The Financial Reporting Council (FRC) has signalled a crackdown on audit firms who fail to improve the quality of their work and is threatening to publish individual audit scores in the next Audit Quality Inspection reports in mid 2020
The FRC's annual review found that audits are not consistently reaching the necessary high standards required to provide confidence in financial reporting.
The regulator’s Developments in Audit report noted that this year the overall inspection results of the biggest seven firms were unsatisfactory, with only 75% of the FTSE 350 audits reviewed being classified as good or requiring no more than limited improvements.
These results fell significantly short of the FRC’s target set three years ago that by 2019 at least 90% of FTSE 350 audits would be assessed in this category.
The report said the 2018/19 audit quality review inspections showed auditors still struggle to challenge management sufficiently, with long-term contracts and items held at fair value being two areas where this was particularly prevalent.
While these areas are typically considered more judgemental and thus harder to audit, the FRC also observed instances in other areas where auditors failed to perform more routine procedures to a consistently high level, notably when auditing revenue, which is typically a key metric considered by users of financial statements.
The FRC highlighted concerns that internal controls are not being consistently tested and therefore relied upon, even in areas which would typically lend themselves to this approach (for example, significant transaction volumes involving limited judgement).
It found too many auditors were not properly identifying relevant controls in areas of significant risk or were not adapting their audit approaches sufficiently when controls were found to be deficient.
The regulator said year-on-year familiarity with audited entities can lead to the same audit approach being followed even when changes in the business or trading environment demand a different strategy.
In addition, too often, audit teams appear prepared to accept what management tells them rather than questioning its plausibility and drawing on specialists to form their own view, while audit teams are also accepting unrealistic deadlines resulting in inadequate work on too many occasions.
David Rule, the FRC’s executive director of supervision, said: ‘At a time when the whole audit market faces reform, we expect audit firms to make audit quality their number-one priority and to have effective programmes of work to deliver consistently high standards.
‘Inconsistent quality erodes confidence in the profession, which can lead to diminished trust in business. Stakeholders and investors rightly demand high-quality work on all audits.
‘While we see many examples of high-quality audit, our inspectors are still identifying too many audits which require significant improvements. Inspections show that challenge of management is a particular area of concern on which audit firms need to focus.
‘The FRC will continue to scrutinise these efforts and hold firms to account for their delivery.’
The FRC review highlighted that when a poor-quality audit is identified, audit firms’ current root-cause analysis and response procedures may not have been designed, executed or acted upon sufficiently to facilitate a systematic improvement in audit quality.
Sir John Kingman’s independent review of the FRC recommended the publishing of summary versions of individual audit quality inspection reports, including gradings. The FRC says it intends to pilot publishing these reports with the consent of companies and audit firms, starting with the 2020/21 inspection cycle.