The financial services sector is also identified as an area requiring an increase in audit quality. The report, which looked at the audit of eight banks, six building societies and one insurance company, calls in particular for firms to strengthen their testing in respect of loan loss provisioning and general IT controls. The FRC reported that two smaller building society audits were assessed as requiring significant improvements.

"The audit of loan loss provisions in a number of banks and building societies continues to be an area of concern and it is disappointing that we have not seen any significant improvement,” the report reads.

“The issues included insufficient challenge to the key assumptions and inputs used to determine both specific and collective provisions, together with inadequate corroboration of management’s explanations and insufficient verification of supporting calculations. In one instance we noted that insufficient consideration was given to the appropriateness of the credit risk characteristics used to determine the collective provision. Insufficient evidence demonstrating the completeness of information in respect of forbearance arrangements and the implications for both provisioning and disclosures was also of concern in a number of audits."

It also sounded a note of caution against working on audits where the majority of operations and general financial and corporate management are in a different country than the auditor.

“When auditing such companies firms should recognise the risks inherent in such arrangements and ensure they have sufficient involvement in the audit work of component auditors to enable the engagement partner to lead and control the audit as a whole,” the FRC warned.

Third country auditor inspections (TCAs) are to start in the financial year 2013/13, where the FRC will regulate non-EU auditors of non-EU incorporated companies that have listed on UK markets.

Paul George, executive director, conduct, said, “Audit makes a vital contribution to investor confidence in financial statements. We are pleased to see in this year’s results that firms’ efforts to address our concerns on professional scepticism are bearing fruit, particularly in the FTSE 350.

“It is important that further improvements are more uniformly and consistently achieved across all entities and by all firms.”

The report inspected 85 audits this year, with 13 requiring significant improvements in total, 22 rated “acceptable overall” but with some improvements still required, and 50 set as “good” with limited improvements needed.

Vernon Soare, ICAEW executive director, said, "There will always be room for futher improvement and it is the regulator's job to point out areas in need of further attention and enhancement. Audit firms and audit committees should pay attention to the findings and consider steps that may help improve audit quality further."

The FRC inspects Big Four firms annually, but has decided in future it will inspect the audits of mid-tier firms Baker Tilly, Crowe Clark Whitehall and Mazars every three years. BDO and Grant Thornton audits will continue to be inspected every two years.

The FRC said that the “change to our inspection frequency ensures that our inspection activities are focused on those firms where the number of entities falling within the scope of our inspections is greatest.”