Britain’s accounting watchdog has criticised auditors for failing to challenge management when scrutinising company accounts, following a series of major corporate failures such as Thomas Cook and Carillion.
The Financial Reporting Council’s annual Developments in Audit report found that “audit quality is still not consistently reaching the necessary high standards expected”.
It found that auditors continued to struggle most with challenging management sufficiently in areas such as long-term contracts and the valuation of financial instruments such as bonds and loans.
Other shortcomings were identified in more routine audit procedures, notably in revenue recognition, a key metric for the financial performance of a company. Another concern is that too many auditors do not properly identify internal controls in areas of high risk or act when they are found to be deficient.
The report comes after an influential committee of MPs accused the accounting and audit industry of being complicit in the failure of firms including BHS and Patisserie Valerie.
It shows that:
Year-on-year familiarity with companies can lead to the same audit approach being followed even when changes in the business or trading environment demand a different strategy.
Too often, audit teams appear prepared to accept what management tells them rather than questioning its plausibility and drawing on specialists to form their own view.
Audit teams too regularly accept unrealistic deadlines, resulting in inadequate work.
The FRC’s executive director of supervision, David Rule, said: “At a time when the whole audit market faces reform, we expect audit firms to make audit quality their number one priority … Inconsistent quality erodes confidence in the profession, which can lead to diminished trust in business.
“While we see many examples of high quality audit, our inspectors are still identifying too many audits which require significant improvements. Inspections show that challenge of management is a particular area of concern on which audit firms need to focus. The FRC will continue to scrutinise these efforts and hold firms to account for their delivery.”
The FRC review also highlights that when a poor quality audit is discovered, some auditors do not do enough to systematically improve the situation.
The FRC itself has faced strong criticism and is to be replaced by a more effective regulator, although the necessary legislation was not included in the Queen’s speech. Its chief executive Stephen Haddrill left after nine years in the job and has been succeeded by the former HMRC head Sir Jonathan Thompson.
A review by Sir John Kingman, the chairman of Legal & General, also recommended the publishing of individual audit quality inspection reports, and the FRC said it would start issuing them with the consent of companies and audit firms from 2020-21.
In the past year, fines imposed by the FRC have more than doubled to a record £32m. There has also been a greater use and range of non-financial sanctions, rising to 38 from 11 in 2017-18. The watchdog can bring prosecutions against auditors for misconduct or breach of the accounting standards.
