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In auditing, no news is usually good news. Well-run companies expect the same outcome every year: a clean audit report, with no qualifications.
The UK’s auditors are stuck in an unhappier rut. Their regulator’s annual inspection of audit quality has read very similarly for the past five years. Between a quarter and a third of audits by the seven largest firms have required improvement or significant improvement, according to the Financial Reporting Council. Its latest audit of auditors found 29 per cent of 103 “higher-risk” audits fell into those categories, just a small advance on 33 per cent a year earlier.
“Some may question what the FRC has been doing and why audit quality improvement remains slow,” Sir Jon Thompson, the body’s chief executive, said in a statement about the latest inspections. Well, indeed.
The burden of improvement needs to fall mainly on the audit firms. None is perfect, but the FRC singled out KPMG for falling short of its required standards for the third year in a row, and pointed to “significant weaknesses” in procedure in the firm’s audits of the banking sector.
A further concern was signalled by the disappointing results of the inspections of Mazars and BDO, two of the would-be rivals to the dominance of PwC, Deloitte, EY and KPMG. The FRC reviews only a very small sample of audits from these firms, and a third challenger (Grant Thornton), was the best performer of the seven firms reviewed annually. Even so, the challengers must prove they can sustain audit quality as they beef up to compete with the Big Four.
As for the watchdog, it would be harsh to describe it as toothless, but the FRC is certainly showing signs of decay. Its permanent chair stepped down in May 2020, and Keith Skeoch, the interim chair, is due to leave in October. He has warned of the “grave risk” that gaps in the board could delay the much-needed transformation of the institution. The government needs to act quickly to plug the gaps. Weakened governance could risk undermining the FRC’s efforts to improve auditing and throw further obstacles in the way of the creation of a harder-hitting successor, the Audit, Reporting and Governance Authority (Arga).
Consultations about the government’s white paper on these reforms closed this month. The proposals promise an even stronger emphasis on audit quality, alongside the promotion of effective competition. The government wants Arga to strengthen governance of audit practices. Among other plans, Arga would help ensure that audit partners’ pay and incentives were linked to the quality of their work.
Such changes would be welcome. The FRC is, meanwhile, doing its best to push for the operational separation of the Big Four’s consulting and audit arms, enhance standards and strengthen enforcement, while encouraging more challenge and professional scepticism in audit culture. As things stand, though, even if the kennel for the new watchdog is ready, it will not be occupied until 2023.
As the regulator points out in relation to KPMG’s below-par inspection, though, culture change “takes time to embed”. It is only natural that auditors, however good their intentions, will move more quickly if they sense that failure to advance will lead to direct consequences. Unfortunately, wider trust in the system is suffering at the moment.
Each year that goes by without significant improvement in audit quality leaves companies, their employees and investors exposed to a higher risk of another corporate failure.
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