The AQR team monitors the quality of the audits of listed and other major public interest entities and the policies and procedures supporting audit quality at the major audit firms in the UK. The overall objective of their work is “to monitor and promote improvements in the quality of auditing of listed and other major public interest entities”.  Reviews were performed on a risk-based approach with a specific focus on banks and building societies and the audit of letterbox companies (those groups or companies that have little more than a registered office in their country of registration, with management and activities being based elsewhere). 

Detailed findings from the inspection of individual audits showed that there was “an improvement on prior years”.  Specifically the annual report highlights: 

• That 60 per cent of all audits were assessed as either good or requiring only limited improvements, maintaining the improvements in grading of audits seen last year.
• That there was an increase in the proportion of audits that achieved the highest grading (19 per cent up from 13 per cent in 2012/13 and 11 per cent in 2011/12).
• That 86 per cent of the FTSE 100 audits reviewed were assessed as either good or requiring limited improvements.  

However, against these improvements the annual report also highlights that: 

• Of the audits inspected, 15 per cent were assessed as requiring “significant improvements”, consistent with 2012/13.  This included one FTSE 100 company, a level consistent with 2012/13 and 2011/12.  The number of FTSE 350 audits assessed as requiring significant improvements increased from two to four.
• Four of the audits assessed as requiring significant improvements related to letterbox companies, compared with two in 2012/13.
• One bank/building society audit was assessed as requiring significant improvements and no bank/building society audits were assessed as good, with 56 per cent assessed as requiring improvement. 

Alongside these key findings, the annual report also provides key messages that audit firms should pay attention to if they are to improve their overall audit quality: 

Banks and building societies 

• The annual report highlights that “the overall grading of bank and building society audits is, and continues to be, generally below those of other types of entity”.
• The key area of concern is the audit of loan loss provisioning, particularly “weaknesses in the testing of loan impairment models and related assumptions”.  Such weaknesses include “insufficient challenge of management or the failure to obtain further evidence to support provisioning judgments” and the audit testing procedures to test management’s identification of loans subject to forbearance arrangements for both provisions and disclosure purposes.
• There were also deficiencies in testing operational effectiveness of general IT controls and IT application controls.
• The annual report indicates that in response to these findings, the FRC are undertaking a thematic inspection of the quality of bank and building society audits in these areas.  The results of this thematic review will be published in Autumn 2014.

Group audit considerations  

• The annual report highlights that “firms should ensure that there is greater consistency in quality between the audit work undertaken at group level and that in respect of components”. 

Letterbox company audits 

• Inspection work undertaken in 2013/14 indicated that there were issues in respect of the control, supervision, and review of audit procedures performed by other auditors.
• The annual report indicates that “firms should ensure that their methodologies and related guidance for the audit of letterbox companies require sufficient involvement at all stages of the work of other auditors to meet the relevant requirements of Auditing Standards”. 

Fair value measurements and impairments    

• Inspection work undertaken in 2013/14 indicated that there deficiencies in the audit of fair value measurements and impairments with “limited evidence” that firms had robustly challenged management assumptions and key judgments.
• The FRC would like firms to apply professional scepticism, robustly challenge management assumptions and request adjustments to be made in the financial statements, where appropriate.  It highlights that audit committees “have a valuable roles to play in supporting and encouraging their auditors to challenge management in this way”. 

IT controls

• The FRC comment that “significant improvements are required in the audit of IT controls” and that firms should review their approach to the audit of IT controls.  Areas to address include whether audit teams have sufficient training and knowing when to use an IT specialist.

Auditor independence and ethics:  

Financial interests in audited entities

• The FRC identified instances where partners were holding financial interests in audit clients and comment that “firms should review the robustness of their policies and procedures and the communication thereof, both to prevent and respond to instances of this nature”. 

Non-audit services

• The FRC identified instances where insufficient consideration was given to the provision of non-audit services and comment that “firms should ensure that they have appropriate procedures in place to monitor the ongoing provision of non-audit services to existing clients”.  

In 2013/14, the FRC also undertook further inspection activity including two thematic inspections related to audit materiality and aspects of the audit of fraud risks and compliance with laws and regulation.  These activities provide additional key messages that firms and audit committees should pay attention to.

In the future, the FRC’s inspection activity is set to increase as a result of major legislative change and other proposals affecting audit and audit monitoring including the Competition Commission recommendations, the EU audit Directive and Regulation and a new requirement for the FRC to review local government audits.

Alongside the Audit Quality Inspection Annual Report for 2013/14, the FRC has also published individual reports for the 'Big Four' accountancy firms in the UK; Deloitte LLP, Ernst & Young LLP, KPMG LLP and PricewaterhouseCoopers LLP and a separate report for overseas inspections.

Click for:

• FRC press release (link to FRC website).
• Audit Quality Inspection Annual Report 2013/14 (link to FRC website)
• Our previous UK Accounting Plus news item on the FRC Audit Quality Inspection Annual Report 2012/13