On 8 December 2020 the Executive Director of Supervision at the Financial Reporting Council (FRC) published a letter emphasizing the importance of an effective challenge approach to audits, following an analysis arising from a review of the findings of the past two year’s Audit Quality Review (AQR).
Challenging management
Effective challenge of management is one of the most critical responses for the auditor in order to demonstrate that it has exercised appropriate professional scepticism, as required under a number of International Standards on Auditing (“ISAs”), particularly ISAs 200 and 540. The FRC's analysis found however that ineffective challenge of management was a driver in more than 80% of the audit files reviewed for 2018 - 2020 which had a less than satisfactory grading.
The FRC found that auditors "often struggle to challenge the management of audited entities effectively, especially in more judgemental areas such as long-term contracts, goodwill impairment or the valuation of financial instruments." The FRC stressed that robust and independent challenge was "vital to a high-quality audit, particularly so at a time of prolonged heightened uncertainty, compounded by operational challenges."
The FRC has stated that its AQR team will continue to focus on this area by monitoring the appropriateness and success of each firm’s root cause analysis and their audit quality plans. More widely, the FRC has committed to carrying out a thematic review on how firms support effective challenge of management and encourage a culture of challenge and robust professional scepticism.
These initiatives are consistent with a renewed focus by the FRC on audit quality. In 2019, the FRC revised its Ethical Standard and its Auditing Standards, in order to support the delivery of high-quality audits in the UK, with the stated intention of strengthening auditor independence and reducing the risk of conflicts of interest.
Comment
While the FRC's analysis may not make for comfortable reading, its conclusions and recommendations present a valuable opportunity to auditors to restore confidence in the sector.
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