News May 2014 FRC publishes Audit Quality Inspections Annual Report 2013/14

FRC publishes Audit Quality Inspections Annual Report 2013/14

28 May 2014

PN 31/14

Good standards in audit quality maintained but greater consistency required

The Financial Reporting Council (FRC) today publishes its 10th annual report on its inspections of audit quality in the UK, individual reports on each of the four largest firms and, for the first time, a separate report on its overseas inspections.

The quality of auditing in the UK is generally good, 60 per cent of audits were good or required only limited improvements, maintaining the significant improvements observed last year. The proportion of audits with the highest grade in the FRC’s inspections continues to increase and this is a high bar to pass. 86 per cent of the audits inspected of FTSE 100 companies were good or required only limited improvements.

However quality is not consistent across all audit firms and types of company. 15 per cent of all audits inspected required significant improvements including one FTSE 100 company. The FRC found breaches of the rules on auditor independence and continuing problems in the audit of letterbox companies. Most significantly the quality of bank and building society audits continues to fall below average, in particular because of insufficient testing and challenge of the provision banks have been making against possible losses on their loans. In consequence a thematic inspection of auditing across the sector is underway, based on the review of 13 bank audits. If necessary firms will be required to undertake more work when significant shortcomings are found. The FRC’s conclusions will be published in November 2014.

Paul George, Executive Director, Conduct said:

“Audit makes a vital contribution to investor confidence in financial statements and in the UK is generally good, particularly among the FTSE 100. Where improvements in audit quality are needed action plans are developed with the firms and followed up with them. 

However we have not seen enough progress in the quality of bank and building society audits which continues to be generally below that of other types of entities.  We are particularly concerned about the lack of sufficient challenge when testing key assumptions underpinning loan loss provisions.

Looking ahead, our inspection activities will be significantly affected by a number of recent developments including the recommendations made by the Competition Commission, the changes arising from the revised EU Statutory Audit Directive, and the abolition of the Audit Commission. These changes will significantly expand the scope of our inspections and the number of audits we report on each year. Following the Competition Commission’s recommendations we will also consult later in the year on guidance for audit committees on how they might report to shareholders on the findings of an Audit Quality Review.”

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. The FRC uses a risk model in the selection of listed and AIM companies’ audits to be reviewed each year, the audits inspected may not be representative of the market as a whole. By way of example, in 2013/14 we gave particular emphasis to the audit of letterbox companies.  These factors illustrate that the summaries of our inspection results should be interpreted with caution and that the results in any one year should not be considered in isolation.

    Audits of the following entities were within scope for the 2013/14 inspections:

    • All UK incorporated companies with listed equity and/or listed debt.

    • All non-EEA incorporated companies with listed equity and/or listed debt audited by a UK Registered Auditor.

    • AIM or Plus-quoted companies incorporated in the UK with a market capitalisation in excess of £100 million.

    • Unquoted companies, groups of companies, limited liability partnerships or industrial and provident societies in the UK which have group turnover in excess of £500 million.

    • UK incorporated banks not already included in any other category.

    • UK building societies.

    • Private sector pension schemes with either more than £1,000 million of assets or more than 20,000 members.

    • Charities with incoming resources exceeding £100 million.

    • Friendly societies with total net assets in excess of £1,000 million.

    • UK open-ended investment companies and UK unit trusts managed by a fund manager with more than £1,000 million of UK funds under management.

    • Mutual life offices whose “with-profits” fund exceeds £1,000 million.

  3. Our reviews of individual audits focus on the sufficiency and appropriateness of the audit evidence obtained to support the key audit judgments made in reaching the audit opinion. Our initial assessment of an individual audit engagement is based primarily on the evidence on the audit files provided to us. However, our inspection conclusions take account, as appropriate, of any explanations provided to us by audit teams to supplement the evidence on the audit files.

    Our audit inspection work is subject to quality control procedures which include a peer review process at staff level and a final review of our findings by independent non-executives who approve the issue of all reports. These processes are designed to ensure a high quality of reporting and a consistent approach, including grading, across all inspections.

    In previous years we have combined grades 1 & 2A in this report. This year we have reported all four grades separately in order to increase the transparency of our inspection findings.

    We grade the audit work on individual audits as follows:

    • good (grade 1);

    • limited improvements required (grade 2A);

    • improvements required (grade 2B); and

    • significant improvements required (grade 3).

  4. During 2013/14 the FRC began inspecting ‘Third Country Auditors’ – auditors of companies incorporated outside the European Economic Area that have issued securities on UK regulated markets. Three audits were reviewed. Two were graded as requiring improvements. The FRC encountered significant difficulties navigating the legal and practical challenges to carrying out inspections in some jurisdictions, and is continuing to discuss legal difficulties with certain audit firms with respect to planned inspections. FRC is hopeful that a larger number of these inspections will be possible in 2014/15.

  5. The FRC’s report on the 2012/14 Audit Quality Inspection of Baker Tilly UK Audit LLP (PDF) was published on 17 April 2014 and the reports published today complete our reporting on the 2013/14 cycle.