UK Inspectors Name Names in Grading the Big Four

The PCAOB's British counterpart releases its inspection findings of the large accounting firms for the first time, noting areas for improvement.
Sarah JohnsonDecember 9, 2008

UK inspectors of the Big Four firms have released reports noting ways that each of the auditors can improve its internal procedures — and identifying the shortcomings of individual firms more than its American counterpart does.

The UK Audit Inspection Unit, which is part of the Professional Oversight Board, was set up around the same time as the U.S. Public Company Accounting Oversight Board to review the firms that audit U.K. companies. The AIU is tasked with reviewing the firms’ audit quality, methodologies, independence and ethics, in addition to other matters. On Monday, the group released its 2007/2008 reviews for the first time publicly of the largest audit firms in the U.K., including Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers.

For each firm, taking a risk-based approach, the AIU reviewed fewer than 20 audits. Because of those small numbers, the inspectors discouraged readers of the reports from assuming that their findings are representative of the firms’ overall quality. It’s a similar disclaimer to the one used by the PCAOB, which has, since its inception, publicly released all its inspection reports, but which does not reveal how many audits were under review at each firm.

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Instead, the U.S. board lists any significant audit deficiencies without naming the clients involved. The PCAOB also refrains from giving a succinct, overall assessment of the firms.

The AIU takes a different approach. While the AIU is less specific on accounting issues than the PCAOB, its reports draw conclusions. For instance, the inspectors reviewing 14 of Deloitte’s audits concluded that the firm’s work “was generally performed to a good or acceptable standard and, in relation to one FTSE 100 entity, to a very good standard.” Among its recommendations for Deloitte were improvements to independence, processes for fraud risks, and evaluation of specialists’ expertise.

The findings in the reports — which each range from 24 to 27 pages — are generally positive. Between April 2007 and March of this year, the inspectors reviewed audits conducted for financial years ending between June 2006 and August 2007 and concluded that the quality of auditing in the U.K. overall is “fundamentally sound.”

To be sure, the inspectors do note areas that need work. For example, the inspectors criticized KPMG for lacking evidence that the “relevant data, procedures, and thought processes underpinning key audit judgments” had been properly evaluated. “The quality of audit evidence on file did not always reflect the extent of partner involvement in the resolution of key audit issues or the thoroughness with which these matters were addressed,” the inspection report added.

In its defense, KPMG agreed to disagree with the inspectors on the level of evidence needed. “Too much emphasis on excessive levels of documentation will result in a ‘tick box’ approach, which in our view, will undermine the very objective we are striving for — ever-increasing audit quality,” the firm wrote.

For E&Y, the AIU questioned the firm’s independence when a tax audit partner provided tax advice to his audit client. The inspectors also criticized the auditors for not showing how they believed there was enough data in an audit of a clients’ revenue numbers. In response to the report, the firm said it hopes the AIU’s standard for what kind of information will be shared publicly in future inspections report “will develop over time.”

Following their review of 16 audits at PwC, the AIU inspectors considered the firm’s work to be “good or acceptable.” However, the firm believes that message could have gotten lost in the inspection publication. “We remain concerned that the tone and length of the report makes it difficult for a reader to understand this overall positive conclusion,” the firm wrote in a letter to the AIU.

The AIU inspectors said PwC should work on improving documentation for its risk-assessment methodology and be more consistent in following guidance. For example, the majority of audits reviewed did not identify revenue recognition as a significant risk as required under auditing standards.