When Fine is not Fine!

Financial audits report on whether a company’s annual statements are true and fair with no material error or omissions.  They are supposed to provide assurance to stakeholders.  They are supposed to be completed professionally and diligently.  However, the Financial Reporting Council’s (FRC) Annual Enforcement Review of 2022 stated that financial sanctions had reached an annual record of £46.5 million while non-financial sections had also grown in number and scope from 28 to 62 cases in the last year.  The FRC referred to the failure of some audit teams to document work properly, show sufficient professional scepticism, and obtain sufficient audit evidence prior to concluding on a company’s annual statements. 

The FRC listed financial sanctions in its Review for audit firms.  These included: KPMG for Conviviality (£4.3m), Rolls-Royce (£4.5m), Silentnight (£13m), Revolution Bars (£1.25m); Grant Thornton for Patisserie Holdings (£2.35m), Interserve (£1.3m), Sports Direct (£1.7m); PwC for Galliford Try (£5.5m), Kier (£3.35m); EY for Stagecoach (£3.5m); Deloitte for Mitie Group (£2m).  All these sanctions, which allegedly play an important dissuasive role from audit firms neglecting their reporting duties, were discounted by a significant percentage for reasons ranging from recognition of failure, mitigating factors, early disposal, and level of cooperation during the investigation.  The FRC reduced the £46.5m record total fines charged to the entities, the audit firms, to £34.6m.

The FRC also issued in 2022 non-financial sanctions targeted at individual auditors (non-entities) as well as audit firms.  These sanctions included reprimands, exclusion of auditors (usually audit partners) from professional bodies, detailed work to understand the underlying causes of the deficiencies which gave rise to the breaches, remedial measures, and detailed reporting to the FRC. 

The main question is whether the FRC is doing enough?  Year after year there are lists of examples of audit firm sanctions.  Possibly the bigger audit firms shrug off these financial sanctions, which are a very small percentage of their profits, as a cost of doing business; a minor threat associated with providing a pared back, risk based audit to generate higher profits from all its audit clients; a relatively small penalty for delivering cheaper, more profitable audits; a chance worth taking when the FRC only escalates a few of the audits these firms complete each year; a penalty worth paying if it enables these firms to make much bigger profits by taking short cuts, using cheaper audit teams, collecting inadequate evidence, and reducing audit time.  Perhaps the bigger audit firms believe the non-financial sanctions to be minor: excluded audit partners can easily be replaced; reprimands brushed aside; remedial measures diluted; actions plans’ partly executed; promises partially broken; subjective changes modified.  

It seems the deterrent effects of fines are inadequate and the non-financial measures ineffective.  The FRC, instead of discounting fines, should impose financial sanctions of the magnitude that would impel rational entities to conclude the financial gain from delivering poor quality audits is less than the expected financial punishment.   Its non-financial sanctions should be more potent.  It should be able to threaten qualified auditors, at whatever level, with exclusion from the profession; to exclude firms from auditing clients in certain industries; to suspend the audit services of a firm in an office, city, region, or country.   The Auditing Reporting and Governance Authority, which is to replace the FRC, needs to be a much tougher and harsher enforcer, otherwise audit firms are unlikely to change.

The Auditing Team

Department of Finance, Accounting and Economics

The increase in non-financial sanctions in the past few years could suggest that these measures to prevent recurrence are insufficient.