News January 2014 FRC seeks improvements in auditors’ identification of and response to fraud risks, and consideration

FRC seeks improvements in auditors’ identification of and response to fraud risks, and consideration of laws and regulations

23 January 2014
PN 006/14

The Financial Reporting Council (FRC) has today published the report of its Audit Quality Thematic Review (PDF) into auditors’ identification of and response to fraud risks, and their consideration of compliance with laws and regulations by audited entities. The themes for the review, which looked at relevant aspects of 26 audits by the six largest audit firms, were chosen because they are matters of public interest where there are high expectations and common misunderstandings of the auditor’s role. The report highlights a number of areas where auditors should improve the quality and effectiveness of their audit procedures and provides an overview of areas of good practice identified at one or more audit firms. These improvements would better position auditors to detect possible material misstatements in the financial statements due to fraud and non-compliance with laws and regulations. The extent to which improvements in these areas have been achieved will be assessed in the FRC’s future inspections of individual firms.  

Auditors are encouraged to increase their focus on identifying fraud risk factors when assessing the risks of the financial statements being materially misstated due to fraud. In particular, they should ensure their approach is tailored to the entity they are auditing. Auditors should also improve their identification and assessment of the laws and regulations affecting the specific audited entity, as well as exercising greater professional scepticism in relation to possible breaches that could affect the financial statements.

To assist Audit Committees, the report also identifies a number of areas in which their oversight of the audit process relating to fraud risks and laws and regulations might be enhanced. Further, when tendering their audit, Audit Committees are encouraged to enquire about the nature and frequency of the training firms provide on these areas to audit staff.  

Paul George, Executive Director, Conduct said:
“The consideration of fraud risks and compliance with relevant laws and regulations, and the performance of related audit procedures, tends to be viewed as a compliance exercise rather than as an important and integral part of the audit.  Improvements are needed to better focus attention on the potential impact on the financial statements and the need for appropriate professional scepticism to be exercised in these areas throughout the audit process.”
Notes to editors:
  1. The FRC is responsible for promoting high quality corporate governance and reporting to foster investment.  We set the UK Corporate Governance and Stewardship Codes as well as UK standards for accounting, auditing and actuarial work.  We represent UK interests in international standard-setting.  We also monitor and take action to promote the quality of corporate reporting and auditing.  We operate independent disciplinary arrangements for accountants and actuaries; and oversee the regulatory activities of the accountancy and actuarial professional bodies.
  2. Thematic reviews supplement the FRC’s annual programme of audit inspections of individual firms. Thematic reviews enable us to probe deeper into aspects of auditing not normally considered in detail during routine inspections. They allow us to make comparisons between firms with a view to identifying both good practice and areas of common weakness.
  3. For a thematic review the AQR examines firms’ policies and procedures in respect of a specific aspect of auditing, and their practical application, allowing the AQR to focus in greater depth than is generally possible in their annual inspections. 
  4. We visited the six largest audit firms (BDO LLP, Deloitte LLP, Ernst & Young LLP, Grant Thornton UK LLP, KPMG LLP and KPMG Audit plc and PricewaterhouseCoopers LLP) to review their audit methodology and guidance and training provided to staff in respect of fraud risks and consideration of laws and regulations. We also reviewed relevant aspects of the audit procedures performed for 26 audits for entities in the retail, construction, support services, banking and mining industries (6 FTSE 100; 8 FTSE 250; 6 other full listed; 5 AIM and 3 banks).  These related to audits of financial statements for financial year ends between December 2011 and September 2012. Our reviews focused on the audit team’s assessment of fraud risks and risks of non-compliance with laws and regulations and the planned audit procedures to address these.