The UK market for firms auditing Public Interest Entities (PIEs) is going through a period of adjustment. Factors such as operational separation of audit by the Big Four accountancy firms, recent and upcoming regulatory changes, and de-risking of audit portfolios by some firms, have helped to increase the number of PIEs seeking new auditors and also the number of smaller firms taking on more PIE audits or considering a move into the PIE audit market.

The Financial Reporting Council (FRC) is keen to encourage and support greater choice and competition. “The FRC wishes to see a more resilient PIE audit market with a pipeline of firms capable of entering and growing in the PIE audit market, including taking on audits of greater complexity, while performing high-quality audits,” says Sarah Rapson, the FRC’s Executive Director of Supervision and its Deputy Chief Executive.

Most PIE audits are conducted by the largest UK firms, which the FRC classifies as ‘Tier 1’ (with firms allocated to Tier 1, 2, or 3, based on the number of PIE audits conducted and other risk factors). In December 2022, the first of what will be an annual, collective, aggregated and anonymised Audit Quality Supervision and Inspection Report for Tier 2 and Tier 3 firms found that their share of FRC-scope audits had grown to 13% from 9% in 2021/22.

Room for improvement

Many of the FRC’s audit inspection findings were in similar areas to inspection findings by ICAEW’s Quality Assurance Department (QAD) and were also reported by the FRC at Tier 1 firms, for example, the inadequate application of professional scepticism and judgement. There were, however, more findings at Tier 2 and Tier 3 firms in relation to the nature and extent of audit evidence, and in particular independent evidence, gathered across various audit areas.

In addition, FRC inspection data found an absence of formal procedures at firms with small PIE audit portfolios, in contrast with the more isolated procedural gaps seen at firms with larger PIE audit portfolios. Based on inspection findings, the FRC highlighted some areas for Tier 2 and Tier 3 firms to consider if they are to address these recent findings and grow or take on more complex audits.

More FRC support 

“There is an unacceptable gap in audit quality between PIE audits conducted by Tier 2 and Tier 3 firms and those by Tier 1 firms,” says Rapson. Many Tier 2 and Tier 3 firms have a small number of audits within the FRC’s inspection scope, some just one, and the FRC acknowledges their need for more support. “Firms tell us that they do not understand enough about what good looks like and feel daunted by the FRC’s regulatory approach.” 

The FRC has acted to address this. “We are increasing our support for Tier 2 and Tier 3 firms and expanding it to firms that are looking to enter the PIE audit market and which we refer to as Tier 4,” says Rapson. In May 2023 the FRC published What Makes a Good…Smaller PIE Audit Firm, sharing examples of good practice and what the regulator expects of audit firms seeking to scale up in or enter the PIE audit market. 

It includes guidance on how the FRC regulates PIE audit firms, covering, for example:

• FRC registration of auditors who carry out PIE audit work;
• what to expect from supervision and inspection of a firm’s PIE audits and its systems of quality management, including how this may differ from the approach taken by ICAEW and other recognised supervisory bodies;
• how the FRC’s approach to supervision, review and inspection differs between PIE audit firms it classifies as Tier 1, Tier 2 and Tier 3;
• how the FRC allocates firms to one of these tiers;
• areas where findings feature heavily in FRC inspections of audits at firms with smaller PIE audit portfolios; and 
• how the FRC’s enforcement process works, and how to manage some of the challenges an investigation may bring.

This addition to the FRC’s ‘What makes good…’ series also highlights particular factors for Tier 2 and Tier 3 firms to consider in the planning and execution of a PIE audit, including:

• size and complexity of the entity including, for example, structure and whether there are overseas components;
• nature of the entity’s business, internal control environment and transactions, and the basis of accounting (which may be international rather than UK financial reporting standards);
• extent and types of technical and sector-specific knowledge and skills needed; 
• need for expert or specialist input, including technical support for the audit team; 
• audit approach including when a controls-based approach may be appropriate;
• extent of judgements and estimates in the financial statements;
• laws and regulations applicable to an entity that is listed or operating in a regulated area such as banking, financial services and insurance; and
• level of sophistication of the entity’s management, including the adequacy of the information they prepare for their internal reporting and for the audit.

The FRC draws attention to areas where, based on its supervision and inspection work, firms that are planning to enter or scale up in the PIE audit market must pay particular attention. These include risk assessment continuance procedures, technical and people resources, and more stringent requirements around ethics and quality control. There are pointers on both International Standards on Quality Management, but primarily ISQM 1.

Good practices

Examples of good practices are provided in the following areas:

• culture (‘tone at the top’, promoting purpose, and having a ‘speak up’ culture;
• governance and leadership (providing those in leadership roles with sufficient information and ensuring they are bot overstretched);
• ethical requirements (well-documented roles and processes);
• acceptance and continuance (aligning audit portfolio, resources and expertise);
• resources – methodology (bespoke procedures and embedded guidance);
• resources – people (audit quality linked to reward and recognition);
• audit team support (processes to support audit quality, ‘in-flight’ review and action); and
• root cause analysis (structured approach, clear feedback loop to remedial actions and their assessment).

Around the same time as this guide was published, in May 2023, the FRC also launched its Audit Firm Scalebox. The Scalebox initiative aims to support firms in developing and maintaining audit quality as they grow or start out in the PIE audit market. It provides valuable insights from the FRC for firms that may come within the FRC's scope for the first time, to help them better understand, prepare for, and meet regulatory expectations around PIE audits.

The Scalebox team and its input is outside the FRC’s formal inspection process. The focus is on areas where common findings occur, requirements are changing, or where firms may need most support, as outlined in What does the Scalebox do? “Working with these firms, we hope to increase their audit capabilities and capacity as they enter the PIE audit market,” says Rapson.

Types of activities the Scalebox may undertake include: 

• a review of aspects of completed audits to provide feedback on good practice and areas for improvement;
• a review of a particular element of a firm’s system of quality control, including specific areas of audit methodology and audit approach; and 
• a review of a firm’s actual or proposed governance processes if it has chosen or is planning to adopt the Audit Firm Governance Code.

Engaging openly

All firms currently in Tier 2 and Tier 3 for FRC Supervision purposes are eligible to join the Scalebox as well as ‘Tier 4’ firms that are considering or intend to enter the PIE audit market. The FRC is keen to engage openly with firms. Registered PIE audit firms may directly contact their supervisor or the FRC’s Registration team to discuss queries. Firms thinking of registering as PIE audit firms for the first time may contact the Registration team (registration@frc.org.uk) or the Scalebox team (scalebox@frc.org.uk).