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FRC publishes Audit Quality Inspections Annual Report 2014/15

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29 May 2015

The Financial Reporting Council (FRC) has today published the Audit Quality Inspection Annual Report for 2014/15 which provides an overview of the audit quality inspection work carried out by its Audit Quality Review (AQR) team for the year ended 31 March 2015 (“the annual report”). A total of 109 private sector audits were inspected.

The annual report provides an assessment of audit quality and also provides key messages that audit firms should pay attention to if they are to improve their overall level of audit quality. The annual report indicates that “audit quality is improving”.  However the FRC indicates that “there is room for further improvement”.

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 FTSE 350 companies (as a result of the recommendations of the Competition and Markets Authority (CMA)) and banks and building societies.

Detailed findings from the inspection of individual audits showed that there was a continued improvement in the quality of audit work. 

Specifically the annual report highlights:

  • That 67% of all audits inspected in 2014/15 were assessed as either good or only requiring limited improvements, maintaining the improvements in grading of audits seen last year.
  • That the quality of FTSE 350 audits is higher than other categories of audits inspected with only 6% assessed as requiring significant improvements (10% for all audits inspected).  The FRC highlights that FTSE 350 work that it inspects is “of a higher standard than that of other audits”.
  • Although the level of audit being assessed as either requiring improvements or significant improvements has fallen from 40% in 2013/14 to 33% in 2014/15, the FRC remained “concerned” at these figures.  Listed companies outside of the FTSE 350 continue to account for the largest number of audits assessed as requiring significant improvement.

A number of issues were identified during the audit quality inspections, many of which were common to prior year inspections.  These include:

  • Insufficient scepticism in challenging the appropriateness of assumptions in key areas of audit judgment such as impairment testing and property valuations.
  • Insufficient or inappropriate procedures being performed. This was common to many audit areas including revenue recognition.
  • The failure to adequately identify the threats and related safeguards to auditor independence and to appropriately communicate these to audit committees.

To promote further improvement in audit quality the FRC is undertaking the following initiatives:

  • Requesting that firms develop of action plans to address weaknesses identified in individual audit engagements and firm-wide procedures.  This would include detailed root-cause analysis of the factors contributing to the factors leading to the issues identified during the audit quality inspections.  The annual report indicates that these actions plans and the related analyses should be subject to follow-up inspections.
  • Requiring firms to undertake remedial action to address certain deficiencies identified during the inspections where these are deemed to be particularly significant or may call into question the appropriateness of the financial statements or the audit opinion.
  • Performing thematic inspections such as those of performed in 2014/15 on the audit of loan loss provisioning and related IT controls in banks and building societies and the auditor’s consideration of the quality of financial reporting in smaller listed and AIM companies.  In 2015/16 the FRC propose to undertake thematic inspections of audit sampling, the role of the engagement quality control reviewer (EQCR) and firms’ internal quality monitoring procedures.

In terms of the new extended auditor reporting requirements, the annual report indicates that “firms have responded positively” and the FRC were “generally satisfied that the extended audit reports appropriately reflected auditors’ work and judgements”.  There were only a “small number” of instances where the auditor’s description of the nature or extent of audit work performed was “inaccurate”.  Alongside the annual report, the FRC has also issued a ‘Practice Aid’ for Audit Committees to help them assess audit quality.

In the future, the FRC’s inspection activity will be focused to the audits of businesses in “potentially high audit risk industry sectors including those where complex supplier arrangements are likely to be prevalent and to audits where there has been a recent change in auditor”.  Such businesses will include food, drink and consumer goods manufacturers and retailers – priority sectors set out in the FRC Plan and Budget 2015/16.  The FRC will continue to monitor this area in subsequent inspections.

Alongside the Audit Quality Inspection Annual Report for 2014/15, 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 BDO LLP.

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