Audit Quality Monitoring Report 2020/21

Adherence to Professional Standards and guidance

8. 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 Recognised Supervisory Body (RSB) for local audits in England.
9. The AQR inspects a sample of the largest local government and NHS audits. These are known as ‘Major Local Audits’ (MLAs) 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 inspections cover both financial statement and VFM arrangements work. The publicly reported results cover all local government bodies, including those 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 general findings as reported to inform and support our contract monitoring arrangements.
10. The regulatory 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. It follows therefore that they are not expected to be representative of all audits undertaken in the local government and NHS sectors. 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.
11. On 28 October 2022, the FRC issued its Local Audit Inspection Report (FRC report) containing the results of its audit quality inspections of engagements completed in 2020/22. 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. This provided the review results of 57 financial statement audit and 40 VFM arrangements files.
12. 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 and 2022 reviews concluded that all of the subsequent Mazars’ audits inspected have met the required standard as they were assessed as requiring no more than limited improvement.

Financial Statements

13. 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.
14. This report considers the results of 2020/21 audits as far as is possible. Both the AQR and the QAD reported that due to the large, accumulated backlog of delayed opinions their inspection sample included audits from earlier years that were completed during the period.
15. The FRC report set out that 14 of the 20 financial statements audits the AQR inspected met the required standard (which is being assessed as ‘good or limited improvements required’). They noted that this proportion (70%) was the same as the prior year, and an improvement on the 46% average over the preceding three years. However, of the six audits that did not meet the required standard, three were judged as requiring significant improvement (the lowest grade), compared to none in the previous year. The FRC reported their concern at the inconsistency in the quality of audits inspected, and that the firms must review their individual quality action plans to ensure this deterioration is addressed and that consistently high-quality audits are delivered.
16. Table 3 shows the results of this year’s inspection reviews (by AQR and QAD), together with those from the previous two years (those completed under the LAAA 2014 quality monitoring arrangements.

Table 3: Financial statements – inspection review gradings 

Results of the reviews completed by review year.

*sample could include NHS and other bodies not within the PSAA contract

Source: FRC audit quality inspection reports

17. The FRC’s report provided information on all firms reviewed by either the AQR or QAD. The number of inspections at each firm varies by year.

Table 4: Financial statements – firms’ inspection review gradings

Results of 2020/21 reviews for PSAA contracted firms.

Source: FRC audit quality inspection reports

18. The AQR reviewed seven Grant Thornton (GT) financial statement audits: five were assessed as meeting the required standard, one with improvements required and one with significant improvements required. Two years ago, one of the six GT audits reviewed met the required standard. The QAD inspected eight GT audits; seven of these met the required standard with one requiring improvement.
19. The AQR reviewed four Ernst and Young (EY) audits, two of which were assessed as meeting the required standard, and two as improvements required compared to the previous year where three of four EY audits reviewed met the required standard. The QAD inspected eight EY audits; seven of these met the required standard with one requiring significant improvement.
20. The AQR reviewed three Mazars financial statements audits; all were assessed as meeting the standard, as were the four audits inspected last year. In accordance with their cyclical programme Mazars were not scheduled to be reviewed in 2022 by the QAD.
21. Two BDO audits were inspected; one was assessed as meeting the required standard, the other as requiring significant improvement. The AQR reviewed two Deloitte (DL) audits; one was assessed as meeting the required standard, the other as requiring significant improvement. Individual firm information from comparative reviews is not available. The AQR reviewed two KPMG audits; both were assessed as meeting the required standard. The QAD reviewed one audit at PricewaterhouseCoopers which was graded as meeting the required standard. In accordance with their cyclical programme BDO, DL and KPMG were not scheduled to be reviewed in 2022 by the QAD.
22. In the audits judged by the AQR as requiring significant improvement this was because the audit procedures were inadequate as they had failed to ensure that primary statements were free from material errors. Material errors were present in two sets of audited financial statements, and in the third the unadjusted audit differences reported to the Audit Committee were material. In the audit judged by the QAD as requiring significant improvement there were two material errors in the cash flow statement.
23. As in previous years key audit quality findings included the evaluation and challenge of management and management’s experts. In this year’s report insufficient procedures were identified in respect of:
    • pension fund asset valuations and investment returns; and
    • assumptions used in investment property valuations.

