FRC review calls for early warning systems enhancement

FRC review calls for early warning systems enhancement

Tools for flagging signs of poor quality audits should be used more effectively so timely corrective action can be taken, according to a major review of their use by the Financial Reporting Council (FRC).

The FRC’s study looked at the most useful indicators of both poor and good audit quality within the UK. If used properly, Audit Quality Indicators (AQIs) are a vital tool in helping audit firms detect audits at risk of not meeting necessary standards and for Audit Committees to hold audit firms accountable.
The FRC is encouraged that these indicators are being rolled out by audit firms to highlight audits in need of remedy and to promote good practice so that this can be replicated.
However, the FRC found that most monitoring of AQIs across the largest audit firms takes place after audits are completed, rather than prior to or during the process.
A range of indicators are needed to assess the quality of audits, leading to audit firms adopting a broad approach to selecting both qualitative and quantitative indicators.
The FRC examined how audit firms are using AQIs and assessed their benefits. Across the largest six firms, it found:

  • Monitoring of AQIs is an important foundation for initiating actions and interventions to improve audit quality.
  • Firms must focus on forward-looking and granular AQIs to ensure they are identifying early interventions which could prevent deficiencies in audits.

At firms outside the largest six, two had commenced a program of monitoring AQIs. The FRC encourages other firms to follow suit.
In the study, the FRC also assessed the breadth of AQIs reported publicly by UK firms in their annual Transparency Reports as well as their use by Audit Committee Chairs and investors.

Consistent public reporting of AQIs can help Audit Committees and investors hold audit firms accountable for achieving high quality audit, complementing the FRC’s public reporting of its audit quality review work. The FRC identified areas in which public reporting of AQIs requires improvements:

  • AQIs reported in the UK are concentrated on five areas whilst other countries require firms to report on eight or more.
  • Publicly-reported AQIs are not easily accessible or comparable across firms.
  • Few Audit Committee Chairs and investors interviewed for the report were aware of published AQIs. 

Some other countries have adopted initiatives where audit teams report AQIs specific to individual audits directly to Audit Committees. The FRC believes there is merit in exploring whether a similar initiative in the UK would help Audit Committee engagement in this area. 
The FRC plans to consult publicly on proposed standards for disclosure of AQIs by UK firms. The timing of this consultation will depend on the COVID-19 pandemic. 
David Rule, The FRC’s executive director of Supervision, said: “Audit firms need a relentless focus on improving audit quality. Our review found that audit quality indicators, if used correctly, can help firms take decisive and immediate actions to improve audit quality. 

“Public reporting of a consistent set of audit quality indicators is required to provide companies and investors another window on audit quality. It is clear that improvements are needed in this area and the FRC will be consulting on proposals in due course.”

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