Audit Quality Monitoring Report 2019/20

Adherence to Professional Standards and guidance

Information on the firms’ adherence to professional standards and guidance comes from the results of professional regulatory reviews completed by the Audit Quality Review team (AQR) for the Financial Reporting Council (FRC) and the Quality Assurance Department (QAD) for the Institute of Chartered Accountants in England and Wales (ICAEW), the principal Recognised Supervisory Body (RSB) for local audits in England.

The AQR reviews a sample of the largest local government and NHS audits. These are known as ‘major local audits’ and are those bodies with income or expenditure above £500 million. The QAD reviews a sample of local audits that fall below this threshold. The regulatory reviews covered both financial statement and VFM arrangements work. The publicly reported results cover local government and police bodies which have not opted-in to the PSAA appointing person arrangements as well as NHS bodies. However, our judgement is that we are able to use the findings as reported to inform and support our contract monitoring arrangements.

The professional reviews focus on identifying areas where improvements are required and individual ratings will reflect a wide range of factors, which may include size, complexity and risk of the individual audits selected for review. The FRC notes that because of this and the small non-statistically valid nature of the review sample, the inspection findings may not be representative of audit quality across a firm’s entire major local audit portfolio. Nonetheless, any inspection cycle which identifies audits requiring more than limited improvements is a cause for concern and indicates the need for a firm to take action to achieve the necessary improvements.

The FRC issued its audit quality inspection News I Financial Reporting Council (frc.org.uk) (FRC report) containing the results of its audit quality inspections of 2019/20 engagements on 29 October 2021. This contained the results of its reviews, those of the ICAEW regarding non-major Local Audits, and also the firms’ own internal quality monitoring. This provided the results of 61 audit file reviews, although VFM arrangements work was not reviewed in every case.

In January 2022 the FRC reported that they had fined Mazars £250,000 in relation to a 31 March 2019 year end audit. The FRC considered that it was necessary to impose a sanction to ensure that Mazars’ Local Audit Functions are undertaken, supervised and managed effectively. The FRC had previously reported the grade of this inspection in their 2020 report. The FRC’s 2021 report, as noted above, concluded that the audit quality results of their inspection of four Mazars’ audits showed significant improvement compared to the prior years. All the audits were assessed as requiring no more than limited improvement. The FRC commented that these results reflect positively on the efficacy of actions that the firm has taken in response to previous quality issues but highlighted the need to maintain a focus on audit quality and ensure this standard is achieved on future inspections.

Financial Statements

Auditors are required to give an opinion on whether the financial statements of an audited body give a true and fair view of its financial position and of its income and expenditure for the period then ended. They have other reporting responsibilities with respect to the preparation of the financial statements, the remuneration report and other information published with the financial statements.

The FRC reported an improvement in the number of audits requiring no more than limited improvement compared to the number of such audits identified in the 2018/19 report. They concluded that whilst this is encouraging it is imperative that the firms work to build on this progress to ensure the observed improvement is both permanent and continuous.

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 nine Grant Thornton (GT) financial statement audits: six were assessed as meeting the required standard, and three as improvements required. This is an improvement on the previous year where only one of six GT audits met the required standard. The FRC reviewed four EY audits, of which one was assessed as improvements required. Four Mazars financial statements audits were reviewed and assessed as meeting the required standard. This is an improvement on the previous year where the two audits reviewed were assessed as ‘significant improvements required’. Two of the remaining three firms inspected (BDO, Deloitte, and KPMG) had individual audits that required more than limited improvement, but the FRC did not indicate which firms they were.

Firms are required to perform a full Root Cause Analysis (RCA) for each audit assessed as requiring more than limited improvement. This should help establish the reasons for individual instances of inadequate audit quality and how consistently high audit quality might be achieved.

As in previous years key audit quality findings relate to challenge and corroboration of the valuation of properties (council dwellings, specialised properties and investment properties), particularly evaluating and challenging the underlying valuation assumptions.

Other key findings highlighted for improvement include strengthening audit procedures to test the accuracy and occurrence of expenditure, improving evidencing of consultations such as technical panel discussions, and concluding on modified opinions.

The FRC reported that improvements had been made in the testing of journal entries, but that this had still to be applied consistently across all audits: No key findings were reported in respect of the testing of journal entries, but limited improvement requirements were noted at nine audit inspections.

We noted from the FRC’s report that their risk-based review scope included matters of particular interest to local government audit including the exercise of auditor’s additional powers and duties, disclosure of senior officer remuneration and the adjustments between the accounting and the funding base such as minimum revenue provision.

Table 3 shows the results of this year’s inspection reviews together with those from earlier years completed under PSAA’s initial post-Audit Commission remit in respect of transitional arrangements which included firms’ internal quality monitoring results moderated by PSAA.

Table 3: Financial statements – inspection review gradings 

Results of the reviews completed by engagement year.

