KPMG's audit work unacceptable

Professional services firm KPMG’s audits had shown an "unacceptable deterioration" and will be subject to closer supervision, the Financial Reporting Council said.

The FRC added all the Big Four audit firms needed to reverse a decline in quality of work.

Background

The Big Four are the four largest professional services networks in the world, offering audit, assurance services, taxation, management consulting, advisory, actuarial, corporate finance, and legal services. They handle the vast majority of audits for public companies as well as many private companies. It is reported that the Big Four audit 99% of the companies in the FTSE 100, and 96% of the companies in the FTSE 250 Index, an index of the leading mid-cap listing companies.

KPMG is a professional service company and one of the Big Four auditors, along with Deloitte, Ernst & Young (EY), and PricewaterhouseCoopers (PwC). Headquartered in Amstelveen, the Netherlands, KPMG employs 189,000 people and has three service lines: financial audit, tax, and advisory. The name "KPMG" stands for "Klynveld Peat Marwick Goerdeler." It was chosen when KMG (Klynveld Main Goerdeler) merged with Peat Marwick in 1987.

The Financial Reporting Council (FRC) is the UK's and the Republic of Ireland's independent regulator responsible for promoting high quality corporate governance and reporting to foster investment. The Financial Reporting Review Panel (FRRP) was established in 1990 as a subsidiary of the United Kingdom's Financial Reporting Council. The FRRP seeks to ensure that the provision of financial information by public and large private companies complies with relevant accounting requirements such as the Companies Act 1985.

Analysis

KPMG, one of the world’s “Big Four” accounting firms, has shown an “unacceptable deterioration” in how it audits top British firms and will be first to undergo special supervision, Britain’s accounting watchdog stated.

The Financial Reporting Council (FRC) said the Big Four auditors – which also include PwC, EY and Deloitte – must act quickly to reverse the weakening of this year’s audit inspection results if they are to hit targets set by FRC. It singled out KPMG.

“There has been an unacceptable deterioration in quality at one firm, KPMG,” the FRC said in a statement. “Fifty percent of KPMG’s FTSE 350 audits required more than just limited improvements, compared to 35 percent in the previous year. Our key concern is the extent of challenge of management and exercise of professional scepticism by audit teams … and more generally the inconsistent execution of audits within the firm.”

Increased scrutiny of KPMG will involve the FRC inspecting 25 percent more audits done by the firm in the 2018/19 financial year, the first time the FRC has taken such action. Michelle Hinchliffe, head of audit at KPMG since October 2017, said she was disappointed with the FRC findings and that steps taken in previous years have not resulted in improvements to audit quality.

She said the findings mainly cover the time before KPMG’s new audit quality transformation program began last October. “We cannot and will not be satisfied with these results and, as a firm, we are already working to put this right,” Hinchliffe said.

KPMG was already being investigated by the FRC over its audit of Carillion, the outsourcing company, whose collapse has triggered a call from lawmakers to break up the Big Four accounting firms. They said the FRC was “timid”, piling pressure on the watchdog to crack the whip.

The FRC inspected a sample of audits from the eight leading accounting firms for the 2017/18 financial year. They showed that 72 percent required no more than limited improvements, down from 78 percent in the previous period. Among the FTSE 350 leading listed companies, 73 percent required only limited improvements, down from 81 percent in the previous year.

The FRC said the audits of the other four accounting firms examined, BDO, Grant Thornton, Mazars, and Moore Stephens, showed general improvements in quality, the FRC said. The green light given by auditors to accounts of banks just months before taxpayers had to rescue them in the financial crisis triggered a reform of the sector.

The FRC this month fined PwC 6.5 million pounds ($8.6 million) and severely reprimanded the firm for misconduct related to two 2014 audits. KPMG was fined 3.15 million pounds over a 2013 audit. A government-ordered review of the FRC is underway to see if it needs more powers to bring bad auditors to book.

Assessment

Our assessment is that across the Big Four, the fall in quality is due to several factors, including a failure to challenge management and show appropriate skepticism across their audits. We believe that the responsibility of the auditor which is to review the accounts of a firm and to see if the figures are a true reflection of the company’s financial health. We feel that the accounting industry has faced a lot of flak in the last few years whether their verdicts on companies’ accounts can be trusted.