24. In respect of the audit judged by the QAD as requiring significant improvement the auditors needed to improve the work completed on complex property investments including classification and valuation. Other findings included the need to continue to enhance the audit procedures over expenditure and the testing of journal entries.
25. The FRC’s risk-based review scope included matters of particular interest to local government, including expenditure on services, the disclosure of senior officer remuneration, the appropriateness of capital expenditure, investment property valuation, and adjustments between accounting basis and funding basis, such as minimum revenue provision. We noted from the findings that where authorities have unusual and higher risk transactions auditors are expected to expand the depth of their audit work.
26. For each review, the AQR team have an opening meeting with the Audit Committee Chair. These provide an opportunity for the Audit Committee Chairs to highlight any areas they would like to be scoped into the inspection. Following each review the AQR team send a private report to each Audit Committee Chair, with the offer of a follow up meeting. We welcome the FRC involving Audit Committee Chairs in the process.
27. As part of their review of the firms the FRC also considered:
    • Root Cause Analysis (RCA) and audit quality initiatives;
    • Engagement Quality Control Review (EQCR) procedures, consultations and audit documentation; and
    • Audit methodology (property valuations and going concern).

28. The FRC reported that they continued to observe improvements at individual firms that were linked to the implementation of quality action plans developed from RCA. However, firms needed to ensure that the appointment of EQCR reviewers is appropriately focused on quality risks, including at non-major local audits. We are pleased to see that the FRC highlighted the need for ‘going concern audit work programmes’ to be suitably tailored to the sector.
29. The FRC report highlighted examples of good practice across the audit process, including in some areas where there were concerns elsewhere. Good practice examples included:
    • Designing audit tests to address the risks from management’s incentive to manipulate its reserves position, including fraudulent revenue recognition;
    • Use of an auditor’s expert to assist with the audit of complex high-risk property valuations;
    • Clear stratification of errors identified in PPE testing to inform the further audit work conducted;
    • Good levels of challenge and corroboration on assessing valuer assumptions including evaluation of assumptions used by management’s valuer using third party market data;
    • Responding to errors identified in testing with robust follow up, including increased testing and challenging management to recognise a prior year adjustment;
    • Use of consultation panels to consider sufficiency of audit procedures in extremely high risk situations; and
    • Clear documentation of the impact of the COVID-19 pandemic.

30. The FRC report included results from the firms’ internal quality monitoring reviews. These reviews covered 20 financial statements audits including 8 MLAs. Of these 18 were considered to be of a good or limited improvements standard (including 7 for MLAs). One MLA was assessed as requiring significant improvement and one other audit as needing improvement.
31. The firms’ internal inspection programmes generally consider the full population of both major and non-major local audits performed. The programmes’ are varied but are usually risk-based as well as structured to cover all Key Audit Partners (KAPs) over a fixed period of time. Audit files are selected for review based on a number of criteria, including risk and public interest. Reviews are supervised by the firms’ own internal quality teams.

Value for money arrangements

32. The NAO’s Code of Audit Practice applied for 2020/21, and required that auditors provide a commentary on bodies’ VFM arrangements as part of an Auditor’s Annual Report, rather than as previously a conclusion contained within the opinion on the financial statements.
33. The FRC and the ICAEW reported that, in all bar one case, they assessed that the arrangements met the required standards. One audit engagement that was reviewed by the AQR was judged as requiring significant improvement, because the evidence on the VFM arrangements audit file had not been properly compiled, reviewed or archived. Changes were made to the audit file after the AQR notified the firm of the inspection.

Table 5: VFM arrangements – inspection review gradings

Results of the reviews completed by review year.

*sample could include NHS and other bodies not within the PSAA contract

Source: FRC audit quality inspection report

34. We were pleased that in the first year of the new reporting arrangements the report highlighted examples of good practice. At four inspections the Auditor’s Annual Reports were judged to be comprehensive, well-structured, and made good use of benchmarking data. Communication was clear, including the nature of significant weaknesses identified and their impact on the entity. Additionally, the FRC report noted a joined-up audit approach at one audit with issues identified as part of the financial statement audit being further assessed for their impact on VFM arrangements. It also identified good practice with examples of a timely update to an Audit Committee when a significant weakness in VFM arrangements and been identified and the use of consultation panels to consider complex judgements. The QAD highlighted comprehensive documentation of the VFM arrangements’ risk assessment and good tailoring of improvement recommendations to reflect an impending local government reorganisation.
35. The FRC report included findings where limited improvement was required for all firms’ future consideration. These included aspects of risk assessment, reporting of significant weaknesses and the use of the findings of other regulatory inspectors.
36. The FRC report included results from the firms’ internal quality monitoring reviews of VFM arrangements work. The firms reported that of the 16 VFM arrangements reviews, 15 were of a good standard or required only limited improvements. One review was assessed as requiring improvements.

Transparency Reports

37. The FRC’s Local Auditors (Transparency) Instrument 2015 requires firms that conduct major local 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.

38. The Transparency Reports published by firms provide information on the results of regulatory reviews and the responses of firms to the matters raised. Some firms produce a specific ‘Local Audit’ Transparency Report, whilst others publish a firm-wide version. Either way they are available on firms’ websites.
39. We found that the required disclosures were contained within each of them, 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 identifiable.
40. 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.

41. 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 enforcement measures against the firm.

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