The FRC in 2017/18 reviewed the audit of pension balances and disclosures of 51 entities as part of their focussed reviews to assess audit quality. The findings show that almost half of audits required limited improvements in at least one aspect.  However elements of good practice were also identified such as the strong use of specialists and auditor’s experts.

The FRC chose to focus on pensions due to significant pension assets and liabilities appearing in financial statements and the significant assumptions and management judgements that go in to the valuation of these balances which are at risk of material misstatement and manipulation through management bias. There is an increasing risk in the valuation of pension balances, in part due to a rise in financial management transactions being used by scheme trustees in order to reduce risks and costs of funding schemes. These include transactions such as liability-driven investment strategies, partial buy-outs and longevity swaps which add complexity to valuation judgements. Furthermore, auditing the company’s defined benefit obligations and related pension assets encompasses a number of the more complex aspects of audit including: auditing significant accounting estimates, use of service organisations and management’s experts, use of auditor’s experts, using the work of other auditors and the audit of disclosures.

Melanie Hind, Executive Director, Audit and Actuarial Regulation at the FRC, said, “The valuation of pension obligations is complex requiring significant judgements and assumptions which carry the risk of material misstatement and/or manipulation. Auditors need to understand the work of actuaries inputting to their work and pay attention to assets as well as liabilities. We hope to raise standards by highlighting good practice and areas for continuous improvement.”

To promote continuous improvement the FRC has suggested 9 areas where auditors can bring about improvements to the audit of pension fund balances:

• carefully assessing the risk for the more sensitive assumptions and planning and performing appropriate procedures to conclude on the valuation of the defined benefit obligation;
• clearly evidencing the work done by the auditor’s actuarial expert to assess the valuation of the defined benefit obligation and explaining the basis for the conclusions arrived at, on which the auditor relied in forming their opinion on the financial statements;
• considering, evidencing clearly and, where appropriate, communicating to the Audit Committee the financial impact of key assumptions at the optimistic or pessimistic end of the acceptable range, along with the auditor’s view on whether the actual assumptions are at the appropriate place in the range, taking into account the specific circumstances of the entity;
• considering whether the source data used to calculate the valuation of the defined benefit obligation is materially accurate and complete, and performing appropriate audit procedures to be satisfied that a material misstatement is unlikely to arise;
• where the IAS 19 valuation of the defined benefit obligation has been calculated by adjusting and rolling forward the last triennial actuarial valuation, clearly evidencing the audit work done on this roll forward and clearly explaining how the auditor’s conclusions have been reached;
• clearly analysing the different categories of investment assets and how they planned to obtain sufficient audit evidence for each of these categories so as to obtain a sufficient level of audit evidence for “harder to value” assets;
• obtaining sufficient audit evidence to support the allocation of the defined benefit obligation and pension scheme assets in a multi-employer scheme;
• carefully considering the completeness and accuracy of the pensions related disclosures in the financial statements and reporting errors or omissions to the Audit Committee; and
• considering whether reference to the audit work on pensions should be included in the auditor’s report and ensuring that the auditor’s report clearly and accurately reports the audit procedures performed.

The FRC highlighted in the report that where companies have significant pension scheme balances it expects Audit Committees and auditors to discuss the findings and to consider whether the audit approach can be enhanced.  The report provides a number of actions for Audit Committees.  

The FRC’s Corporate Reporting Review also undertook a thematic review on pensions in November 2017 which can be found here.  This report should be read in conjunction with that report.

The press release and full report are available on the FRC website.