Nearly a third of audits completed by small and mid-tier firms needed ‘significant improvements’ after inspections by the regulator
Out of 13 audits reviewed in the latest audit inspection round, 38% needed significant improvement, the worst performance in three years since the 2019-20 FRC Tier One and Two inspection report.
The Financial Reporting Council (FRC) made it clear that mid-tier and smaller audit firms ‘must prioritise improvements and respond swiftly’.
The FRC said: ‘Our inspection findings at tier 2 and tier 3 firms for the year ended 31 March 2023 are again unacceptable.
‘Disappointingly, many of our findings were in routine areas, such as the audit of journal entries and complying with archiving requirements.
‘It is of particular concern that we continue to identify findings in the audit of judgments and estimates, and going concern, both of which require audit teams to demonstrate robust professional scepticism.’
Going concern was described as ‘an area of particular concern to audit firms’ by the FRC and there were no signs of improvement since the previous review, and was actually found to be worse by 1%.
Key findings of going concern included insufficient procedures to test cash flow forecasts, inadequate procedures to elevate the impact of loan covenants and insufficient procedures to assess the financing of debt.
Certain flaws were prevalent such as quality control procedures, for instance ‘shortcomings in the reviews of audit work performed by engagement partners and/or engagement quality control reviewer’.
Other areas that led to such a high number of audits needing significant improvement revolved around revenue and accounting errors. Two audits were found to have insufficient procedures to respond to risks around revenue accuracy and one had made material accounting errors during an acquisition in the inspection period.
Estimates and judgments were 17% worse than the previous report with 77% requiring significant improvements. Inspections found that these audit teams were not being professionally sceptical.
‘The FRC continues to identify deficiencies in the audit of judgments and estimates, and going concern, both of which require audit teams to demonstrate robust professional scepticism.’
There are currently 29 tier two and tier three firms. RSM, Crowe, haysmacintyre, MacIntyre Hudson and PKF Littlejohn are the largest, classed as tier two. All these firms were inspected this year.
The FRC set out a number of areas for improvement the firms, including investment in their audit methodology, human resources, and audit quality functions. They also needed to learn from the mistakes made throughout their current auditing processes.
Sarah Rapson, FRC executive director of supervision said: ‘The FRC’s ongoing supervision of the largest audit firms has helped to deliver audit quality improvements at those firms, but it is important that all firms step up to improve the overall health and resilience of the audit market.
‘The FRC has developed a comprehensive, forward-looking supervision approach to ensure audit quality is prioritised at the Tier 2 and Tier 3 firms, including now imposing conditions or undertakings through our PIE Auditor Registration process where we have audit quality concerns, and providing support where appropriate.’
The FRC also suggested audit teams refer to the FRC paper, What Makes a Good Audit.