The Financial Reporting Council (FRC) has branded the quality of major local audits as ‘unacceptable’ and says urgent action is required from firms specialising in the sector, including Grant Thornton and Mazars
The regulator’s report on its inspection findings into the quality of major local audits in England for the financial year ended 31 March 2019 is the first such review it has published following a change in responsibilities.
The report describes the overall results across the seven firms it assessed as ‘concerning’, with just 40% of the 15 audits reviewed requiring no more than limited improvement compared to 64% in 2018/19.
There were nine audits (60%) that required improvements, which the FRC noted ‘is unacceptable.’
The report stated: ‘Urgent action is required from some of the firms to take appropriate action to respond to our findings to ensure improvements are made in audit quality, given the deterioration in quality in the year.
‘Furthermore, from our firmwide work, we identified that the proportion of major local audit financial statements containing a prior period adjustment was 36% when the engagement was an initial audit and 12% for a continuing audit.
‘These are extremely high levels and all firms need to consider the causes of this and what changes in their audit approach might be required.’
Of the 271 major local audits in the FRC’s inspection scope, the FRC reviewed 15 audits across the seven largest audit firms, covering both the financial statement opinion and the value for money arrangements conclusion work.
Of these, three related to health bodies, two were other bodies and ten related to local government authorities.
For two firms, Grant Thornton and Mazars, the level of audit quality requires significant improvement, and the FRC said those firms should perform a detailed root cause analysis of the issues it has identified and put in place an audit quality action plan across local audits to address the FRC’s findings.
Of the six Grant Thornton audits reviewed, the FRC judged that five required improvements, with at least two key findings identified on all audits requiring improvement.
Both of the Mazars audits reviewed were assessed as requiring ‘significant’ improvement, with the FRC stating: ‘This is clearly unacceptable and follows a trend of poor inspection results.’
According to the FRC, Grant Thornton had 109 major local audits within scope of the review, equating to a 40% market share, while Mazars is responsible for 42 audits and has a 15.5% market share.
EY, which had 72 audits in scope of the review and a 26% market share, saw all three of the audits inspected judged by the FRC to be of a ‘good’ standard.
The regulator also assessed one audit each from BDO, KPMG, Deloitte and PwC.
The key areas of concern requiring action by some audit firms were the valuation of property (including investment property) and pension valuation, sufficiency of audit procedures over the occurrence and completeness of expenditure, the response to fraud risks, the impairment of receivables, valuation of pension assets and the effectiveness of the engagement quality control review.
There were also issues with audit testing over material balances such as deferred income, PFI arrangements and amounts receivable. The FRCs aid these findings often related to insufficient challenge of, and standing up to, management in areas of complexity and forward-looking judgement.
The FRC made a number of recommendations for all firms, which include greater levels of self-review of their audits where they have been auditor for an extended period to ensure that the audit approach remains sceptical and challenging.
On any future first year audits, the firms should enhance their initial audit procedures and enquiries of management and the audit committee to cover the potential risk of a prior period adjustment.
They should also improve the challenge of management over complete and accurate financial statements, to minimise the number of financial statements containing a prior period adjustment.
David Rule, FRC executive director of supervision, said: ‘High quality local audit is essential to providing local taxpayers and the wider public with an independent, impartial view of a local body’s financial statements and controls.
‘The high percentage of major local audits requiring improvements is unacceptable.
‘We are pleased to report that all value for money conclusions reviewed were assessed as requiring no more than limited improvement and we observed areas of good practice in the audit work of some firms.
‘We recognise the challenges in the major local audit sector and will be working with stakeholders on the Redmond review recommendations.’
A spokesperson for Grant Thornton UK said: ‘As a leading provider of audit and related professional services to local authorities, we remain committed to the quality and integrity of our work.
‘A key determinant of the FRC’s scores relate to a specific area relating to the valuation around certain assets in March 2019 audits.
‘The steps we have already implemented in the current audits to March 2020 deal with the FRC findings.
‘Whilst this is an important part of our work, we know that given the increased pressures on financing faced by local governments, most users will be focussed on the value for money aspects of our work.
‘Our strong inspection results in this area (both by the FRC and ICAEW) show our ongoing expertise in public sector audit.’
In its response to the regulator, Mazars said: ‘Our commitment to audit quality is at the core of our values and we are dedicated to the continuous improvement of our audit work and the service we provide to our audit clients.
‘Whilst we are pleased with the results of the AQR’s reviews of our work on value for money conclusions (which show only limited improvements identified for a number of years), we are disappointed with its findings on our work on the audit of the financial statements at two of our local audit clients.
‘The firm will robustly respond to the findings and has plans in place to improve the quality of our local audit work.’
Andrew Walton, EY’s UK head of audit, said: 'Audit is fundamental to building trust and confidence in local authority finances, and we are making significant ongoing investments in audit quality as we seek to meet the evolving needs of local authorities, the public and the public interest.
'We are pleased the FRC has recognised the progress we have made and that all of our reviewed local authority audits have been rated in the FRC’s highest category. The FRC also highlighted areas of good practice, including our use of internal specialists for property and pensions valuations.'