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December 14, 2008

UK Audit Inspection Reports: Debating the documentation

The UK Audit Inspection Unit’s (AIU) insistence on stringent documentation risks a move away from principles and towards rules, according to KPMG UK head of audit Richard Bennison. However, the regulator has argued that in most cases it is more a question of insufficient evidence for significant decisions.

The AIU, which operates under the Financial Reporting Council (FRC), this month reported publicly for the first time on the findings from the inspections of seven audit firms. The reports cover reviews of firm-wide procedures and individual audits conducted by the AIU between April 2007 and March 2008. BDO Stoy Hayward, Deloitte, Ernst & Young (E&Y), Grant Thornton, KPMG, PKF and PricewaterhouseCoopers (PwC) were the firms involved.

Fundamentally sound

The AIU said the quality of auditing in the UK is fundamentally sound and the senior management at each firm is committed to quality and has appropriate quality control procedures in place.

A number of shortcomings were identified, however, and Bennison said many of these relate to insufficient documentation.

Audit partners being rewarded for selling non-audit services to audit clients was one area the reports said some firms, including PwC, BDO and KPMG, could improve.

Bennison said KPMG sticks by the principle that people involved in the audit should not be rewarded for selling services to their clients and that the instance where the firm was criticised was an example where documentation should have been better.

The documentation of risk assessment is a topic Bennison said he is involved in constant discussions with the AIU about.

“It would be at an extreme if everything has been thoroughly documented and what I call ‘tick the box’,” he explained.

“I think our people are doing absolutely what they need to do although clearly we have to take the AIU’s points on board – it is an area that I know we need to do that much more to improve. The problem is, if the AIU insists on this documentation, we move right away from principles into rules because you have to demonstrate you complied with each and every rule.

“Whereas my principle is ‘have we done a robust audit?’ and it really is a matter of tone – have the people involved in the audit exercised sufficient scepticism?

“You can’t write and document that on a file, it’s a state of mind. There is a hell of a lot of work on questioning and everything else that goes on, such as looking the finance director in the eyes when you ask ‘have you manipulated any of the numbers?’”

Bennison added that overall the AIU has done a good job and firms learn from the monitoring activity.

FRC director of auditing, Paul George, argued that the reports do not use the term ‘documentation’ to any great extent.

“This is a bit of a circular argument. When challenged, firms will argue that they undertook certain work but just didn’t document it rather than agree work was not performed,” he said. “Then they say ‘all the AIU ever does is comment on lack of documentation’.

“Where we do challenge the firms about the adequacy of their evidence, it is not about insignificant items. We challenge them around their major audit judgements.”

The length of the reports was another issue firms commented on. George said the more broadminded appreciate that in the present climate it is necessary to have reasonably detailed reports to demonstrate the profession is regulated firmly and robustly.

“I think firms were appreciative of the fact that unlike many regulators, we did make considerable effort to bring out some positives as well as negatives. But the firms are very sensitive and they would rather we didn’t say anything critical,” he added.

The reports included responses from the firms. E&Y welcomed the reports but said it hoped the standards for determining what matters are reported will develop over time.

George said E&Y’s comment “understandably challenges us to ensure consistency in how we report matters, but smacks a little bit of ‘let’s have more rules’”.

“We are far keener to have principals,” he added.

He said the underlying theme behind the E&Y letter is that the firm wants a bar to be set, so only items that are clearly above that bar get reported on.

“At the end of the day it is down to judgement. We would argue we have drawn that balance reasonably fairly.

“I think most stakeholders would feel that it is better that we feel able to challenge the firms and comment publicly when we feel that it is appropriate to do so, rather than to have our ability to challenge and report unduly fettered.”

Carolyn Canham and Melanie White

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