Strong audit firm governance and leadership necessary for improved audit quality and independence
14 February 2017
The Financial Reporting Council (FRC) will review the governance and culture at audit firms as concerns emerge about the handling of conflicts of interest and delivery of improvements in audit quality.
The FRC has a strategic objective to promote justifiable confidence in audit in the UK. Recognising that audit quality is not yet consistently sufficiently high, the FRC aims to promote continuous improvement, taking action when necessary and focusing on areas of higher risk to the public interest. Six months after becoming the UK's Competent Authority for Audit, the FRC has published an update on Developments in Audit
(PDF) which highlights that while progress has been made, audit firms need to focus on the pace of improvement in audit quality and consistency.
Key findings in the FRC report are:
- Whilst progress has been made in consultation with stakeholders on implementing the new standards for auditor independence, concerns have been raised that in dealing with perceived conflicts of interest, not all audit firms are demonstrably serving investors’ interests.
- A faster pace of improvement in, and greater consistency of, audit quality requires strong leadership of, and the right culture in, the audit firms. The FRC proposes to review the effectiveness of governance and the culture of firms adopting its Audit Firm Governance Code, which clarifies and emphasises the public interest role of independent non-executives of those firms.
- Audit committee chairmen surveyed by the FRC, at the same time, remain overwhelmingly positive as to tendering developments and audit quality. Of those entities responding to the survey that had carried out an audit tender, 70% changed auditors and of those 18% think there has been a significant change for the better in audit approach and quality. The FRC has issued updated notes on good audit tender practice to promote effective audit tenders.
- The FRC will increase the transparency of its audit quality reviews on individual audit engagements. It will now publish periodic lists of those entities whose audits it has reviewed. Accordingly, the FRC expects increased reporting by audit committees of its findings and increased investor scrutiny of audit quality.
- An emerging theme from its ongoing 2016/17 audit quality monitoring cycle is insufficient auditor scepticism in identified areas of significant risk such as the assessment of potential impairments and judgements concerning material accounting treatments.
- As highlighted in FRC thematic reviews, audit firms can accelerate audit quality improvements through root cause analysis and structured support of the introduction of data analytic tools.
- Justifiable confidence in audit is underpinned by sound and effective enforcement. Since July 2016, the FRC has concluded four audit related cases resulting in sanctions of £6,525,000; begun its first investigation under the new Audit Enforcement Procedure into the audit of Sports Direct International; and following high profile public announcements, launched enquiries into the audits of Rolls Royce and British Telecom.
Melanie McLaren, FRC Board member and Executive Director, Audit and Actuarial Regulation, said:
“The FRC is determined to make a success of our competent authority status and, in liaison with the professional bodies for audit, will promote further improvements in audit quality. In doing so we will work with auditors, audit committees and investors to highlight good practice and advocate continuous improvement; keeping pace with, and accelerating changes in, audit and its use of technology in improving effectiveness and quality. In doing so we will continue to challenge and hold the leadership of the audit firms to account.”
Notes to editors:
- The Financial Reporting Council (FRC) is the UK’s independent regulator responsible for promoting high quality corporate governance and reporting to foster investment. The FRC sets the UK Corporate Governance and Stewardship Codes and UK standards for accounting and actuarial work; monitors and takes action to promote the quality of corporate reporting; and operates independent enforcement arrangements for accountants and actuaries. As the Competent Authority for audit in the UK the FRC sets auditing and ethical standards and monitors and enforces audit quality.
- The first Developments in Audit report was produced in July 2016. It provides background on the continuous improvements, and drivers of confidence in audit. The report can be found here.