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The Professional Oversight Board, part of the Financial Reporting Council, has today published reports on the findings of the Audit Inspection Unit’s (AIU) inspections for each of the six largest audit firms.
Lack of audit scepticism trips E&Y
Ernst & Young’s audits were weakened by lack of scepticism and evidence to support auditor findings, the Audit Inspection Unit has concluded.
Of 13 audits inspected, just five were found to be "good with limited improvements required" - down from seven last year - while one needed "significant improvement", up from zero in the 2009/10 report.
Performed by members of the Financial Reporting Council's Professional Oversight Board, it found issues with group audit, finalisation procedures and the annual employee appraisal process.
E&Y's response was brief, focusing on audit quality and the "common aim" of the firm and the AIU.
Lack of evidence to support audit findings is a recurring shortcoming in relation to the impairment of goodwill and other assets, revenue recognition and fraud risks.
Failure to challenge management assumptions also dogged the report; in one audit of a financial institution, client judgements on impairment provisions were not subject to robust examination in two out of 40 products reviewed.
Group audits triggered a major alarm bell at the AIU, with referral instruction or overseas communication "weaknesses" in four of the 13 cases. In the audit of one financial institution, an overseas network firm carried out much of the work but UK files made it impossible to determine whether there was sufficient evidence to support financial statements at the UK entity.
Questions were raised over the assessment of the quality of component members' work on group audits and in one case the group audit partner did not visit the main overseas location, despite it being a requirement of E&Y's methodology.
Failure to follow International Financial Reporting Standard 8, operating segments, is potentially embarrassing for the firm, as on three audits those responsible may not have applied the standard.
Year-on-year, E&Y's progress was mixed. It "did not appear to have taken effective action" to address recurring problems with goodwill impairment assessments, and the audit of revenue remained of concern.
Despite these shortfalls, the firm's improvement was described as "generally good" and procedures in particular have been tightened up. The number of internal quality reviews has risen, a recommendation to remove target percentages for outsourcing audit work was accepted and staff appraisal documentation was completed in a more timely and compliant manner.
E&Y may have reason to worry about a few isolated yet glaring errors; in two cases the auditor's report was signed before the review had been completed, and undetected clerical errors in the accounts went unchecked, including on mistake in the disclosed audit fee.
The firm said it is pleased that this year's report reflects some of its "significant investment" in audit services, concluding: "The AIU report does identify some areas for improvement for all firms. We are responding positively to the recommendations made to us and are taking the necessary action as agreed with the AIU."
Deloitte criticised over AIM audit client work
Deloitte "did not properly fulfill its responsibilities as group auditor" when working with an AIM-listed client, according to the Audit Inspection Unit (AIU).
The watchdog's annual report into 13 Deloitte audits found "insufficient" audit evidence had been gathered by the firm at an AIM-listed business based outside of the UK.
The UK audit team was involved throughout the audit, with a UK team member based overseas for most of the audit. However, audits of the impairment testing of property, plant and equipment, the valuation of stock held and the completeness of related party transaction were insufficient, the report found. ..."
This situation could have been avoided if the firm's procedures for planning and conducting group audits had been applied properly," stated AIU director Andrew Jones' report.
Nine of the 13 audits were performed to a "good standard"; three to an "acceptable standard"; and one that required "significant improvement".
The report also found weaknesses in the firm's audit of the impairment of goodwill and other intangible assets. In another three audits the AIU discovered insufficient audit evidence obtained concerning fair value measurements of assets and liabilities.
Five reviews found weaknesses in the firm's communication with audit committees. Three of those included unadjusted misstatements above the "clearly trivial" threshold neither reported to the audit committee nor included in the schedule of unadjusted misstatements attached to the representation letter.
Some partners over-assessed their own performance and others who provided minimal information to support their self-assessment.
A Deloitte spokeswoman said: "Deloitte believes the external inspection process provides further impetus to our quality agenda.
"The pursuit of the highest quality and integrity in our professional work remains one of the cornerstones of our firm's continuing success, allowing us to deliver excellence to our clients.
"We were therefore disappointed that one audit file, relating to the audit of a non-financial AIM-listed entity, was found to require significant improvement. We have taken action to address the specific issues that arose in respect of that audit and all of the AIU's other comments."
PwC must improve goodwill impairment auditing
Insufficient evidence has been gathered by PwC auditors when gauging clients' goodwill impairment and revenues, according to a report by the industry watchdog.
The Audit Inspection Unit's 2010/2011 report into the firm found issues over the sufficiency of audit evidence obtained or recorded to support the related carrying values from goodwill assessments.
Two FTSE 100 audits contained errors in disclosures that went unidentified by the auditors.
Revenue issues were found with the majority of the 15 audits inspected by the AIU. In five, a lack of detailed testing, substantive analytical procedures and a response to fraud-related risks were highlighted. Seven of the 15 audits inspected were performed to a "good standard, another seven were to an "acceptable" standard while a further one required "significant improvement".
The audit that required "significant improvement" was a UK subsidiary of an overseas bank. There was insufficient audit evidence for key aspects of the audit, including reliance on management's testing of controls. The AIU also flagged concerns over the extent of audit evidence obtained or recorded in key areas such as the valuation of financial assets and provisions for loan impairments.
PwC auditors failed to formally report their findings and conclusions on a FTSE 100 audit to its audit committee.
