Executive Summary
We are pleased to present our Annual Quality Monitoring Report for 2020. This covers the work of local auditors appointed by PSAA for the 2018/19 financial year, the first under the appointing person arrangements. This report is later than intended because the impact of the Covid-19 pandemic has delayed the completion of the professional regulators’ work.
PSAA is committed to good quality audit services being provided to its opted-in bodies. PSAA has adopted the International Auditing and Assurance Standards Board’s Framework for Audit Quality (IAASB framework) as the model for its appointing person audit service quality monitoring arrangements. This is widely regarded as a definitive statement on overall audit quality. The IAASB framework recognises there is a complex interplay of many factors in audit quality and notes the need for a rounded approach. We have taken the attributes that IAASB Framework expects to be present within a quality audit and distilled them into three tests which we use to monitor the quality of audit services provided by auditors under our contracts:
- Adherence to professional standards and guidance;
- Compliance with contractual requirements; and
- Effective relationship management.
Local audit has had to adapt and respond to a number of significant pressures and challenges over the recent period. High profile corporate failures have led to unprecedented scrutiny of auditors and their regulators, with three government initiated reviews of corporate audit and reporting (Kingman, Competition and Markets Authority, and Brydon) all of which will impact significantly on the firms that currently provide local audit services. Unsurprisingly local audit is facing similar challenges and in September Sir Tony Redmond published his independent review for MHCLG of the effectiveness of local audit and the transparency of local government financial reporting. He drew attention to many of the significant challenges and the unprecedented turbulence which exist in the current local audit system highlighting that at present local government audit is under-resourced and under-valued and is not having sufficient impact. The Government published its response to the review on 17 December, identifying that further work was required to refine the recommendations that had been made.
Adherence to professional standards and guidance
Information on the quality of local audit work in this report comes from the reports provided by the audit regulators, the Financial Reporting Council (FRC) and the Institute of Chartered Accountants of England and Wales (ICAEW). The FRC issued its audit quality inspection report (FRC report) containing the results of its audit quality inspections of 2018/19 engagements on 30 October 2020. It also included the results of reviews undertaken by the Quality Assurance Department (QAD) team of the ICAEW, and firms’ own internal quality monitoring arrangements. We note that the scope of the report covers the whole of local audit, including those not opted-in to the PSAA appointing person arrangements and NHS bodies, but our judgement is that we are able to use the findings to inform our contract monitoring arrangements.
FRC reviews
The FRC is the primary regulator, and it reviewed the audits of 15 of the 271 bodies that meet the major local audit definition (Expenditure in excess of £500 million), 10 local authorities, two other local government bodies and three from the NHS, focusing in particular on audits with ‘higher risk attributes’. The report sets out that nine financial statements audits (across four of the seven firms reviewed) did not meet the required standard (which is being assessed as ‘1 – good’ or ‘2A – limited improvements required’) for their work on financial statements, and that accordingly urgent action is required by the relevant firms to address the issues concerned; but the results at some of the reviews at some individual firms were encouraging with no more than limited improvements identified.
The FRC report commented specifically on three firms where it reviewed more than one engagement, those with the largest share of major local audits. The FRC reviewed six GT financial statement audits: one was assessed as meeting the required standard, and five as 2B (improvements required). The FRC reviewed two Mazars financial statements audits which they assessed as 3 (significant improvements required). All EY’s audits reviewed by the FRC were assessed as meeting the required standard (no more than limited improvement). Two of the remaining four firms inspected (BDO, Deloitte, KPMG and PwC) had audits that required more than limited improvement although these were not named by the FRC.
The FRC report highlights that the quality of audit work on property valuations continues to be its greatest concern and that firms must focus on improvement, some of them urgently. Other areas of concern include the audit evidence for debtor balances, the audit response to fraud risks relating to journals and expenditure, the Engagement Quality Control review process, auditing estimates, and the audit of pension fund assets.
The main areas of concern highlighted by the reviewers have been raised in previous reports. Whilst auditors have responded by increasing their coverage of these areas the FRC report states that some firms still need to do more if its professional expectations are to be met.
