The regulator looked at 22 individual audits performed by Deloitte in 2015/16, of which 18 were held to be good with limited improvements needed, while four were judged to require improvement.

The report highlighted a number of issues regarding the extent to which audit teams challenged management, particularly in the assessment of impairment. These included applying a discount rate without any risk adjustment for individual Cash Generating Units (CGUs) and comparing value in use to the carrying value of goodwill rather than the carrying value of the whole CGU and the appropriateness of the determination of CGUs.

The FRC was also unhappy about insufficient challenge of management’s assessment of indicators of potential impairment such as planned closures, declining profitability and carrying values exceeding market valuations.

The report identified instances where there was insufficient evidence of the challenge of certain key assumptions included within management cash flow projections, such as growth rates and discount rates, or the assumptions used by external valuers in determining property valuations.

Revenue recognition was identified as a significant risk area for all audits the FRC reviewed in this cycle. In its assessment of Deloitte’s audits, it found instances where there was insufficient justification of why the risk was assessed as limited to only a small portion of revenue or an individual revenue assertion, and cases where there were questions over the accuracy of the classification of revenue streams, and whether revenue was being recognised in the correct accounting period.

There were some similar concerns over areas of inventory valuation, with the FRC finding instances where the assessment of significant risks was limited to only a small proportion of the inventory balance. The FRC said that on some audits Deloitte showed deficiencies in the testing performed to assess whether inventory was held at the lower of cost and net realisable value. There were also cases where insufficient consideration had been given to the use of sampling across non-homogenous inventory populations.

The report flagged up the need for Deloitte to improve communications with audit committees, saying it had found examples of inadequate communication of changes in the audit strategy and audit procedures performed, or of the reasons for changes, compared to the planning information previously communicated to the audit committee.

In addition, the regulator said at times Deloitte did not provide sufficient explanation of the threats arising from non-audit services and related safeguards, and had also failed to give a clear explanation of differences between the methodology, key assumptions and judgments adopted by the firm’s actuaries compared with those used by the entity’s own actuaries.

The AQI report drew attention to a number of concerns on audit work relating to defined benefit pension scheme balances and disclosures. These included insufficient evidence of procedures carried out to check on the accuracy and completeness of membership data or to verify employer contributions, and insufficient evidence that an appropriate assessment had been undertaken of the risks associated with a new investment strategy and whether these risks were adequately disclosed in the financial statements.

The report indicates the FRC believes Deloitte needs to strengthen its policies and procedures regarding the engagement quality control review process, or risk failing to spot deficiencies in the audit work undertaken or the judgments made in key audit areas.

Deloitte amended the structure of its Professional Standards Review (PSR) function during the period covered by the inspection, making it an integral part of the Engagement Quality Control Review (EQCR). An independent review of the financial statements is performed by the EQCR and other members of the PSR team.

However, the FRC raised some concerns about these arrangements, highlighting that the output of the EQCR and PSR reviews is not retained. On a number of audits reviewed there was, therefore, insufficient evidence of appropriate challenge of audit teams. In addition, there is no requirement for PSR reviewers to confirm that they are independent of the audit team, while the pre-issuance reviews of the financial statements of the firm’s highest profile audits are undertaken by the PSR team with no involvement of the firm’s accounting technical specialists.

In its response to this last point, Deloitte said it has introduced an additional technical review of financial statements for audits which display certain risk characteristics.

As regards the FRC’s other comments, Deloitte stated in the response included in the report: ‘Throughout our training, methodology and work we emphasise the critical importance of challenging management in areas of judgement. This has been, and will continue to be, at the very heart of our work’.

The firm said it has implemented additional learning associated with the challenge of management in areas of judgement including all the matters identified as specific examples. In addition, it is enhancing the guidance on the content and timing of communication with audit committees and the evidence of the outcomes of discussions and meetings.

Deloitte also reported that it has reinforced the procedures audit teams should be performing in the area of defined benefit pension scheme balances in corporate entities, including the need to evaluate the accuracy and completeness of data provided by management to actuaries, and the required level of control over the custodian confirmation process.

Stephen Griggs, managing partner for audit at Deloitte, said: ‘We share the FRC’s objective to promote improvements in the quality of auditing and welcome this report. The report provides a balanced view of the focus and results of the AQR’s inspections and it is an accurate reflection of our efforts to improve audit quality across our practice over a number of years.’

According to the AQI report, Deloitte audited 388 UK entities as at 31 December 2014, including 172 listed companies. This includes 21 FTSE 100 companies and 66 FTSE 250 companies.

The FRC AQI report 2015/16 for Deloitte is here