*sample includes NHS and other bodies not within the PSAA contract
#sample includes internal quality monitoring results

Source: FRC audit quality inspection reports

The sampling methodology used means that changes in ratings from one year to the next are not necessarily indicative of any overall change in audit quality. Nevertheless, any inspection cycle which reveals audits requiring more than limited improvements is a cause for concern and indicates the need for a firm or firms to take action to achieve the necessary improvements. However, assessing an audit as needing improvement or significant improvement does not necessarily mean either that the audit opinion was incorrect or that the financial statements were materially misstated.

Following each review the FRC sent a private report to each Audit Committee Chair, with a follow up meeting (at the discretion of the audited body). The FRC plans to meet further with those chairs where the quality of the audit was assessed as requiring more than limited improvement. We welcome the FRC involving Audit Committee Chairs in the process.

As part of their review of the firms the FRC also considered:

• RCA and audit quality initiatives;
• audit training and methodology;
• Engagement Quality Control (EQC) review; and
• prior period adjustments.

The FRC reported improvements at individual firms being clearly linked to the implementation of audit quality improvement programmes. Individual firms were encouraged to ensure that practitioners complete required mandatory training on a timely basis, increase the amount of mandatory training that auditors are required to undertake, and train local auditors how to effectively evaluate key assumptions in investment and operational property valuations. Firms were also encouraged to maintain focus on the robustness of EQC reviews, and in responding to prior period adjustments caused by material error.

The FRC report did highlight a number of specific examples of good practice including in some of the areas where they have raised concerns previously. Such examples included:

• response to revenue recognition risk by considering individual material revenue streams;
• use of an auditor’s expert to assist with the audit of complex high-risk property valuations;
• challenge of management’s property valuer in respect of unreported material valuation uncertainties; and
• appropriate and robust responses to audit findings;
  • delaying issuing audit report until appropriate evidence obtained and evaluated;
  • insisting on relevant uncertainty disclosures; and
  • responding to control deficiencies identified by internal audit.

Value for money arrangements

Auditors are required to give a value for money (VFM) arrangements conclusion as to whether the audited body has made proper arrangements for securing economy, efficiency and effectiveness in its use of resources.

We are pleased that the assessments of VFM arrangements work have continued to show that this is meeting required standards. Both the FRC and the ICAEW reported for all reviews that the audit work to support the VFM arrangements conclusion met the required standard (Table 4).

Table 4:  VFM arrangements – inspection review gradings

Results of the reviews completed by engagement year.

*sample includes NHS and other bodies not within the PSAA contract
#sample includes internal quality monitoring results

Source: FRC audit quality inspection report

2019/20 was the last year of engagements under the 2015 Code of Audit Practice. The new Code of Audit Practice applies from 2020/21 onwards and seeks to address widespread concern that a binary VFM conclusion is of limited value to the bodies. The new Auditor’s Annual Report will provide a commentary on a body’s VFM arrangements, which provides scope for more tailored and forward-thinking observations.

Transparency Reports

The FRC’s Local Auditors (Transparency) Instrument 2015 requires firms that conduct major public audits to report annually on information specific to their local audit responsibilities and includes:

• a statement on the effectiveness of the functioning of internal quality monitoring arrangements in relation to local audit work;
• a description of independence procedures and practices, including a confirmation that an internal review of independence practices has been conducted;
• a statement on the firm’s policies and practices to ensure that Key Audit Partners continue to maintain their theoretical knowledge, professional skills and values at a sufficiently high level; and
• confirmation that all engagement leads are competent to undertake local audit work and staff working on such assignments are suitably trained.

The Transparency Reports published by firms in December 2020 provide information on the results of regulatory reviews of 2018/19 engagements and the responses of firms to the matters raised. Some firms produce a specific ‘Local Audit’ Transparency Report, whilst others adopt the practice of publishing a firm-wide Transparency Report. Transparency Reports can be found on firms’ websites.

We found that the required disclosures were contained within each contracted firms’ Transparency Report, but these were not always clear. Arguably it is more helpful for local audit stakeholders if a separate report is produced covering ‘Local Audit’ requirements or, if a combined firm-wide report is produced, the matters relating to Local Audit are clearly delineated.

The reports also present an opportunity for the firms to:

• provide relevant, reliable and useful information that facilitates engagement between firms and users of financial information;
• communicate a balanced self-assessment of the challenges the firms face in relation to audit quality and the effectiveness of their actions to overcome them, including how the independent non-executives at the firms have assessed this; and
• promote confidence (where warranted) in their systems, processes and governance to engender public trust.

The reports also documented how audit quality was taken account of in partner and employee remuneration packages.

We noted that the Transparency Reports highlighted where firms had received ‘unsatisfactory’ reviews from the regulator, both in terms of the response to audits being judged as requiring significant improvement, or where the FRC had taken measures against the firm.

Back to top