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Smaller companies' audit quality continues to suffer

The UK's Financial Reporting Council (FRC)'s annual audit quality review (AQR) has found the audits of smaller clients are far more likely to require significant improvement than those of their listed counterparts, according to data published today.

The review for the year ended 31 March 2015 included 126 audit engagements, 103 of which conducted by major firms, including Deloitte, EY, KPMG, PwC, Baker Tilly, BDO, Crowe Horwath, Grant Thornton and Mazars.

In particular, the Big Four accounted for 78 of the total audits reviewed, with 20 carried out by Deloitte, 16 by EY, 20 by KPMG and 22 by PwC.

Areas of concern include insufficiently questioned assumptions, inappropriate procedures and failure to identify threats.

Overall, the picture was one of continued long-term improvement, with 67% of audit work assessed classified either as good or as requiring limited improvements, an increase on the 60%, 59%, 46% and 48% of the previous four years.

However, listed companies outside the FTSE 350 accounted for the largest proportion of audits the FRC assessed as needing significant improvement in the last five years.

In particular, the latest review showed large private and LLP clients received 47% of the audits identified by the FRC as requiring significant improvement.

According to the FRC, "These results indicate that there continues to be a correlation between the size of the entity and our findings, with a higher proportion of smaller entity audits assessed as requiring significant improvements."

The review described the findings as in line with "wider concerns within the FRC in respect of the quality of financial reporting by smaller listed and AIM companies."

By contrast, only 7% of FTSE 350 audits were found to require significant improvement, a result "consistent with our general view that FTSE 350 audit work we inspect is of a higher standard than that of other auditors," according to the FRC.

The FRC also said it is close to issuing an overall report on the first phase of an April 2014 project aimed at catalysing "a step change in the overall quality of financial reporting" by smaller listed companies.

The report is expected to include data on the root causes underpinning the relatively poor performance of smaller listed companies' audits, as well as "suggestions as to how those involved in the reporting by smaller listed companies can be better supported to
deliver improvements in quality."

Key findings of the inspection, included in the AQR, identified several areas for improvement, including clearly defining responsibilities, potentiated technical reviews, heightened training and experience thresholds, greater focus on cash-flow statements and improved communication with audit committees.

Despite the overall trend of long-term improvement, issues previously identified as a cause for concern in audit quality by the FRC continue to affect a significant proportion of audits.

TherReview found the factors contributing to audits being assessed as requiring significant improvement formed a range, "with no specific themes discernible".

In one case, the audit was found to have suffered from "an inadequate assessment of the self-interest threat arising from the provision of non-audit services", while in another auditors were found to have used the wrong auditing and ethical standards according to UK
audit regulations.

Moreover, the cases identified as requiring significant improvement did not appear evenly distributed among the major audit firms inspected; while two firms counted two cases each, a third firm counted three.

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