Auditors need to improve their challenge of management urgently
05 November 2019
Audit quality is still not consistently reaching the necessary high standards expected, according to the Financial Reporting Council’s (FRC) Developments in Audit
report, particularly when challenging management and performing routine procedures such as revenue recognition. High quality audit is essential to ensure confidence in financial reporting by UK companies.
The FRC is working with audit firms to ensure quality improves and will hold firms to account where remedial action is not taken to an appropriate level or on a sufficiently timely basis.
AQR inspection reports show that auditors continue to struggle most with challenging management sufficiently, especially in more judgemental areas, such as long-term contracts, goodwill impairment or the valuation of financial instruments. The inherent uncertainty and high potential financial impact of these issues mean the importance of robust, specific and independent challenge is vital.
Other shortcomings were identified in more routine audit procedures - notably in relation to revenue recognition, which is typically a key metric considered by users of financial statements.
The FRC’s Executive Director of Supervision, David Rule said:
“At a time when the whole audit market faces reform, we expect audit firms to make audit quality their number-one priority and to have effective programmes of work to deliver consistently high standards.
“Inconsistent quality erodes confidence in the profession, which can lead to diminished trust in business. Stakeholders and investors rightly demand high-quality work on all audits.
“While we see many examples of high-quality audit, our inspectors are still identifying too many audits which require significant improvements. Inspections show that challenge of management is a particular area of concern on which audit firms need to focus.
The FRC will continue to scrutinise these efforts and hold firms to account for their delivery.”
This year’s Developments in Audit also spotlights the FRC’s assessment of auditors’ work on internal controls. The FRC found too many auditors were not properly identifying relevant controls in areas of significant risk or were not adapting their audit approaches sufficiently when controls were found to be deficient.
The FRC review also highlights that when a poor-quality audit is identified, audit firms’ current root-cause analysis and response procedures may not have been designed, executed or acted upon sufficiently to facilitate a systematic improvement in audit quality.
A closer analysis of inspection results also revealed:
• year-on-year familiarity with audited entities can lead to the same audit approach being followed even when changes in the business or trading environment demand a different strategy;
• too often, audit teams appear prepared to accept what management tells them rather than questioning its plausibility and drawing on specialists to form their own view; and
• audit teams too regularly accept unrealistic deadlines resulting in inadequate work.
Sir John Kingman’s independent review of the FRC recommended the publishing of summary versions of individual audit quality inspection reports, including gradings. The FRC intends to pilot publishing these reports with the consent of companies and audit firms, starting with the 2020/21 inspection cycle.
Over the past two inspection cycles, the FRC's Audit Quality Review team has referred 17 audits for potential Enforcement action and investigations have been opened in ten of those cases.
And in the past year, the FRC’s wider enforcement activity has seen a near trebling of fines from £15.5m in 2017/18 to £42.9m in 2018/19 and a far greater use and range of non-financial sanctions, rising from 11 in 2017/18 to 38 in 2018/2019.
A link to Developments in Audit can be viewed here