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What Makes a Good Smaller PIE Audit Firm
The purpose of the FRC is to serve the public interest by setting high standards of corporate governance, reporting and audit and by holding to account those responsible for delivering them.
The FRC does not accept any liability to any party for any loss, damage or costs however arising, whether directly or indirectly, whether in contract, tort or otherwise from action or decision taken (or not taken) as a result of any person relying on or otherwise using this document or arising from any omission from it.
© The Financial Reporting Council Limited 2022 The Financial Reporting Council Limited is a company limited by guarantee. Registered in England number 2486368.
Foreword
Sarah Rapson Deputy Chief Executive and Executive Director of Supervision
The FRC is an improvement regulator and is committed to supporting firms build their capacity and capability in the public interest entity (PIE1) statutory audit market. This is vitally important in order to improve audit quality, competition and choice.
As we reported in our December 2022 Tier 2 and Tier 3 Audit Firms Inspection and Supervision report, while currently only 13% of PIE audits are conducted by these firms, their share of the market is growing. Opportunities in the PIE market are increasing as more entities are inviting a wider range of firms to tender for audits and larger audit firms are adjusting their audit portfolios for commercial, resource-related or other reasons. We also reported that, based on our inspection of a sample of audits, there is an unacceptable gap in audit quality between the PIE audits conducted by Tier 2 and Tier 3 firms and those conducted by Tier 1 firms.
The FRC wishes to see a more resilient market with a pipeline of firms capable of entering and growing in the PIE audit market, including taking on audits of greater complexity, while performing high-quality audits. However, firms tell us that they do not understand enough about what good looks like and that they feel daunted by the FRC's regulatory approach.
To address these challenges we are increasing our support for Tier 2 and Tier 3 firms and expanding it to firms that are looking to enter the PIE audit market (which we refer to as Tier 4). A key element of this additional support is the Audit Firm Scalebox, which we announced in December 2022. We are launching the Scalebox project along with this publication. We are also developing additional ways to drive quality improvements, by sharing more good practice and forward-looking insights from our work at all firms.
High-quality audit requires all elements of the audit ecosystem to be functioning effectively. At the same time as calling on audit firms to rise to the challenge of conducting high-quality audits, we also call on the preparers of financial statements, to focus on producing high-quality information, and on their Audit Committees to focus on prioritising audit quality. The firms at whom this publication is aimed often rely on third-party service providers to conduct quality control and other functions and we also call on such providers to ensure that their services meet the quality standards that we expect.
We wish to see a strong pipeline of firms capable of performing high-quality PIE audits and we are increasing the support we offer to firms
1. Introduction
This document is aimed at firms that plan to enter the PIE audit market, or currently have a small PIE audit portfolio. It provides:
- An overview of what we expect firms to focus on to ensure that their audit practice is capable of performing high-quality audits. This includes insights from our supervision of audit firms and areas for firms to focus on as they grow - both in terms of what they should do and things to avoid doing (section 2).
- A guide to how the FRC regulates PIE audit firms covering:
- What firms need to do to register with the FRC as a PIE auditor and their ongoing obligations (section 3). Registering with the FRC is the first step that a firm must take before it becomes the statutory auditor of any PIEs.
- What to expect from supervision and inspection by the FRC, including how our inspections of a firm's audits or its quality monitoring system may differ from the approach taken by a firm's Recognised Supervisory Body (RSB) (section 4).
- How the FRC's Enforcement process works, and how to manage some of the challenges an investigation may bring (section 5).
- New initiatives from the FRC to provide more support to firms, including our new Tier 4 and the Audit Firm Scalebox (section 6).
While the focus of this document is on PIE audits, the FRC expects high-quality standards to be applied to all audits. These should be underpinned by a robust system of quality management developed in accordance with International Standard on Quality Management (UK) 1 (ISQM 1) and in compliance with the ethical standards (currently the Revised Ethical Standard 2019).
Nothing in this document should be interpreted as suggesting that it is acceptable for quality standards to vary between PIE and non-PIE audits or that it replaces or qualifies the requirements of UK auditing standards and associated guidance issued by the FRC.
The FRC is keen to engage openly with firms. Registered PIE audit firms may contact their Supervisor or our Registration team to discuss any queries they have about the FRC's regulatory approach and our expectations. Firms thinking of registering as PIE audit firms for the first time may contact our Registration team ([email protected]) or the Scalebox team ([email protected]) to find out more about the registration requirements and the help that the Scalebox may be able to offer.
