The Financial Reporting Council (FRC) is calling on the UK's biggest firms to improve their independence and ethical procedures, amid concerns about the current 'boilerplate' approach.
In its Audit Quality Inspection Annual Report for 2012/13, the FRC says it has Identified 'a number of specific issues relating to compliance with the requirements of the ethical standards' across all firms.
These included references to targets for the cross-selling of non-audit services to audited entities in partner appraisal documentation; failure to consult the ethics partner on the appropriateness of contingent fee arrangements for certain tax services; key partners involved in the audit from other network firms not being identified as such or monitored for potential rotation; and instances where shareholdings in audited entities were not disposed of on a timely basis.
FRC wants firms to review their procedures and staff training, and says audit committees need to ensure they take auditor independence into account when putting audits out to tender. It also says it is undertaking a review of recent director appointments across an extensive sample of FTSE 350 and other listed companies to identify any further instances where there may have been a breach of the ethical standards.
In the report, FRC warns there needs to be further improvement in the auditing of financial services companies, noting that fewer banks and building societies have been given the top grade for their audits compared to the overall sample over the last five years. It says firms should strengthen their testing, particularly in respect of loan loss provisioning and general IT controls.
The regulator also raises concerns over the audit of so-called 'letterbox companies', which are registered in one country but where all management and economic activity takes place elsewhere. The FRC says there is a lack of 'appropriate control, supervision and review' of the work outsourced to component auditors in such cases, and wants group auditors to step up their controls.
This year's report indicates an improvement in the overall standard of audit work, particularly in the audits of FTSE 350 companies, where 59% of audits were categorised as good or acceptable, up from 46% in 2011/12. However, the proportion of audits assessed as requiring significant improvement rose to 15% from 10% the year before. The majority of these were for organisations outside the FTSE 350, but among those judged as inadequate were two smaller building society audits.
FRC has announced changes to the frequency of its inspections of individual firms. The Big Four will continue to be assessed annually, and BDO and Grant Thornton will still be inspected every two years, but inspections of Baker Tilly, Crowe Clark Whitehall and Maars will now be undertaken every three years.
From next year, FRC will also pass responsibility for inspecting 50 or so firms with 10 or fewer audits that come within its scope to the monitoring units of the professional accountancy bodies responsible for registering these firms. It says this move will allow the FRC to devote more resources to the inspection of the largest audits.
For this year's report FRC looked at 111 audits, including the audits of 33 FTSE 350 companies and 52 other full listed companies, as well as 26 public sector and follow-up reviews. In 2013/14 the regulator plans to expand inspection activities to include two thematic inspections relating to aspects of the audit of fraud risks and compliance with laws and regulation, and to audit materiality.
