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Newsflash – What makes a good audit? – new FRC publication

November 2021

The FRC has published new guidance material, What makes a good audit? This material sets out the FRC’s views on what constitutes a good or high-quality audit, focusing on two key areas: how the audit itself is run and what makes for a high-performing audit practice.

The FRC explains that the material is relevant to audit in all sectors, including the public sector, and should be used not only by audit firms focusing on audit quality but also by audit committees to support their engagement with their auditor.

In the foreword, Sir Jonathan Thompson (FRC CEO) observes that the publication does not aim to be comprehensive, but instead focuses on the areas that it has observed as making good audits stand out. He adds:

“We also recognise that auditing requires the application of judgement within a principles-based framework. It is not just a rules-based compliance exercise… Although not part of this paper, we also recognise the important contribution that the management of the audited entity and those charged with governance can make to a robust and comprehensive audit. A well governed company, which reports transparently, and has clear and robust evidence that underpins that reporting, as well as effective internal controls are all important in underpinning a high-quality audit.”

The FRC’s definition of a high quality audit

The FRC sets out six factors that it uses to define high-quality audits as those that:

  1. provide investors and other stakeholders with a high-level of assurance that financial statements give a true and fair view;
  2. comply with both the spirit and the letter of auditing regulations and standards;
  3. are driven by a robust risk assessment, informed by a thorough understanding of the entity and its environment;
  4. are supported by rigorous due process and audit evidence, avoid conflicts of interest, have strong quality management, and involve the robust exercise of professional judgement and professional scepticism;
  5. challenge management effectively and obtain sufficient audit evidence for the conclusions reached; and
  6. report unambiguously the auditor’s conclusion on the financial statements.

Key attributes of a good audit

The FRC sets out 19 key aspects of the audit process, across three key areas - risk assessment and planning; execution; and completion and reporting. Throughout there is a high level of focus on the careful documentation of process, all testing and evidence-gathering as well, of course, on judgements.

For risk assessment and planning, the nine key aspects are:

  1. Careful risk assessment – appropriately tailored to the risks identified; taking account of management bias and external sources of data
  2. Timely planning – well in advance of the year end, involving relevant partners and specialists, giving enough time to design appropriate procedures to address the risk and report to those charged with management; making allowance for the unexpected and for adapting as the audit progresses
  3. Knowledge and understanding – tailored to the sector and the specific company; conscious that a complex business model can result in an audit that isn’t focused on the right risks; evaluating and planning for the level of judgement and specialist knowledge required
  4. Informed expectations –key financial metrics and performance measures should be clearly recorded with the basis of the expectations explained
  5. The auditors’ responsibilities relating to fraud – considering the risk of fraud particularly carefully; being alert to the possibility of linked transactions; discussion and documentation of the vulnerability of the entity to fraud
  6. Appropriate resources – covering both the skills and the time needed; agreeing with the entity that sufficient time is available; allocating more complex risk areas to more experienced team members or specialists; flagging resourcing issues to firm’s leadership
  7. Planning analytical review – completed well, this blends the team’s knowledge, expectations and year-to-date management information and flags anomalies to resolve before the start of fieldwork
  8. Planning the group audit – clear communication and shared understanding regarding significant components and audit approach; timely interactions and robust challenge from both the group and the component audit teams
  9. Communicating to those charged with governance – communicating the audit approach, any changes to the approach and the rationale behind them

For execution, the eight key aspects are:

  1. Fieldwork must execute the agreed audit plan – applying high-quality judgement to assess both corroborative and contradictory evidence; using the approach set out in the audit plan or explaining clearly why this has been varied, with partner approval and communication with those charged with governance where this is the case
  2. Appropriate oversight and direction – a well-structured team, with clear communication channels and frequent access to appropriately senior team members
  3. Proportionate approach to higher risk engagements – greater involvement of the engagement partner; access of partner, quality control reviewer and audit team to the support of central functions and appropriate specialists
  4. Audit documentation tells the story – the file should show an understandable and easy to follow narrative of the audit and the critical thinking applied, with suitable cross-referencing across the file where necessary
  5. Professional scepticism and challenge of management – auditors must “stand back” and evaluate the overall audit evidence, both corroborative and contradictory; they should persist in challenging management where concerns have not been addressed; junior team members should be empowered to raise concerns; relevant matters should be brought to the attention of those charged with governance who also have a part to play in challenging management
  6. Specialists and experts appropriately involved – specialists and experts included in all key phases of work, able to challenge management and share their findings with the wider audit team; clear documentation and understanding of the advice requested and the advice received
  7. Sufficient group oversight - close contact, supervision and oversight of component audit teams to deal with issues that may arise at the component level; clear documentation of the consolidation process that brings together the story of the group audit
  8. Consultation and oversight – appropriate consultation is a strength, supporting the team when reaching a conclusion on significant matters; audit teams should have the confidence to consult and request additional oversight; a clear record of consultation, conclusions, rationale and how matters were resolved

For completion and reporting, the two key aspects are:

  1. Assess that sufficient, appropriate audit evidence has been obtained – despite a two-way dialogue with those charged with governance throughout the process, communicating about the audit as a whole, not shying away from explaining the challenges along the way, which will in many cases link through to the key audit matters in the audit report
  2. Communicate matters of interest - to those charged with governance: including governance concerns, deficiencies in controls, aggressive assumptions and estimates and insufficient disclosures. The FRC recommends using graduated findings as it facilitates more effective communication with those charged with governance

Key elements of a high-quality audit practice

The FRC explores the following areas where they have evidence of good practice:

  • Firm’s quality risk assessment process – undertaking risk assessment of quality arrangements on a stand-alone basis, establishing quality objectives, identifying and assessing quality risks and implementing responses to those quality risks
  • Governance and leadership - senior leadership must live and drive the right values, ethics and behaviours that support high audit quality throughout the firm. There must be an emphasis on the public interest role of audit
  • Performance monitoring and remediation – an effective feedback loop to monitor the performance of the audit practice, including inputs from stakeholders and audit quality indicators, and embracing improvements through processes such as root cause analysis
  • Quality monitoring – incorporating “cold reviews” of completed audits and “hot reviews” of audits in progress, evaluating how effective the process is and how it integrates with other elements of the quality control system
  • Resources:
    • Resource planning and people management – focusing on attracting and retaining high-quality talent and ensuring there is sufficient capacity to manage reasonable demands, which may include monitoring project management and milestones
    • Appraisals and rewards – ensuring that reward and performance management is aligned to the delivery of high-quality audit
    • Methodology and technology – consistently applied methodology and the use of technology, delivered by appropriately trained people, supported by a robust and effective platform
  • Information and communication – investment in training, supported by ongoing information and communication and by access to central teams with in-depth knowledge

The FRC’s publication can be found here.

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