The Financial Reporting Council (FRC) has recently issued a Final Decision Notice under the Audit Enforcement Procedure and imposed sanctions against Haysmacintyre LLP and David Cox, Audit Engagement Partner in relation to the statutory audit of the financial statements of Associated British Engineering plc for the financial year ended 31 March 2018.
The Final Decision Notice identifies breaches of relevant requirements in six areas of audit work. In this blog post, we take a look at a selection of the issues identified, many of which are not unique to this case and crop up as regular themes when we perform our audit file reviews.
There were three key criticisms:
- Sample size for inventory testing was deemed to be inappropriate - it was insufficient for an area of significant risk.
- Deficient execution of testing was also identified as an issue as they had not traced the cost price both to a purchase invoice (to ensure that costs had been correctly recorded) and to a sales list (to ensure that stock was subsequently recorded at the lower of cost and net realisable value) for each item within the sample of stock lines selected.
- It was also noted that when testing work on the stock ageing on which provisioning was based, no verification of the ageing data was undertaken.
Journals testing undertaken was too focussed on entries in discrete parts of the accounts, for example testing year-end journals as part of balance sheet testing rather than also for the purpose of complying with ISA (UK) 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements which includes a requirement to consider the need to test journal entries and other adjustments throughout the period.
Revenue recognition and recoverability of debtors
Work over the recoverability of debtors, which was deemed a significant audit risk, failed to include a retrospective review related to the prior year’s provision against trade debtors. ISA (UK) 240 requires auditors to perform a retrospective review of management judgements and assumptions related to significant accounting estimates (such as this one) reflected in the financial statements of the prior year.
In addition to the requirements relating to accounting estimates contained within ISA (UK) 240, it’s worth noting that for periods commencing on or after 15 December 2019, the revised ISA (UK) 540 Auditing Accounting Estimates and Related Disclosures takes effect. The revised ISA includes enhanced risk assessment procedures, a greater emphasis on professional scepticism and enhanced documentation requirements as well as a greater work effort structured around testing methods, data and assumptions.
Another weakness of the audit was that it did not appropriately reflect the different risks associated with the two main revenue streams of the audited entity – sales and service.
Defined benefit pension scheme
One of the key areas of concern in the audit work over the defined benefit pension scheme liability was the use of management’s expert. There was a failure to verify the appropriateness of the
information provided to management’s actuary, to ascertain the basis on which the actuary evaluated and selected comparator investment funds for use as valuation evidence and to challenge or test other assumptions underlying the actuary’s valuation work.
This is another common failing identified by file reviews. Agreeing amounts back to reports provided by experts or service organisations is, unfortunately, often undertaken without due consideration of their expertise, the underlying data they have used or the assumptions they have made.
Documentation of audit work on going concern
The results of audit procedures performed in relation to going concern, the audit evidence obtained, conclusions reached, and judgements made were inadequately documented on the audit file. This is another common area of weakness across many audit files. Auditors need to ensure all of these aspects are carefully documented.
It’s worth noting that ISA (UK) 570 Going Concern has also been revised for periods commencing on or after 15 December 2019. This has resulted in changes to the wording of the auditor’s report which now generally includes more ‘positive’ conclusions in respect of going concern.
Review and supervision of the audit
The Final Decision Notice highlighted that the auditor did not obtain sufficient appropriate audit evidence to support the conclusions reached and that there was inadequate supervision. Whilst the level of review and supervision may vary from audit to audit, care should be taken to ensure that it is adequate. This is particularly important at the present time when so much audit work is being undertaken remotely.
In addition, significant changes are currently being consulted on with respect to quality management – more information is available in our blog post Changes ahead on quality management for audits.
How Mercia can help
Our Audit Update courses also cover the changes to the ISAs and other common issues such as those highlighted in this blog. Details of our training programme are available on the training pages of the website.
Our peer review services (including both hot and cold file reviews) are also available to support your firm in remaining up to date and compliant.
Users of the Mercia methodology will already be aware that it has been updated for the changes to ISAs applying for periods commencing on or after 15 December 2019.