Unacceptable Audit Quality at Tier 2 and 3 Audit Firms

The FRC has published its Audit Quality Inspection and Supervision findings for Tier 2 and Tier 3 Audit Firms, with unacceptable findings once again identified. In this blog we take a look at the common themes.

What are Tier 2 and Tier 3 audit firms?

Tier 2 and Tier 3 audit firms are broadly those audit firms which carry out audits of PIEs but do not fall into the Tier 1, the largest seven firms. These firms are subject to review by the FRC on cycles typically ranging from a three-year cycle for Tier 2 firms to a six-year cycle for Tier 3 firms (generally those with only one or two PIE audits).

What are the key findings?

Whilst the sample of reviews undertaken by the FRC in this cycle was relatively small, its findings identified that only 38% of audits reviewed required no more than limited improvements, with a further 38% requiring significant improvements.

The FRC identified that many of its findings were in routine areas, including:

• Estimates and judgements
  A general lack of professional scepticism and challenge was the most common finding.
• Going concern
  The findings in relation to going concern highlighted insufficient procedures to test cash flow forecasts and assess sensitivities, inadequate procedures to test breaches of loan covenants, and insufficient procedures to assess the refinancing of debt (which was critical to the going concern assumption).
• The audit of journal entries
  Findings related to insufficient procedures to test the completeness of journal entry listings obtained from management, and a lack of procedures to test journals that were identified as meeting fraud risk criteria.
• Failure to comply with archiving requirements
  Failure to archive files within the 60 day time period were identified, as well as a lack of controls around ensuring that working papers added after the date of the auditor’s report, but before the date the file was archived were logged with the reasons for their addition recorded.

None of these areas are particularly surprising – they come up time and time again in FRC reports.

The findings also identified many weaknesses in quality control procedures. These were based on the requirements which applied at the time – those of ISQC 1, whereas the requirements of ISQM 1 now apply instead.

What if we don’t audit PIEs?

The findings identified by the FRC offer useful learning points for all auditors, no matter the size of the entities they audit. Unfortunately, the themes arising are commonplace across the whole market and crop up time and time again not just in FRC reviews, but those carried out by the ACCA and QAD as well as Mercia.