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FRC reflections: Annual Enforcement Review 2020

Posted on 23 September 2020

Introduction

On 31 July 2020, the Financial Reporting Council (FRC) published its Annual Enforcement Review 2020 ("the Review"). The tenor of the report is one of a concerned regulator. Elizabeth Barrett, the FRC's Executive Counsel and Executive Director of Enforcement, stated: "Now, more than ever, investors, businesses, workers, pension holders and the public are reliant on financial information they can trust as a basis for making informed decisions that protect livelihoods, and support the integrity of our financial system". The backdrop of the inevitable challenges COVID-19 will pose to those whom it regulates and a 14% growth in the FRC's Enforcement division means the FRC is likely to bare its teeth. This coupled with the sweeping architectural changes expected at the FRC will mean now more than ever it wants to show its worth .

Year at a glance

The FRC's year at a glance highlights the following:

  • 42 current investigations
  • 14 investigations opened into auditors, accountants and/or actuaries in the year
  • 3 preliminary enquiries opened
  • Financial sanctions of £16.5 million (before settlement discount) 
  • 31 cases resolved through Constructive Engagement 
  • 2 undertakings to suspend membership 
  • 80% increase in matters identified through horizon scanning activities 
  • Recurring themes in concluded cases: failure to obtain sufficient appropriate audit evidence and failure to exercise professional scepticism 
  • 14% growth in Enforcement division

Themes: Recurring audit failures in cases investigated over the past 6 years

The FRC has made clear that the overwhelming majority of audit related enforcement actions it has taken over the past 6 years fall under two themes: (1) a failure to obtain sufficient appropriate audit evidence; and (2) a failure to exercise professional scepticism when assessing the decisions and judgments made by management. The FRC note these are common issues raised in Audit Quality Reviews.

The FRC suggest a number of underlying reasons for these failings. A select few have been considered below:

  • Insufficient involvement of the audit partner and over delegation to junior members of the team: The lack of supervision, that is ensuring the appropriate types of audit checks are carried out and the lack of proper communication with junior members of the team, are often the causes of problems which ultimately lead to audit failings.
  • Disorganised audit work: The FRC lists a number of ways in which audit firms have been disorganised. The key point being that disorganisation leads to lines of inquiry not being pursued to their conclusion and parts of the financial statement being signed off without testing.
  • Failure to step back and take an overall look at the financial picture: The FRC state that their investigations experience tells them that audit work is often conducted in silos. The risk of silos is that red flags may only become apparent when looking across the audit as a whole.
  • Auditor too close to management: The FRC highlight examples where audit team members use terms such as 'we', 'us' and 'our company'  when referring to the company they are auditing and suggest that on occasion auditors appear more concerned with client relationships than the quality of the independent audit work.
  • Use of auditors' experts and specialists: The FRC observe that a lack of proper communication with the expert or specialist teams and a tendency to accept their work unquestioningly are issues.

More severe penalties in these recurrent areas may be on the horizon, especially given the FRC will be able to point to their own publicity and warnings around these issues.

Enforcement and COVID-19

The FRC acknowledges the challenges COVID-19 has caused it and recognises that "accountants, actuaries and auditors will be faced with unique and complex decisions in the context of financial reporting". Noting these challenges, it adds that "there cannot be individual exceptions made to the standards". One can read from this that Enforcement will be as active as ever in enforcing standards irrespective of the challenges that a potentially stressed economic environment will create. 

With this sentiment, a select number of areas that the FRC have highlighted as being of heightened risk are explained below:

  • Financial reporting pressures: Noting that some companies may feel pressured to report results in a particular way, the FRC makes clear that professional accountants at all levels should not be associated with misleading financial information. They should speak up if they do feel pressured.
  • Documentation: The FRC acknowledges the current situation may make it more challenging to obtain the required evidence but unequivocally states that the pandemic is not an excuse for not having obtained and retained sufficient and appropriate evidence.
  • Professional scepticism: The FRC states that auditors must maintain their independence and objectivity, recognising that it is not the auditor's role to assist the company in presenting an optimistic or pessimistic picture but to assure the truth and fairness of the financial statement.
  • Fraud: The COVID-19 crisis means that there may be situations where there is a greater risk of fraud. Noting this, the FRC states that accountants within the business must maintain the highest ethical standards in the face of any undue pressure from within the business and the auditor should be alert to red flags.

Conclusion

The FRC has acknowledged the challenges firms will face in light of COVID-19 and described areas of heightened risk. It has made clear that there will be no individual exceptions to the standards. Further, it has highlighted areas of repeated failings by firms. Readers will likely be aware that the FRC will be re-configured as the statute based Audit, Reporting and Governance Authority. They may also be aware of its previously planned increase in Enforcement headcount of approximately 35% this year.  In light of these, and with government priorities shifting in light of COVID-19, together with the heightened importance of financial reporting at this time, the FRC will be wanting to demonstrate its value in light of the fallout to consumers, investors and market integrity. 

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