U.K. audit regulator rips quality at major firms

Audit regulators in the United Kingdom have taken off the gloves in their assessment of audit quality among the major firms, especially the Big 4.

The U.K. Financial Reporting Council issued inspection reports on all the major firms assailing them for a decline in audit quality and calling for swift, significant improvement to achieve regulatory targets. The report even singles out KPMG as turning out “an unacceptable deterioration in quality.”

Across the eight largest firms, including the Big 4, the FRC says its 2017-2018 inspection cycle identified 72 percent of inspected audits as requiring “no more than limited improvements,” which fell from 78 percent in the prior year. Among audits of larger companies, the top 350 companies listed on the Financial Times Stock Exchange, the FRC says only 73 percent required no more than limited improvements compared with 81 percent the year before.

The FRC says quality fell as a result of “a number of factors,” including a failure on the part of auditors to challenge corporate management, and a failure to exercise appropriate levels of skepticism. The results are especially concerning to the FRC in its review of bank audits, the report says.

“At a time when public trust in business and in audit is in the spotlight, the Big 4 must improve the quality of their audits and do so quickly,” said Stephen Haddrill, CEO of the FRC, in a statement. In addition to challenging management and exercising skepticism, the FRC is looking for more improvement in group audits and in the audit of pension balances, he said. “Firms must strenuously renew their efforts to improve audit quality to meet the legitimate expectation of investors and other stakeholders.”

In terms of specific firm results, the FRC says it found 61 percent of KPMG’s audits to require limited or no improvements compared with 65 percent the year before. Among FTSE 300 audits, the approval rating was only 50 percent compared with 65 percent the prior year. The FRC has set a target rate of 90 percent for all the firms to achieve by its 2018-2019 inspection cycle. “The overall quality of the audits inspected in the year, and indeed the decline in quality over the past five years, is unacceptable and reflects badly on the action taken by the previous leadership, not just on the performance of front line teams,” the FRC wrote in KPMG’s report.

KPMG said the work inspected by the FRC focused on 2016 year-end engagements, which predate corrective measures the firm has since taken. The firm says it initiated in October—when Michelle Hinchliffe assumed her post as head of audit at KPMG in the U.K.—a new “audit quality transformation program.” It includes greater support to engagement teams, increased central monitoring, and new audit partner development approaches.

“We want all of our audits, regardless of size, to meet the highest standards set by the audit quality review,” said Hinchliffe in a statement. “We cannot and will not be satisfied with these results and, as a firm, we are already working to put this right.”

In the United States, KPMG has also taken it on the chin from the Public Company Accounting Oversight Board, turning out the worst inspection results of the Big 4 firms. KPMG replaced U.S. audit leaders in 2017 when they were accused of gaming the inspection outcomes by using fraudulently obtained confidential inspection information. The PCAOB has not yet published its most recent inspection report for KPMG.

At EY, the FRC gave a passing grade to 67 percent of audits compared with 88 percent the year before. “This is a disappointing outcome in comparison to the progress made in the previous two years,” the FRC said. PwC’s passing grade fell from 93 percent in the 2016-17 inspection cycle to 82 percent in the most recent cycle, and Deloitte’s passing score fell from 78 percent to 76 percent.

Hywel Ball, EY’s UK head of audit, said in a statement the firm is committed to meeting the FRC’s quality targets for 2019. ““We continue to make significant investments in audit quality and established a long-term audit quality program and a dedicated audit quality board in the UK four years ago, which are aligned to the steps we have taken globally,” said Ball. “We continue to invest in new technology, data analytics software and training for our people, as well as performing detailed ‘root cause’ analyses of our best audits and areas identified for improvement.”