The Financial Reporting Council (FRC) released its 2021 inspection reports today, which include BDO, Deloitte, EY, Grant Thornton, KPMG, Mazars, and PwC. I’ve linked the individual reports for each firm (note they are in PDF) should you feel like wasting a Friday afternoon reading overseas audit inspection reports but we need to talk about the FRC specifically calling out KPMG in its inspection press release. Let’s go.
The 2020/21 results show that nearly one third of audits inspected by the FRC still require improvement.
• 29% of audits reviewed required improvement or significant improvement
• Quality across firms was mixed; improvement measures implemented
• Specific concerns regarding KPMG’s banking audits
• Improvement measures expected of BDO and Mazars
FU in particular, KPMG. Yikes.
Perhaps the worst part of this call-out is the fact that the FRC wasn’t impressed with any of the contenders, so it’s not like KPMG’s poor audit quality stood out because everyone else did so well. “While these results show some improvement on last year’s results, this improvement is marginal and significant change still needs to happen to meaningfully improve audit quality,” said FRC CEO Sir Jon Thompson. “High quality audit is essential to maintaining trust and confidence in the UK’s financial markets. If the UK is to retain its position as a world leading professional services marketplace, and a global financial centre, outstanding audit quality and rigorous professionalism is at the heart of this.”
Of the 103 audits across the seven firms inspected by the FRC, 29% (30 of 103) required improvement or significant improvement. The overall inspection rate was higher this time around, with the FRC inspecting 88 audits for 2019/20 and 67% of those (59 of 88) requiring no more than limited improvements (meaning: they were good enough).
So while some firms gave the FRC hope audit quality can be improved, KPMG is coming in as the checked-out spouse who won’t stop leaving their skidmarked drawers on the bathroom floor despite being nagged about it non-stop for years.
Inspection results at KPMG did not improve and it is unacceptable that, for the third year running, the FRC found improvements were required to KPMG’s audits of banks and similar entities. Given the systemic importance of banks to the UK economy, the FRC will be closely monitoring KPMG’s actions to ensure findings are addressed in a timely manner. KPMG has agreed additional improvement activities to be delivered this year over and above its existing audit quality improvement plan.
“In the UK we have cumulatively invested £184 million in audit quality across the three years of our Audit Quality Transformation Programme,” says KPMG in its UK Transparency Report 2020 [PDF]. In addition to establishing the Audit Culture Working Group and a Head of Culture, KPMG says it is taking steps to address the bank audit problem in particular:
We have dedicated significant additional resource as part of our transformation programme to embed consistent and sustainable good practices in banking audits and to facilitate consistent application of our tools, training and guidance.
Our updated methodology and approach to banking audits will be implemented for our 31 December 2020 year-end audits, including:
- Simplify – revision and simplification of our banking workpapers, guidance and an improved clarity of approach to risk assessment for key risk areas;
- Plan – banking specific planning directive with central monitoring and remapping of skillsets to engagement allocations;
- Challenge – early review of planning by the second line of defence team and challenge panels for IFRS 9, risk assessment and final significant risk conclusions;
- Execute consistently – additional training and coaching for our engagement teams, additional challenge from our second line of defence team for engagements identified as higher risk, central tracking of milestones, development of centres of excellence and more consistent use of specialists.
Writes the FRC in KPMG’s report:
We acknowledge that KPMG has already invested significantly in its banking practice and considers that, based on steps it has already taken, it will be able to demonstrate improvements in its 2020 year-end audits (which we will inspect in 2021/22). In response to our findings this year the firm’s senior leadership has committed to make the further changes necessary to improve audit quality in time for 2021 year-end banking audits. We will monitor these closely to assess on a timely basis the extent to which they address our findings. We will also continue to focus our inspections on KPMG banking audits.
Calling it a matter of urgency, the FRC thinks KPMG should evaluate its audit quality initiatives quarterly to ensure they’re not going to disappoint for a fourth year in a row next time inspections come round:
With our last three inspection cycles reporting key findings in relation to the audit work performed on banks and similar entities, the firm needs to take further, comprehensive action to improve the quality of audit work in this area. The firm should specifically consider the further actions required, over and above those contained in its 2020 banking audit quality improvement plan, to assist its banking audit teams to perform sufficient, appropriate audit procedures which support the opinion on a set of financial statements.
The firm should also continue to monitor the progress and effectiveness of its audit quality initiatives, at least quarterly, to assess whether the required improvements are implemented on a timely basis to achieve a satisfactory and consistent level of audit quality on banks and similar entities.
It’s not all bad. The FRC did throw KPMG a bone to say they “identified improvements in the level of challenge and scepticism on high-risk audits (excluding banking audits), a key finding last year, and we also identified good practice in the audit of going concern.”
Interestingly, KPMG points to auditors jumping ship as one of the issues leading to poor audit quality. From the firm response on page 30 of the FRC inspection report:
In common with the profession more widely, the level of change of personnel within our audit practice has increased resulting in a need for more proactive and flexible coaching and support arrangements. The integration of new hires and secondees, the support for individuals delivering stretching and challenging new work, and the oversight of individuals working notice periods are all examples where proactive and tailored coaching and support is required;
Other factors noted by KPMG as contributors to the audit quality problem include quality and timeliness of information provided by audit clients, weaknesses in risk assessment (“means that the audit team default to following prior year procedures rather than using current requirements increasing audit delivery risks,” writes KPMG), inconsistent use by engagement teams of materials and guidance available to them, and issues with project management (“work is reviewed too late in the audit process when individuals are under increased time pressure”).
The firm hopes that its Culture Change Programme will leverage peer pressure to improve audit quality through personal responsibility, accountability, and mentoring.
Better luck next year, guys!
KPMG LLP July 2021 Audit Quality Inspection and Supervision [Financial Reporting Council]