The UK’s Financial Reporting Council (FRC) on Wednesday delivered a scathing review of the UK’s seven largest accounting firms, saying “poor quality audit work remains unacceptably common.”
Grant Thornton and PwC were singled out by the FRC to join KPMG under tougher supervision.
The damning review from FRC will add pressure on the UK government to implement a shake-up of the accounting sector following a string of corporate failures including Carillion, BHS and the accounting scandal at Patisserie Valerie.
The FRC said EY, KPMG, Deloitte and PwC, known as the Big Four, and BDO, Grant Thornton and Mazars from the next level down, all failed to hit a target that 90% of audits reviewed by the regulator were good or required only limited improvements.
The regulator said 25% of assessed audits were “below an acceptable standard.”
Only 75% of FTSE 350 audits were assessed as being good or requiring limited improvements, said the FRC, adding that Grant Thornton has been “placed under increased scrutiny due to sustained poor results.”
The report said: “The latest audit inspections, which relate principally to audits of companies’ December 2017 year-ends, found 75% of FTSE 350 audits reviewed were good or required no more than limited improvements, compared to 73% in 2017-18.
“No firms achieved the FRC’s audit quality target for 90% of FTSE 350 audits to meet this standard.
“Looking across all audit reviews completed at the largest seven firms, the outcome was 75% compared to 74% in 2017-18 …
“The FRC found cases in all seven firms where auditors had failed to challenge management sufficiently on judgemental issues.
“This has been a recurring finding over a number of years and it can have many contributory factors.
“These include the mindset of audit teams, especially an absence of professional scepticism in evaluating evidence presented by company management, tight reporting deadlines and the complexity of the judgements involved.
“Familiarity is also a factor arising from long-standing audit relationships, particularly if the company comes to be considered as ‘the client’ for the auditor, rather than the shareholder or investor.
“The audit firms need to work harder to solve this problem.
“The FRC is undertaking detailed work to assess how the audit firms are responding to this.”
At Grant Thornton, the FRC assessed that 50% of reviews were good or required limited improvements, compared to 75% last year.
In total, 26% of Grant Thornton’s audits reviewed in the past five years have required significant improvement.
The FRC said it has therefore increased its scrutiny of Grant Thornton.
On PwC, the report said: “The deterioration from 84% to 65% in the results for PwC’s FTSE 350 audits inspected is unsatisfactory and the FRC has required the firm to take prompt and targeted action to address this decline.
“In June 2019, PwC announced an action plan to strengthen its focus on audit quality.
“The plan includes additional investment in people, training and technology, structural changes to PwC’s business, and a reinforced focus on culture and quality control.
“The FRC will scrutinise closely the implementation of this plan.”
On KPMG, the report said: “While results at KPMG have improved, the firm remains subject to increased FRC scrutiny.
“This will continue until KPMG has demonstrated a sustained improvement in audit quality.
“The FRC scrutiny will cover the impact of KPMG’s recently announced changes to governance of their audit practice, as well as on key aspects of the firm’s Audit Improvement Plan, including the firm’s central review process and new audit guidance.”
Stephen Haddrill, FRC CEO, said: “At a time when the future of the audit sector is under the microscope, the latest audit quality results are not acceptable.
“Audit firms must identify the causes of their audit shortcomings and take rapid and appropriate action to improve quality.
“Our latest results suggest that they have failed to achieve this in recent years.”
“The latest review also reinforces the importance of work being undertaken by the FRC and others to bring about quality improvements across the sector.
“For 2019-20, we are extending our 90% quality target for FTSE 350 audits to all audits inspected.
“We will set a new target for audit firms, for 2020-21 onwards, that 100% of audits inspected should require no more than limited improvement.
“In other words, starting from June 2019 financial statement year ends, we expect no audit to be assessed as either a 2B or a 3.”