills to ensure that all auditors have the tools and skills to succeed. Our commitment to audit quality, and the related investment is undiminished.’

KPMG AQI report

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