One in four audits need improvement, say ICAEW inspectors

A quarter of audits are sub standard, while audit of going concern, revenue recognition and group audits remain significant problem areas, says ICAEW audit monitoring report

In the latest round of ICAEW audit reviews into audit practice at nearly 600 firms, a quarter of audits fell below expectations, with 16% of audits requiring some improvement, and 10% flagged as needing significant improvement, up from 8% in last year's inspection cycle. The worst audits were described as inadequate by inspectors.

Only one in four audits (25%) were of a satisfactory standard (24%: 2017), which is the top rating, while 49% (51%: 2017) were deemed of an acceptable standard, the level two rating.

Where an auditor was classed as producing satisfactory audits, ICAEW said it had ‘no concerns about audit quality although we may identify some minor improvement points. On acceptable audits, we have limited concerns in relatively isolated areas,’ adding that ‘firms should aim for all their audits to be at least acceptable’.

Where audits need improvement, these may have more gaps or weaknesses in evidence, or more widespread weaknesses in documentation.

In the case of audits needing significant improvement, ICAEW said it had ‘significant concerns over the adequacy or appropriateness of audit evidence or judgments in one key area, or multiple issues across several different areas. This doesn’t mean the audit opinion was incorrect, although there may be some instances where we think that could be the case’.

Audits needing improvement or significant improvement are likely to attract some strong follow-up action by ICAEW unless firms can demonstrate these are isolated examples and that they have taken appropriate steps to understand the root causes and prevent recurrence.

The ICAEW report stated: ‘Audit quality continues to be acceptable or better on a good majority of the audits we review. However, around a quarter of audits are not as good as they should be and we are keen to see an improvement in the overall profile.’

As well as looking at the most common areas for improvement, ICAEW flagged significant problems with three key audit areas relating to revenue recognition, going concern and group audits.

On revenue recognition, continuing problems with the adequacy of audit evidence related to revenue were identified, with firms failing to test the completeness assertion when appropriate and lack of robust review of material income streams. ‘Sometimes expectations are set which are not precise enough in the light of the materiality level, and sometimes we find flaws in the logic applied in setting expectations. Firms sometimes use data provided by the client to set expectations without testing its reliability,’ ICAEW said.

Against the backdrop of economic uncertainty due to Brexit and a spate of major corporate failures including Carillion, BHS and Patisserie Valerie, going concern continues to be a crucial audit area. It is also a challenging area due to the judgment and inherent uncertainties involved.

While the report highlighted some instances of good practice relating to going concern, ICAEW was critical of the way it was addressed. ‘Firms do not always give this area enough attention, with either inadequate testing or showing insufficient scepticism, or with documentation failing to demonstrate the challenge that may have taken place,’ the report stated.

‘When the financial statements show significant net liabilities or net current liabilities, with perhaps losses to date, assessment of going concern can sometimes be rudimentary. Sometimes firms accept management’s high level profit forecasts, with no cashflow forecasts and no detailed work.’

In sector-specific audit areas, ICAEW highlighted: ‘A higher percentage of pension scheme audits required significant improvement (13%) than for other categories. The weakest pension scheme audits were performed by firms that had failed to recognise the specialist knowledge required and had not invested sufficiently in training and tailored procedures.’

There was also a lack of experience in handling group audits, with ICAEW flagging ‘some significant weaknesses in audits of groups, especially where firms are not experienced in dealing with them. Some audit files did not include details of the group structure or any analysis of components, or there was no evidence of consideration at the planning stage of the approach to components’.

On group audits, there was over-reliance on consolidation questionnaires, a lack of evidence of how auditors reviewed the differences where components applied non-UK GAAP, as well as instances where documents in a foreign languages, provided by overseas-based auditors, had not been translated.

The most common problem areas focused around audit evidence, audit documentation, and identifying and assessing risk.

Inspectors also flagged concerns about auditors’ responsibilities relating to fraud, as stated in ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements, with ICAEW stating that ‘there is sometimes no evidence of discussion about fraud with management or consideration within the engagement team discussion’.

As the UK’s largest recognised supervisory body (RSB), ICAEW inspectors reviewed 590 audit firms, making 72 visits to large and medium-sized firms with either audit clients listed on AIM or substantial audit client portfolios, and 353 visits to smaller firms with no obvious risks, as well as conducting desktop reviews of audit registered firms with no statutory audits. It also made over 100 follow-up visits to firms which had been flagged for poor audits in last year's review cycle.

ICAEW Audit Monitoring Report 2019

Sara White

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