Firms may also consult the wealth of resources published by the FRC covering our inspection and supervision findings and our enforcement outcomes (both identifying issues to avoid), and what good looks like. Links to recent relevant publications are included in the Appendix.
Aimed at firms that plan to enter the PIE audit market, or currently have a small PIE audit portfolio
2. Delivering high-quality PIE audits
Introduction and context
What is high audit quality
The FRC defines high-quality audits as those that:
- Provide investors and other stakeholders with a high level of assurance that financial statements give a true and fair view.
- Comply both with the spirit and the letter of auditing regulations and standards.
- Are driven by a robust risk assessment, informed by a thorough understanding of the entity and its environment.
- Are supported by rigorous due process and audit evidence, avoid conflicts of interest, have strong audit quality processes, and involve the robust exercise of judgement and professional scepticism.
- Challenge management effectively and obtain sufficient audit evidence for the conclusions reached; and
- Report unambiguously the auditor's conclusion on the financial statements.
These fundamental quality principles apply to all audits, whether of a PIE or a non-PIE. While all audits must be approached individually, particular factors to consider in the planning and execution of a PIE audit may include:
- The size and complexity of the entity including, for example, its structure and the existence of overseas components.
- The nature of the entity's business, internal control environment and transactions, and the basis of accounting (potentially International Financial Reporting Standards (IFRS) rather than UK Financial Reporting Standards (FRS)).
- The extent and types of technical and sector-specific knowledge and skills needed.
- The need for expert or specialist input, including technical support for the audit team.
- The audit approach including when a controls-based approach may be appropriate.
- The extent of judgements and estimates in the financial statements.
- The laws and regulations applicable to an entity that is listed or operating in a regulated area such as banking, financial services and insurance.
- The level of sophistication of the entity's management, including the adequacy of the information they prepare for their internal reporting and for the audit.
Findings in the above areas feature heavily in our inspections of audits at firms with smaller PIE audit portfolios.
The foundations that will enable a firm to deliver consistently high-quality audits across its entire audit portfolio include:
- The firm's leadership demonstrating an appropriate ‘tone from the top’ that focuses on embedding an environment that develops audit as a specialism and is focused on audit quality and continuous improvement. The firm's culture must support the development and exercise of the right mindset and behaviours by audit teams to ensure appropriate professional scepticism and challenge. Poor quality auditing of judgement and estimates, which require audit teams to gather evidence to corroborate management's representations and apply appropriate professional scepticism and challenge, is one of the most common areas of findings in inspection work carried out by the FRC and the RSBs.
- A system of quality management (SoQM), developed in accordance with each of the elements of ISQM 1, that is appropriate to the firm's current and prospective audit portfolio. While a firm's historical approach under International Standard on Quality Control (UK) 1 (ISQC 1) may provide a reasonable platform for its SoQM under ISQM 1, the latter is more principles-based and requires in-depth thought, rather than a checklist approach.
Our supervision and inspection work has demonstrated that, before a firm enters or scales up in the PIE audit market, it must also:
- Develop a cohesive audit strategy and business plan, including ensuring that audit acceptance and continuance decisions are appropriately targeted and within the firm's capacity and capability.
- Develop its SoQM to accommodate the changing nature of its audit portfolio. When entering the PIE audit market, this will include developing and embedding appropriate procedures to comply with:
- More stringent ethical requirements, in particular regarding: the nature and level of allowable non-audit services (NAS); rotation requirements for the firm; the Responsible Individual (RI) and other members of the engagement team.
- Expanded review requirements, including the need for an Engagement Quality Control Review (EQCR) to be conducted (in accordance with ISQM (UK) 2 Engagement Quality Reviews, also effective from 15 December 2022).
- Additional reporting requirements in relation to both the content of the audit report, reporting to those charged with governance and, potentially, to a regulator.
- Ensure that it has adequate capital to make the necessary investment in new or additional resources including: methodology - many of our inspection findings are linked to deficiencies in a firm's audit methodology, such as the approach to controls testing and data analytics that may be more relevant in audits with greater complexity; and people resources, both front-line audit teams and the support available to them.
In the following section we look at the requirements of ISQM 1 in more detail. These are complex and it is beyond the scope of this document to provide a comprehensive analysis of every aspect of what makes a good audit firm.
In the table on page 9 we set out a selection of specific good practices we have seen and we consider likely to be most impactful in improving audit quality.
Firms must ensure that they have fully understood and embedded procedures to comply with PIE-specific ethical requirements
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In the UK, PIEs are defined in Section 494A of the Companies Act 2006 and Regulation 2 of The Statutory Auditors and Third Country Auditors Regulations 2016 (Satcar). ↩