November 7, 2019 / News

Report: Auditors are allowing poor governance

By Joe McGrath, ESG Clarity

The FRC’s latest report makes for uncomfortable reading for investors

Report: Auditors are allowing poor governance

UK auditors are failing to challenge company bosses over poor corporate governance standards, the Financial Reporting Council (FRC) has warned.

The FRC’s latest Developments in Audit report found audit quality is still not reaching the necessary high standards, particularly when challenging management and performing routine procedures such as revenue recognition.

The Council’s 2018/19 audit inspections revealed auditors continue to struggle with confronting management appropriately in key areas of judgement and obtain sufficient evidence to support the judgements made.

Key areas regularly going unchallenged include management’s estimates of future costs and margins, forecast revenues for onerous contracts, and revenue recognition for multiple-element and complex contracts.

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, the FRC stated.

“At a time when the whole audit market faces reform, we expect audit firms to make audit quality their number-one priority and to have effective programmes of work to deliver consistently high standards,” the FRC’s executive director of supervision David Rule said.

“Inconsistent quality erodes confidence in the profession, which can lead to diminished trust in business. Stakeholders and investors rightly demand high quality work on all audits. The FRC will continue to scrutinise these efforts and hold firms to account for their delivery,” Rule added.

The report also found too many auditors were not properly identifying relevant controls in areas of significant risk or were not adapting their audit approaches sufficiently when controls were found to be deficient.

Over the past two inspection cycles, the FRC has referred 17 audits for potential enforcement action, with investigations opening in 10 of these cases.

And in the past year, the FRC’s wider enforcement activity has seen a near trebling of fines from £15.5m in 2017/18 to £42.9m in 2018/19.

Earlier this year the FRC reported that the inspection results of the biggest seven firms were unsatisfactory, with only 75% of the FTSE 350 audits it reviewed being classified as good or requiring no more than limited improvements – falling far short of the FRC’s 90% target.

The quality of audits by adviser firm Grant Thornton and consultancy giant PricewaterhouseCoopers were found be particularly poor.

Following the independent review of the FRC by Sir John Kingman, the FRC will transition into the Audit, Reporting and Governance Authority (ARGA) under a new mandate, once established by legislation.