By: Helen Roxburgh, ICAEW

The Financial Reporting Council has called for an improvement in auditor scepticism and independence after its recent report found 15% of audits require “significant improvement”

Despite an improvement in the overall standard of audit work, 87% of audits identified as needing significant levels of improvement were of entities outside of the FTSE 350.

The FRC’s Audit Quality Inspection (AQI) annual report for 2012/13 rated 59% of audits inspected as good or acceptable (an increase from 46% in last year’s report) but concluded that while progress has been made, “firms need to maintain and in some cases reinforce their efforts on professional scepticism.”

However, the AQI raised concerns that downward pressure on fees was having an adverse impact the quality of audit.

The report warns that audit efficiency is becoming progressively more important to firms, given the difficult economic conditions, which can lead to firms looking to reduce overall audit hours or applying higher materiality levels, reducing the sample size tested.

"Fee pressures are a commercial reality that cannot be ignored and firms face significant and increasing pressures in the current economic environment as evidenced by substantial reductions in audit fees as a consequence of audit tenders, particularly in respect of large listed entities," the AQI says. The FRC calls for audit committees to keep a check on maintaining quality of maintaining audit where significant fee reductions have been agreed, and says it is to conduct an inspection into audit materiality and policies and practices across audit firms.

The AQI is also critical of the fact that there has been no “substantive improvement” in the area of auditor independence, highlighting failures to comply with the requirements of the Ethical Standards across all audit firms. The FRC is to undertake a review of recent director appointments across the FTSE 350 and other listed companies to guage the extent of this as a problem.

These failures included references to targets for the cross-selling of non-audit services to audited entities in partner appraisal documentation; failure to consult the ethics partner on the appropriateness of contingent fee arrangements for certain tax services; key partners involved in the audit from other network firms not being identified as such or monitored for potential rotation; and instances where shareholdings in audited entities were not disposed of on a timely basis.

The audit report cites the example of a former executive of an audited entity who on re-joining the firm as a partner had a significant shareholding in that entity – this goes against the Standards, which do not permit partners to hold any direct financial interest in an entity they are auditors of.

The AQI also raised concerns over the “off-shoring” of certain audit procedures in order to reduce costs. The report says that while the extent of this practice is generally less than 5% of hours worked on an audit, the practice is on the rise, and sometimes significantly.

It raises the concern that off-shore staff might not be “sufficiently integrated into the audit team” or “possess sufficient knowledge to be able to identify matters that are significant in the context of the particular audit.”