For auditors, big is beautiful, says watchdog

AUDITORS have stepped up a gear in scrutinising the financial health of British companies, but with notably more rigour for audits of bigger businesses than smaller ones, an independent regulator has revealed.

In its annual audit quality inspection report for 2012-13, the Financial Reporting Council (FRC) today discloses a sharp disparity in quality of work done on FTSE 350 companies compared to their smaller publicly quoted and unquoted counterparts, charities, pension funds and mutuals.

The FRC says 59 per cent of audits it inspected were “good or acceptable”, with only limited improvements needed. That compared with 46 per cent in 2011-12.

Just under 80 per cent of FTSE 350 audits fell into these top bands, up from 55 per cent in 2011-12. In further evidence of a marked contrast in quality of audits, of the 15 per cent that were judged to need “significant improvement”, 87 per cent were for audits outside Britain’s biggest 350 quoted companies.

Paul George, executive director conduct at the FRC, said the improvement in the overall standard of UK audit work was “a move in the right direction”.

However, he warned that it was important “further improvements are more uniformly and consistently achieved across all entities and by all firms”.

George added: “Audit makes a vital contribution to investor confidence in financial statements. We are pleased to see in this year’s results that [accountancy] firms’ efforts to address our concerns on professional scepticism are bearing fruit, particularly in the FTSE 350.”

He said that greater scepticism by audit partners was still needed in smaller audits, and that auditors should not allow pressures on fees to restrict the scope of their scrutiny.

“We are not suggesting there’s a correlation between a reduction in audit fees and outcomes, but it is a risk we are flagging. We want to make sure auditing firms do not cut corners due to commercial pressures,” he said.

The FRC’s report reviewed the audits of 85 entities in a wide range of sectors, of which 40 per cent were FTSE 350 companies.

George said that more improvement of audits was needed, although the 15 per cent seen as needing significant improvement was “the rolling average over the last few years”.

Other key messages from the report included that group auditors “need to ensure they are sufficiently involved in all stages of the work of component auditors”.

The FRC singled out the challenges of auditing the financial sector, saying auditors “should strengthen their testing in respect of loan loss provisioning and general IT controls”.

George said he also had concerns about the quality of internal monitoring by auditors of their work. “They tend to be more positive than our findings,” he said.