The FRC reviewed 23 individual audits undertaken by Deloitte in 2016/17, of which the majority (18) were ranked as good or requiring limited improvements while three required improvements (13%) and two required significant improvements (9%), up from zero the previous year.

The issues requiring significant improvement focus around the firm challenging management’s impairment model and key areas of audit such as revenues and costs; contingencies and perpetuity growth rates. There were also weaknesses around reporting revenue and accrued income.

The report highlighted issues around the extent to which audit teams challenged management, especially regarding impairment reviews and valuation of acquired intangible assets. The same issue was addressed as a key finding by the FRC in 2015/16, with the FRC expressing concern with the number and significance of the issues that are still arising in this area, particularly over goodwill impairment reviews.

In response Deloitte said: ‘We took immediate action when it became apparent that we needed to enhance our audit procedures in the area of goodwill and intangible assets despite our focus on the audit of management estimate since our 2016 summer technical training.’

The FRC identified instances where there was insufficient challenge of management over the competence of an impairment model which contained a high level of contingencies and where there was little response to known budget inaccuracies.

Revenue recognition

Revenue recognition was also highlighted as a problem area, with inspectors stating that differences identified between expected and actual revenue figures were not always investigated and management’s explanations were not upheld by evidence.

Deloitte identifies revenue recognition as a critical focus going forward and has begun to address problems with revenue recognition reporting by auditing larger sample sizes with the firm enhancing its risk assessment procedures. It its response to the AQI report, Deloitte said: ‘This included the removal of capped sample sizes for very large balances and facilitation of a combination of test of details and substantive analytical procedures to enable more comprehensive audit responses to be designed.’

The Big Four firm has invested in analytical tools to help with the audit of revenue and is aligning its training on the accounting and audit of revenue as it prepares for the implementation of IFRS 15 Revenue from Contracts with Customers, which is effective for periods beginning on or after 1 January 2018.

In last year’s report, the FRC pulled up Deloitte on a number of concerns relating to defined benefit pension scheme balances and disclosures, which included insufficient evidence of procedures carried out to check on the accuracy and completeness of membership data or to verify employer contributions as well as assessing risks associated with new investment strategy.

This year Deloitte has been warned on its audits of defined pension scheme balances, concerning material reduction in a pension deficit and not obtaining confirmation of investments from scheme upholders.

The FRC has recognised that Deloitte has made efforts to address last year’s concerns but further action is needed. Deloitte said: ‘We note the matters raised relate to the audit of pension balances within corporate entities and not to our audits of pension schemes themselves.

‘We have improved our procedures to ensure confirmations are obtained from asset custodians where appropriate.’

Audit Committee communication

In its AQI report the FRC states: ‘We reported last year on a need to improve the quality of communications with audit committees on certain audits; but also that we had seen a number of examples of good quality communications on other audits. We again saw both examples of good quality communications and cases where improvements were needed in this area.’

The FRC found that Deloitte was not always communicating about key areas of judgment with audit committees, in particular in relation to impairment assessments and pension balances and lacks clarity regarding the reporting on auditing revenue.

Deloitte said: ‘There is a natural follow-on that if there is a failure in the underlying audit work we will inevitably fall short in our reporting on those areas

‘We will continue to stress the critical importance of reporting matters to the audit committee in the training we deliver and in the enhanced procedures we have established, in particular around key management estimates and judgments.’

On a positive note, Deloitte was commended by the FRC on its high quality reporting to the audit committee in relation to property valuations.

The quality of Deloitte’s audit teams planning and risk assessment procedures, particularly in significant risk areas, and their level of interaction with other auditors working on the project was highlighted as an example of good practice.

The firm was also found to effectively audit key management judgments in relation to uncertain tax provisions, which included the use of tax specialists.

In response to the AQI’s findings, Deloitte said: ‘We were disappointed that, despite the high standards we set and many areas of improvement in our quality record, the percentage of audits rated as requiring more than limited improvements has remained broadly similar to the previous year and that two reviews resulted in those audits being scored as requiring significant improvement.’

According to the AQI report, Deloitte audited 366 UK entities as at 31 December 2015, including 251 listed companies. This includes 19 FTSE 100 companies and 61 FTSE 250 companies. 

Deloitte's AQI report is here:  deloitte_llp_-_audit_quality_inspection.pdf.