FRC calls for audit firms to act in the public interest

The Financial Reporting Council’s first ever study of audit culture has concluded it is important that firms create a culture where achieving high quality audit is valued and rewarded, and which emphasises the importance of ‘doing the right thing’ in the public interest

The regulator says culture can be defined as a combination of the values, attitudes and behaviours manifested by an organisation in its operations and relations with its stakeholders. This comes in a year when a number of major corporate failures have forced stakeholders to question the role of audit, both external and internal, together with the wider issues of corporate governance and lack of accountability at board level.

The thematic review looked at how audit firms identify and pay attention to challenges in their culture and take action to address them to promote and sustain improvements in audit quality. The review covered the eight firms that have adopted the audit firm governance code: BDO, Deloitte, EY, Grant Thornton,  KPMG, Mazars, PwC, and RSM.

In the report, the FRC said that it has told firms that at least 90% of the FTSE 350 audits the regulator reviews in the annual audit quality report process should be assessed as requiring no more than 'limited improvements' by 2019.

The FRC said: ‘While we recognise that there have been improvements in audit quality, our monitoring activity in recent years continues to identify a lack of consistency, such that we cannot be confident that the 2019 target will be achieved.’

The report notes that firms are investing considerable time and effort on their firm-wide culture and identifies numerous examples of good practice among firms and highlights key areas that firms should address to enhance audit quality.

The FRC wants to see more effort made to giving additional prominence to audit specific behaviours and values within the firms’ cultural design, including the fundamental principles of integrity, objectivity, independence and professional scepticism that underpin high quality audit.

While most firms recognise that the existence of multi-disciplinary firms contributes to cultural challenges, few firms have clearly articulated those challenges or taken specific, explicit actions to address them. Where improvements have occurred they tend to be too UK focused, without a global reach or rollout.

There are also concerns about a lack of independent oversight and the regulator called for the role of independent non-executives to be strengthened to hold top partners and senior management at audit firms to account.

The FRC report stated: ‘There is scope for independent non-executives to do more in meeting their responsibility to be involved in the firms’ review of the effectiveness of their promotion of an appropriate culture.

‘The INEs could broaden the range of tools, indicators and information that allow them to gain an independent view of the culture of the firms and, where necessary, to challenge the firms’ leadership.’

In addition, there seems to be a lack of cohesion between the audit firms and the FRC’s vision of a robust audit culture, and the users of audit and key stakeholders, who did not feel that audit culture was a particularly obvious factor or issue when choosing or working with external auditors. The FRC admitted that stakeholders ‘felt that audit culture would be a greater factor in their appointment of an auditor if it had more visibility in the first place’.

‘The investors we spoke to identified professional scepticism and an appreciation that the auditors are working primarily for shareholders rather than management as key cultural attributes they look for,’ 

Firms should ensure that all audit partners and staff appreciate that a good audit is of significant societal value and helps to underpin transparency and integrity in business.

There is a need to balance the firms’ robust processes to sanction poor quality work or behaviour with better recognition of positive contributions to high audit quality.

The FRC also wants firms to do more work on developing root cause analysis techniques to identify the behavioural or cultural factors that contributed to good and poor quality outcomes, as well as improving the  monitoring of how successful they are at embedding their desired culture. This includes the independent non executives of the firms being more proactive when performing their assessment of the steps being taken by the firms to embed an appropriate culture.

The FRC says it is encouraging firms to provide more extensive and transparent public reporting on their own internal culture to improve the quality of communications and engagement with stakeholders and to build confidence and trust.

Giving a cautious welcome to the report, Nigel Sleigh-Johnson, ICAEW head of audit warned: ‘The review into audit culture doesn’t just reflect the ongoing commitment of auditors to values and behaviours that deliver high quality audits – it also shows a profession that wants to learn from its successes and failures.

‘Unless this commitment and focus is maintained, the UK risks losing its long-held position as the centre of the global audit profession.

‘It is important not to lose sight of the huge societal purpose of audit and the need to ensure that this is reflected in the culture of audit firms.’

Cutlural issues at the top of firms were flagged as critical issues in the longer term, particularly grasping the importance of acting in the 'public interest'.

Melanie Hind (nee McLaren), executive director of audit and actuarial regulation at the FRC, said: ‘There are many factors that influence the environment within which auditors make their decisions and act. Therefore, it is vitally important that firms create an audit culture where achieving high quality work is valued and rewarded, and which emphasises the importance of “doing the right thing” in the public interest.

‘We found that firms have taken steps to achieving this. However, more should be done by firms to successfully promote and embed their desired culture, so that audit quality can be consistently and sustainably high.’

The FRC says it plans to report publicly within the next three years on the actions firms have taken in relation to the findings of this thematic review. It will also consider culture where it is relevant to the planned 2018/19 thematic reviews on audit quality indicators (AQIs) and transparency reports. In addition, the FRC says it will regularly follow up on aspects of this thematic review through its new audit monitoring and supervisory approach. The work will include monitoring in relation to values and behaviours.

The 36-page FRC Audit Culture Thematic Review issued 10 May 2018

Report by Pat Sweet, Sara White

 

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