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Tuesday, August 11, 2020

Shock as audits of companies done by major accountants fall short in a third of cases

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The scandal-struck “big four” accountancy giants are providing even worse audits than they were a year ago, according to the Financial Reporting Council.

In its annual spot check of audit quality, the FRC found a third of audits of companies fell significantly short of the required standards, compared with 26% a year ago.

The findings come as repeated scandals of poor audit dominate the headlines. EY has been accused of failing for years to ask for proof of the existence of Wirecard’s missing £2 billion and is currently being investigated for its apparent failure to spot alleged wrongoing at collapsed London Capital & Finance and Thomas Cook. KPMG is still in special measures after the watchdog found poor audit quality.

The findings will appal investors who rely on audit firms for reassurance that the companies in which they invest are performing as they claim to be.

Despite repeated scandals, from Carillion to Patisserie Valerie, audit firms are failing to do their job, the FRC audit showed.

The watchdog’s executive director of supervision, David Rule, said: “While firms have made some improvements and we have observed instances of good practice, it is clear that further progress is required.

“The tone from the top at the firms needs to support a culture of challenge and to back auditors making tough decisions.”

A failure of the audit firms to be sceptical about their clients’ claims for their businesses’ performance was a repeated theme, giving further backing to the regulator’s call last week for firms to make their audit teams independent of other parts of the firm. The FRC has ordered this to happen by 2024 in the hope that it will end conflicts of interest causing auditors to “go easy” in the hope their firm will win other work with the client.

:: Deloitte only 76% of audits (last year, 84%) were deemed to be not in need of major improvement. Particular concerns were cited around lack of challenge of clients’ cashflow forecasts for the way they impaired goodwill and other assets. The issue is important because it can lead to companies flattering their financial strength significantly. In one case, the FRC insisted an audit required significant improvement. The firm was told it particularly needs to do better on audits of small firms not in the top 350 of FTSE companies.

::PWC: only 65% of audits (last year, 77%) were measured as requiring no more than limited improvements. Overall inspection results remained “unsatisfactory” and the firm should take specific action to address it although it had introduced an improvement plan in summer last year which would take time to make an impact. Poor challenge of management over cashflow forecasts on impairment reviews were cited as a key problem.

::EY: 71% of audits (78% last year) required no more than limited improvements. While it had improved its measuring of intangible assets from last year’s poor performance, its assessment of impairment of assets on goodwill was defective. The firm generally fell short on the way it challenges clients’ management teams. Like Deloitte, it fell short on non-FTSE 350 audits.

::KPMG: only 61% (last year 76%) needed no more than limited improvements although the company had taken steps to address the key finding of its dismal 2019 report which resulted in it being put under “increased scrutiny” measures but overall, the inspection results “remain unsatisfactory”. Recurring failures appeared in the quality of its audits of banks and building societies, with the main overall issue being the lack of challenge offered to clients’ management teams. As a result of the firm’s poor quality, the FRC will do more inspections on its audits than other firms in the coming year.

::BDO, not one of the Big Four, BDO only passed muster on 62% of its audits (last year 88%) with the most common failure being a lack of robust testing of revenues. The FRC warned that, if the firm did not improve, “we will take further action.”

::Grant Thornton, also outside the Premier League, had the lowest approval rate, at only 55% (26% last year). The firm was already under increased scrutiny after very poor audit quality was discovered last year. While there had been improvements, there were recurring problems with a lack of challenge and scepticism of clients’ claims.


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