Half a decade of “sustained improvement” among the Big Four accounting and audit firms has received a warm welcome in the latest Annual Review of Audit Quality from the Financial Reporting Council (FRC).

However, the watchdog has uncovered a “widening gap” between the Big Four and the other two firms in the Tier 1 bracket, BDO and Forvis Mazars.

Published on 30 July, the review was compiled from an inspection of 92 individual audits produced for the 2023/24 financial year across the six Tier 1 firms – defined as those with the largest share of the UK Public Interest Entity (PIE) market. Of the audits inspected, 74% were classed as either good, or requiring limited improvements.

In terms of Big Four audits that achieved that quality rating, Deloitte led the field on 94%, followed by KPMG on 89%. PwC and EY, meanwhile, tied on 76%. For the FRC, those results mark the latest phase of “a trend of general improvement” among the Big Four over the past five years. At the same time, it notes, audit quality for the FTSE 350 has also improved – up from 81% to 87% year on year. Indeed, the watchdog is “pleased that audit quality in the UK for the largest listed businesses compares favourably internationally”.

Decisive action

Elsewhere, though, the report points out that the performance gap between the Big Four firms and their Tier 1 peers BDO and Forvis Mazars “has widened significantly”. BDO’s audit quality rating plummeted year on year from 69% to 38%, while that of Forvis Mazars fell from 56% to 44%.

In the report, the FRC notes: “BDO and Forvis Mazars are strategically important, and we want to work with them to succeed among their peers. That requires urgent and decisive action to increase their standards on delivering high-quality audits. While we recognise that improving audit quality takes time, not least because of the timing differences between actions being taken and the audits being then performed and inspected, the progress that has been made has not met our expectations.”

Outlining general points of critical focus, the report explains that the FRC paid “particular attention” to key areas of estimation and judgement – including impairment, valuation, going concern and provisions – along with the audit of revenue and journals.

“Our analysis shows that the most common findings from our inspections continue to be in the audit of revenue and areas of estimation and judgement,” the report says. “Findings for revenue included issues with contract testing, data analytics and data input testing.

“For estimation and judgement, they were most often linked to weaknesses in the evaluation of key assumptions and judgements, and the challenge of management. We also identified common findings relating to journals testing, General IT Controls (GITCs) and inventory.”

On a firm-by-firm basis, the FRC identified key findings for impairment at all six firms and for revenue and provisions at three. All six had recurring key findings in at least one of those areas, the report notes, “demonstrating that the actions that they have previously taken have not been sufficient”.

This year, the report points out, ICAEW reviewed 60 audits across the Tier 1 firms, weighted toward higher-risk and complex audits of non-PIE entities. Some 88% of those reviews were graded as either good, or generally acceptable.

Building a presence

In her foreword to the report, FRC Executive Director of Supervision Sarah Rapson stresses that all Tier 1 firms must “continue to embed a culture that promotes audit quality and high ethical standards”, ensuring that any relevant initiatives are refreshed periodically to remain effective. “The widened quality gap in the risk-based samples between the largest four firms and the other firms in the PIE market, BDO and Forvis Mazars, shows the ongoing need for proactive efforts to minimise this disparity,” she writes.

Quoted in a separate FRC statement, Rapson underlined the report’s point that both of the non-Big Four firms at Tier 1 level are strategically important to the UK audit market and the wider UK economy – so it is vital that they deliver on their agreed improvement plans. “The FRC’s supervisory work with these two firms will continue to focus on these improvements,” she said.

Responding to the results, ICAEW Chief Executive Alan Vallance says: “While it is encouraging to see that overall audit quality has gone up, these results demonstrate the challenges firms outside the Big Four have faced while building a presence in the PIE audit market. The FRC has set out plans to boost performance where it is lacking and the report acknowledges the important role smaller firms play in creating a resilient audit market, as well as the potential issues arising from de-risking audit portfolios.”

He adds: “The FRC’s role in improving audit quality and competition must also not be overlooked, including through its Scalebox initiative, and we urge it to renew efforts to support firms seeking to take on PIE audits. The regulator has also highlighted the Spring Report, which found that performing a good audit of challenging companies requires action by the company and the auditors. In our view, it is essential that the new regulator ARGA is established and given wider powers to take effective enforcement action as needed.”