FRC Inspections Show Continued Improvement At Largest Audit Firms

Earlier this month the Financial Reporting Council (FRC) published its annual inspection and supervision results of the largest audit firms (BDO, Deloitte, EY, Grant Thornton, KPMG, Mazars and PwC). In this article, we take a look at the key findings.

 

Headlines

The headline reported by the FRC is that 77% of the 100 audits inspected were deemed good or required little improvement, reflecting a year-on-year improvement spanning four years and a 10% increased compared with 2020.

The FRC also reported that five of the largest audit firms had no audits requiring significant improvements, none of the 16 FTSE 100 audits inspected required significant improvements and overall, six of the seven largest audit firms improved or maintained their audit quality.

Inspection results at BDO and Mazars continue to fall below their peers, despite an improvement from what the FRC described as unacceptable inspection results in the prior year.

 

Recurring inconsistency

One of the key recurring issues identified by the FRC and the firms inspected as part of their own internal quality monitoring relates to the auditor’s evaluation and challenge of management’s estimates and judgements.

Bizarrely this is identified as both a recurring area of poor practice and a recurring area of good practice – it is extremely inconsistent across firms and even within the same firm. Auditors should ensure they apply appropriate professional scepticism to management’s estimates and judgements, and that they obtain corroborating evidence rather than relying on management’s own assessment and representations alone.

Auditors are advised to apply root cause analysis in order to try and address internal inconsistencies within the firm in particular.

 

Revenue recognition

As could perhaps be expected, given its repeated occurrence over recent years, revenue recognition still appears as a key finding.

Common issues relate to a failure to obtain independent third-party evidence to corroborate the accuracy of data used in substantive testing, a failure to properly investigate variances in substantive analytical procedures, and issues with long term contracts.

 

Journals testing

Another regular issue was surrounding journals testing – on several audits there was inadequate justification of the appropriateness of selection criteria for journals testing.

 

Cash flow errors

Cash flow statements were also highlighted as a key finding. There is often a lack of evidence on the audit work undertaken over these statements, and often errors have been found within them.

The cash flow statement is of course a primary statement and needs to be treated with the same level of prominence as other primary statements from an audit perspective.

 

Deferred tax

Deferred tax once again presented an issue with a lack of sufficient appropriate audit evidence over the recoverability of deferred tax assets in particular being identified as part of the inspection findings.

 

Property valuations

The inspection findings once again highlight an overreliance on valuations performed by management’s experts – in particular a lack of sufficient appropriate audit evidence over the key inputs used by the expert in carrying out the valuation.

 

Good practice

As the FRC is keen to highlight, overall, audit quality appears to have improved, albeit marginally, over the past year and this continues the trend over the past three years.

Areas of good practice identified in the inspections carried out included the fraud risk assessment, effective use of specialists and consultations, and good communication with audit committees.

 

How can Mercia help?

Many of the issues identified with the audits inspected by the FRC are commonplace in audits conducted by firms of all sizes. Our training highlights common audit pitfalls and our file review services can assist in providing feedback on the quality of your audits. We’re also available to consult on technical queries.