They just don’t get it. Media coverage of EY’s potential spin-off of its consultancy business that salivates over the ‘historic trousering’ (Sunday Times, 24 July) of millions of pounds by partners is a distraction from the most important issue: improving audit quality.
The latter has at last been happening, according to the latest audit quality inspection overview from the Financial Reporting Council (FRC). Three-quarters of audits inspected in 2021/22 were either good or required only limited improvement – up from 67% two years ago.
Never mind consultants buying their ‘freedom from the auditors’, progress towards separating audit from consultancy has provided the backdrop for what really matters. And that is cultural change at audit firms in the interests of investors and everyone else who relies on audited financial information.
The good news
The good news stories reported by the FRC include an overdue turnround of KPMG’s results – 84% of its inspected audits required no more than limited improvements, up from 59% in 2020/21 – and a 100% score for Grant Thornton, which has recovered from a trough (eg Sports Direct) a few years ago. KPMG has gone some way towards regaining its reputation as a leading auditor of banks, as well as rebuilding a constructive relationship with the regulator.
KPMG’s investment in a ‘high challenge, high support’ culture echoes the transformation programme at PwC, where a ‘continuous improvement team’ implements the ubiquitous requirement for root-cause analysis. The factors that matter for audit quality, according to the root-cause analysis, are those the regulator and external observers have banged on about for years, such as inquiring minds, professional scepticism and the confidence to speak up.
KPMG has gone some way towards rebuilding a constructive relationship with the regulator
It is refreshing to read that audit quality, including good/adverse inspection results, is being incorporated into staff appraisals, with some firms now being explicit that this will affect remuneration. This is an antidote to the previous era’s conversations about billings, margins and business won – all symptoms of a consultancy mindset.
The bad news
Of course, it’s not all good news. The FRC said that inspection results at BDO and Mazars remained unacceptable. The rapid growth of both firms has come partly through picking up the higher-risk audits that their peers have dropped. Minefields include any calculations requiring estimation and judgment, such as impairment testing and expected credit losses.
Most of the seven tier-one firms covered in the FRC’s suite of reports unequivocally welcome the scrutiny of their work by a regulator that boasts, in its annual report, of its ‘assertive supervision approach’ (read the annual enforcement review for more evidence of this). What used to be dismissed as bothering about process is now recognised as essential evidence-gathering and documenting of judgments.
EY’s cavilling is not a good look. It complains that a couple of the FRC’s findings are out of line with its own. Well, who would an objective third party believe? That’s the standard that needs to be applied. Perhaps EY is showing a symptom of consultancy influence – in which case, the sooner they are gone the better. Auditors are rediscovering how to thrive on the exercise of independent professional judgment, in the public interest.