We are pleased that the FRC’s reviews found that the quality of VFM arrangements conclusion work across all firms remains high, with all 15 reviews meeting the standard. The new Code of Audit Practice will change the scope of the VFM arrangements work from 2020/21 onwards.
ICAEW reviews
The FRC report also includes the findings of both the ICAEW reviews of audits of bodies that do not meet the MLA definition, and the firms’ Internal Quality Monitoring (IQM) reviews of audits.
The ICAEW reported that 11 of the 12 financial statement audits that they reviewed across all firms met the required standard, along with all of the associated VFM arrangements work.
The IQM results covered 29 individual audits of which 12 related to major local audits. 19 audits were considered to be of a good or limited improvements standard (nine for major local audits), eight were assessed as requiring improvement and two audits were classified as needing significant improvement.
The FRC report cited some good practice examples such as the increased use of internal specialists for property and pension valuation, improved workpapers to record evidence of challenge of management and better risk assessments for VFM arrangements work.
We will follow up the results and resulting action plans of all firms to get assurance that the FRC’s concerns are being actively addressed. We are aware that firms have taken steps to respond to the findings by updating their work programmes.
Effective relationship management
We surveyed all of our 2018/19 Section 151 officers and Audit Committee Chairs to judge the effectiveness of relationships between bodies and their auditors. We received responses from 193 (40%) Section 151 officers and 75 (15%) Audit Committee Chairs. For 80% of respondents the audit service provided had met their expectations.
The survey also highlighted the known tensions in local audit around resourcing and the topics of specific audit focus.
We have provided firms with details of the anonymised analysis of survey responses to enable them to develop tailored improvement plans where appropriate. Communication is the area where most improvement can be made with delays in reporting the need for an audit deferral or a fee variation highlighted in responses.
Compliance with contractual requirements
The biggest disappointment for 2018/19 engagements was the very large number (208, 42%) where an opinion was not given by the publishing date of 31 July 2019 set out in the Accounts & Audit Regulations. This compares to 2017/18, the first year with a 31 July deadline, when 65 (13%) opinions were delayed beyond the publishing date. In order to comply with auditing and ethical standards there is no statutory or contractual requirement date for an audit opinion to be provided by the publishing date.
The causes of the delays were identified by auditors as a broadly equal combination of:
- Resourcing issues;
- Dealing with technical audit and accounting issues; and
- Poor quality working papers provided by authorities.
The third of instances where firms did not have sufficient staff to undertake particular audits is symptomatic of the vulnerability that has developed in the local audit market, and the lack of trainees and qualified staff with the appropriate knowledge to undertake this work.
We note that firms are prioritising technical audit quality. The report from the FRC commended a decision to delay reporting where there were significant concerns over areas of audit judgements. Similarly, in a thematic review of Audit Quality Indicators published in May 2020, a firm’s decision to defer audit work until it had appropriately experienced resources in place was given as a case study illustrating where an action had prevented poor audit quality.
Overall
We are disappointed with the results of the professional regulatory reviews of financial statement work, with only 62% reviewed assessed as requiring no more than limited improvements. In contrast all VFM arrangements work inspected met this standard. We have discussed with the firms their plans to address the matters raised by the professional regulators.
The fragility of the local audit market supply was exposed by the proportion (broadly one third) of delayed opinions where audit firms acknowledged that audit resourcing issues were a significant contributory factor. We commissioned a report from Touchstone Renard (TR) in March 2020 to better understand the stresses on the system. The TR Report was submitted as evidence to the Redmond Review.
Our client survey identified that there are improvements that firms can make in their communications with clients. For 2019/20 we requested firms to engage early on key issues such as where they believed that a fee variation would be required or a change to the audit timetable was needed.
The IAASB framework notes that all parts of the financial reporting supply chain have a role in contributing to and encouraging an audit environment that supports high quality audits. We will continue to work with regulators, auditors, finance staff and those charged with governance to improve audit quality. Meeting the challenges posed within the Redmond Review will form part of that work.