PwC has been fined £6.5m and given a severe reprimand by the Financial Reporting Council (FRC) for failures of professional scepticism over the audit of AIM-listed IT managed services provider Redcentric, while two of the firm’s partners in its Leeds office have also been sanctioned
The fine, which has been discounted to £4.55m for admissions and early disposal, relates to the statutory audits of Redcentric’s financial statements for the financial years ending 31 March 2015 and 31 March 2016.
There is also a condition that PwC supplement the monitoring and support of the Leeds office audit practice on terms which have been agreed with the FRC; and a declaration that the statutory audit reports did not satisfy the relevant requirements.
Claudia Mortimore, deputy executive counsel to the FRC, said: ‘The sanctions reflect the seriousness and extent of the breaches. Professional scepticism was lacking in this audit. Had it been applied, it is likely that certain material misstatements would have been detected.
‘As this is the second final decision notice involving PwC Leeds’ office in recent years, we have mandated that the firm supplements its ongoing monitoring and support for that office, to further improve the quality of audit work in the future.’
PwC partner Jaskamal Sarai is fined £200,000 (discounted to £140,000 for admissions and early resolution) in respect of work on the FY2015 audit and given a severe reprimand. At the time of the audits, he was UK technology sector leader.
The same sanctions are levied on a second partner, Arif Ahmad, in relation to the FY2016 audit. At the time of the breaches, which the FRC ruled were neither intentional, dishonest, deliberate nor reckless, he was the senior partner of the PwC Leeds office.
Both Sarai and Ahmad have undertaken training on compliance with the requirements of ISA 220 Quality Control for an Audit of Financials, as it relates to supervision of the engagement team and the application of professional scepticism in accordance with ISA 200 Overall Objectives of the Independent Auditor.
The regulator said the breaches of relevant requirements were numerous and in certain cases were of a basic and/or fundamental nature, evidencing a serious lack of competence in conducting the statutory audit work. A number of them related to the auditors’ failure to exercise professional scepticism, which the FRC said is at the heart of auditors’ work.
Amongst the issues raised during the investigation, the FRC said the record of PwC’s discussions with senior management noted that ‘the incentives for fraud are deemed to be low and the controls to avoid fraud are reliable’. This was contradicted by the available facts and not supported by the available audit evidence.
The auditors wrongly concluded that certain management bonuses were ‘completely unrelated’ to financial performance, despite this being obviously contradicted by reference to both the financial statements and other parts of the audit file. They failed to identify, or respond to, the risk created by the link.
When evaluating the design of the entity’s controls, too much reliance was placed on inquiries of management and sufficient appropriate audit evidence was not obtained for the purposes of paragraphs 12 and 13 of ISA 315 Identifying and Assessing the Risks of Material Misstatement. There were also failures relating to the handling of cash balances and audit planning.
The FRC opened its investigation in 2017. The previous year Redcentric revealed an internal investigation by its audit committee had uncovered ‘misstated accounting balances’, which meant it delayed reporting interim results for the six months ended 30 September 2016.
A subsequent independent forensic review by Deloitte and Nabarro found that: ‘To date there has been no evidence of theft and the misstatements are attributable to profit overstatement over a number of years with revenues being overstated and costs understated in broadly equal proportions.’
The review put the cumulative overstatement of net assets and profits after tax up to 30 September 2016 at approximately £20.8m, and said that approximately £5.9m of this misstatement (£4.7m at the EBITDA level) arose in the six months ended 30 September 2016. The remaining £14.9m misstatement relates to periods prior to and including the year ended 31 March 2016.
In response to the multimillion pound fine, a PwC spokesperson said: ‘We are sorry that our work fell below the professional standards expected of us. Since the work in question was completed, we have taken numerous steps to strengthen processes. In addition, this month we announced an additional £30m investment annually as part of a new wide-ranging action plan to provide greater focus on the quality and public interest responsibilities of PwC’s statutory audit services.
‘Our audit quality action plan has three key areas: additional investment in training, people and technology; further alignment of PwC’s audit business behind audit quality; and a reinforced focus on culture and quality control. Taken together these represent a significant transformation of our audit business that will support our high performing teams in an environment which places a culture of challenge at its heart.’
FRC final decision notice PwC Redcentric, issued 13 June 2019