Audit quality concern from 2022 monitoring reviews

Recent data shared by the Quality Assurance Department (QAD) for the calendar year 2022 gives a greater cause for concern, with conclusions from this latest period showing a deterioration in audit quality to just 71% good or generally acceptable compared to 77% for the previous calendar year. QAD experience suggests that this downward trend is likely to be echoed in its final conclusions on the year ended 31 March 2023. Whilst QAD statistics always come with a health warning, explaining that they represent reviews at a substantially different population of firms each year, this is a significant change to see over a single year.

Further analysis of the key drivers behind audits that require improvement or significant improvement shows that there are three common and recurring aspects:

• Group audits and consolidated financial statements
• Long-term contracts
• Stock

Issues relating to group audits are not restricted to multinational audits conducted by the largest audit firms utilising component auditors across the globe, although the direction, control and review of the work of third-country component auditors can still require improvement in some cases. More often QAD concerns relate to relatively simple, UK-based groups where the same audit firm audits the whole group and there are errors in consolidation, overlooked risks of impairment in parent company investments, or whole elements of the consolidated financial statements are missing, such as parent company balance sheets.

Long-term contracts present more challenging audits for any firm. An effective audit strategy requires a holistic and ‘contract-oriented’ approach rather than tackling revenue, cost of sales and balance sheet captions separately, using experienced audit staff. Assessment of the outcome of long-term contracts involves significant judgement and challenge of management, including in the estimation of accruals and costs to complete. There is a lot of scope for these audits to go wrong, and too frequently they do.

Weaknesses in audit of stock may reflect broader long-term changes in the UK business sector as these often relate to manufacturing entities with more complex accounting policies including work-in-progress, manufactured finished goods, standard costing and overhead absorption. Even some of the larger audit firms acknowledge that their audit teams may not come across these businesses and the opportunities to hone their skills in auditing these areas on a regular basis. Other weaknesses relate to arguably more routine audit work, with lack of evidence from stocktake attendance or a flawed approach to reliance on operating effectiveness of controls at companies with perpetual inventory stock counting systems.

Audits reviewed by QAD in 2022 will include many engagements that were undertaken with the additional challenges of COVID-19 restrictions, and so this may be a factor in these audit quality results.

Many aspects of remote auditing developed during the pandemic are here to stay – welcomed by firms, their clients and audit staff. These changes are helping to improve the attractiveness of the profession, with opportunities for better work-life balance and to reduce the carbon footprint. However, some firms express concerns that certain audit clients now have a clear preference for a remote audit when the firm would prefer to be at the clients’ offices, and that remote auditing can mean that it takes longer to train and develop the skills of their junior auditors.

It is important that all audit firms take time to assess the effectiveness of their approach to audits post-pandemic and the appropriate blend of work done remotely and conducted face-to-face. Statutory audit is not just about numbers and checklists, but a depth of understanding of how audit clients, and those who own, manage and are employed by them, work.

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