FRC calls on firms to upgrade audit quality tools
6 May 2020: The Financial Reporting Council has urged firms to enhance their early warning systems for spotting signs of poor-quality audit work following a major review by the watchdog.
The study, which examined the most useful indicators of poor and good audit quality within the UK, found that if used correctly Audit Quality Indicators (AQIs) are an important tool, both for helping firms spot audits at risk of falling below necessary standards and for audit committees to hold firms accountable.
In a statement accompanying the research, the Financial Reporting Council (FRC) said that tools used for flagging signs of poor-quality audits “should be used more effectively so timely corrective action can be taken”.
While the watchdog stated it is “encouraged” that such indicators are being rolled out by audit firms, it also found that most monitoring of AQIs across the largest firms takes place after audits are completed, rather than before or during the process.
The FRC’s latest annual audit inspection found that the UK’s seven largest firms had all failed to hit the quality target for their FTSE 350 audit work.
The study examined how audit firms are using AQIs and assessed their benefits, and across the largest six firms it found:
- Monitoring of AQIs is an important foundation for initiating actions and interventions to improve audit quality
- Firms must focus on forward-looking and granular AQIs to ensure they are identifying early interventions which could prevent deficiencies in audits.
At firms outside the largest six, two had started a programme of AQI monitoring, and the FRC urged other firms to follow suit.
AQI improvements required
The FRC also used the research to assess the breadth of AQIs reported publicly by UK firms in their annual transparency reports, as well as their use by audit committee chairs and investors.
Areas highlighted by the study where public reporting of AQIs required improvement were:
- AQIs reported in the UK are concentrated on five areas whilst other countries require firms to report on eight or more.
- Publicly reported AQIs are not easily accessible or comparable across firms.
- Few audit committee chairs and investors interviewed for the report were aware of published AQIs.
The watchdog highlighted the fact that other countries have adopted initiatives where audit teams report AQIs specific to individual audits directly to audit committees. The FRC believes there “is merit” in exploring whether a similar initiative in the UK would help drive audit committee engagement in this area.
Commenting on the study, the FRC’s Executive Director of Supervision, David Rule said that public reporting of a consistent set of audit quality indicators is required to provide companies and investors with another window on audit quality.
“It is clear that improvements are needed in this area,” said Rule, “and the FRC will be consulting on proposals in due course.”
Director of ICAEW’s Technical Strategy Accountability Group, Nigel Sleigh-Johnson commented "ICAEW welcomes the efforts of the FRC to improve audit quality".
"The Thematic Review is a timely contribution to the on-going debate about the nature of audit quality, how best to enhance, and how to properly evaluate it in a rapidly audit landscape," continued Sleigh-Johnson. The importance of the qualitative aspects of audit quality and effective root cause analysis should form part of that debate. ICAEW look forward to contributing to the FRC’s consultation."
In a statement accompanying the report, the FRC said it plans to consult publicly on proposed standards for disclosure of AQIs by UK firms. The timing of this consultation will depend on the COVID-19 pandemic.