13 December 2013

FRC calls for rapid improvement in quality of bank audits, publishes report on auditor’s materiality judgements

This thematic review will focus on aspects of how bank and building society audits are conducted to identify why progress in improving their quality has been slow and what needs to be done to achieve necessary improvements. The FRC’s review will begin in the 2nd quarter of 2014 as soon as this year’s audits have been completed, with a formal report expected to be published by the end of the year.

The FRC is concerned that the pace of improvements in the quality of auditing of banks and building societies has not been sufficient. Over the last five years, the FRC has increased its monitoring of bank and building society audits in its annual programme of audit quality inspections, but the findings have shown they are below the average of all audits inspected. The 2013 Audit Quality Inspection report identified the need for improvements in the quality of auditing of financial institutions as a key concern. Specific issues highlighted were the adequacy of the testing of loan loss provisions and general IT controls. Early indications from the latest cycle of audit inspections suggest that it is unlikely that the FRC will be able to report that significant progress has been achieved.

Baroness Hogg, Chairman of the Financial Reporting Council, said: “Concerns about the quality of auditing of banks and building societies persist, not least from our own inspections of audits and despite enhanced corporate governance requirements. We are clear that there is scope for improvement and we hope to see a genuine step change in the quality of bank and building society auditing in the UK. The issues and concerns that have been raised mean that a specific review of audit in this sector is warranted. The review will aim to assess the extent to which the firms’ actions to address the FRC’s concerns are having an impact and if not, identifying what further action is required.”

The FRC’s review will focus on the testing of loan loss provisions and general IT controls and look carefully at issues including;

• What specific actions have been taken by the major firms to address issues identified in the FRC’s audit inspections of banks and building societies
• How the major firms have assessed the effectiveness of actions they have taken
• The FRC’s assessment of the effectiveness of the actions taken
• Focussing on issues where recommendations have been made to specific audit firms to ensure they have been properly addressed
• The FRC will continue to perform a number of routine inspections of banks and building societies and will take account of any audit issues arising from those inspections.

The FRC is announcing this review now so that firms and companies are well aware of its expectations in advance of the 2014 audit season. The FRC also plans to discuss with the chairs of audit committees of banks and building societies how they too can reinforce the quality of corporate reporting and audit in this sector.

Press release

The Audit Quality Thematic Review report identifies a requirement for greater focus by auditors on the needs and expectations of users in setting and revising overall materiality levels and for audit committees to seek to better understand the related judgements made by auditors. It also makes a number of recommendations to audit committees and encourages them to discuss with their auditors the basis for the materiality levels set including, in particular, how these reflect the needs and expectations of users of the entity’s financial statements.

Materiality is an area of particular interest to investors given its potential impact on the scope of an audit and the extent of the audit work performed. Audit committees play a highly important role in safeguarding the quality of audit and should actively engage with their auditors in relation to the determination and application of materiality.

The recent revision of ISA (UK and Ireland) 700 requires auditors to report how they applied the concept of materiality in performing the audit and how this affected the scope of their audit. This will enable investors and other users of financial statements to engage directly with audit committees in relation to this area.

Press release

Report

See also: 

• FRC-calls for rapid improvement in quality of bank audits
• FRC-publishes draft plan & budget for 2014/15

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