On another FTSE 100 audit, IT consulting services were provided to the client from PwC's then newly-acquired Paragon Consulting. Paragon's work included updating the client's financial reporting system.
"It was not clear from the audit team's written assessment why this did not give rise to an unacceptable threat to the firm's independence," stated the report by AIU director Andrew Jones.
The AIU also found an audit director who had included details of his success in selling non-audit services to audit clients in his reference pack, when applying for a partner position.
In a written response to the AIU, PwC's Richard Sexton said the firm was "committed to addressing the issues that you have identified in your review and to implementing the detailed action plan that has been agreed between us".
KPMG must improve review procedures
KPMG must improve its review procedures and exercise more scepticism to information provided by audited entities, the Audit Inspection Unit (AIU) has said.
The AIU's report said that the audit teams "should apply appropriate professional skepticism to information provided by audited entities".
There were recurring problems from previous years in the areas of review procedures. "On four audits we identified weaknesses in the substantive analytical review procedures performed in respect of the income statement," it said. "In three cases the analytical review procedures were not, in our view, performed in sufficient depth." It acknowledged that, since those audits, the firm had made improvements.
The AIU reviewed 14 audits and said that two of those required "significant" improvements. One of the audits was lacking in terms of "the sufficiency of audit evidence for revenue and profit recognition", while the other needed improvements to loan impairments and IT general controls. Ten audits were performed to a good standard, and two were performed to an acceptable standards.
There were problems in the independence of senior staff in the audits. It pointed to one example where an IT partner had been involved in the same audit for nine or ten years.
The inspectors also criticised KPMG for staff appraisal forms that included goals related to selling non-audit services to audit clients, which the firm had in common with many of the other firms inspected. "The firm should ensure that managers and their appraisers are in no doubt that such objectives must not be set as such sales are not to be taken into account in performance assessments or remuneration decisions," the report said.
KPMG was praised for making improvements in communicating with audit committees, and the signing and dating of working papers and audit reports.
In its response, KPMG said: "The AIU has commented on our emphasis on professional scepticism within our training programme and notes our significant progress in enhancing our systems and procedures and addressing issues in their application.
"We accept that our efforts with regard to substantive analytical review have not been sufficiently effective and as noted in the report we have taken further action this year. The effectiveness of this action will be a focus of our 2011 quality performance review process and we will take further steps where necessary."
BDO urged to avoid cross-selling
The audit inspection unit has called on BDO to ensure that its growth does not lead to a culture where partners and staff sell non-audit services to its audit clients.
The inspectors' reports said that, of the eight audits inspected, significant improvement was needed in one. This was in relation to the sufficiency of audit evidence obtained for loans payable and receivable and related parties. Four of the audits were performed to a good standard with limited improvements required, and three were performed to an acceptable standard.
It recommended that BDO should be alert to issues caused by the cross-selling of non-audit services. The firm should "ensure that the emphasis on growth does not lead to a culture within the firm where there is an inappropriate focus by partners or staff on the cross-selling of non-audit services to their audit clients, including in the setting of individual objectives", the report said.
There were reoccurring problems regarding the audit of disclosures, the inspectors said, including inadequate supporting evidence. The identification of risks also failed to show adequate improvement having been highlighted the previous year.
The firm should also review its audit of related party transactions, the report said. This included adequately scrutinizing the terms of a loan to related parties and whether transactions are on an arms length basis.
BDO was praised for linking audit quality and partner appraisals and remuneration, especially factors relating to professional scepticism exercised. The firm has also addressed issues around client acceptance and continuance procedures, relationship partners and its audit methodology.
The firm said: "It is pleasing to note from the report that we place much emphasis on audit quality and that we have appropriate policies and procedures in place for our size and the nature of our client base."
Grant Thornton slips in biennial audit review
Two of Grant Thornton’s audits "require significant improvement", according to Audit Inspection Unit's most recent report, a significant decline from the last review when none fell into this category.
A spokesman agreed that "on a purely numerical basis, the figures don't look positive". Two of the ten audits examined were "good", while six were "acceptable", the same as in the last AIU report.
Professional scepticism was found to be lacking, especially in the areas of asset impairment and valuation and going concern.
The firm failed at times to fully challenge management's explanations and key assumptions, and should consider whether more needs to be done to address recurring issues identified by the AIU, the report warned.
GT at times failed to obtain sufficient evidence to support audit conclusions, especially when valuing properties held at fair value, and in relation to budgeted cash-flows.
Half of the audits "required improvement" on work related to going concern, and six of the ten had "deficiencies" in their substantive analytical review procedures.
A lack of scepticism may also have been behind insufficient testing of journal entries. This was despite the fact that the audit team had found weaknesses in the controls over journals, meaning there was a heightened risk of misstatement.
Head of assurance Phil Crooks said recommendations from the most recent AIU review "have not had time to fully impact on audits [examined] for this report", but insisted the firm has addressed many of the issues it identified.
The AIU said reporting to audit committees was generally "timely and of an acceptable standard", as were finalisation procedures, although there were occasional breakdowns in communication.
It was pleased with improvements to GT's internal monitoring of audit quality, with fewer reviews being carried out in greater depth. However, audit partner rotation remained of concern, and there were issues surrounding audits of multinational groups.
GT said it was "naturally disappointed" at the AIU's negative findings, and pointed to its recent audit awards wins, concluding "we keep our audit procedures under constant review".
Source: Accountancy Age
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