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FRC highlights importance of a challenge culture in audit firms

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11 Dec 2020

The Financial Reporting Council (FRC) has undertaken a new analysis of its audit quality inspection results over the last two years to identify recurring themes requiring audit firms’ attention.

The FRC has identified that the most common finding in its quality reviews is that audit firms did not challenge the management of audited entities effectively on the significant judgements they had made in areas such as long-term contracts, goodwill impairment or the valuation of financial instruments.  For more than 80% of those audits which required more than limited improvement, the effectiveness of challenge was a key audit quality consideration. 

The review stresses that robust, focused and independent challenge is vital to a high-quality audit, particularly during current uncertain times, including the continued impact of COVID-19 and Brexit uncertainties and should be at the forefront of the minds of audit teams during December 2020 year-end audits.

The FRC analysis highlights those factors which have given rise to both favourable and unfavourable audit review findings, each firms root cause analysis and the matters reported in each firms public report on quality in July this year.  The FRC identifies processes and attributes which it considers are key features of effective challenge of management and states that developing the right mind set and professional behaviour is critical underpinned by a strong culture of audit scepticism and challenge.

A number of teams have already been able to demonstrate to the FRC enhanced challenge of management with respect to the audit of going concern as indicated in the FRC's recent review.  The FRC hopes that the lessons learned and experience gained from that review will allow firms to replicate effective challenge of management consistently on future audits.

In order to promote change in the area of effective management challenge, the FRC is planning initiatives in 2021.  In June 2021, the FRC will host a conference on the culture of challenge, entitled “Audit firm culture: Challenge. Trust. Transformation” involving academics, other regulators and experts on culture from a wide range of sectors to share experience, ideas and good practice. Building on the output from this conference, the FRC will undertake a thematic review on building a challenge culture in audit firms.

A press release and the FRC analysis is available on the FRC website.

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