KPMG, the former external auditor of collapsed contracting and services giant Carillion, has been singled out for censure by the UK’s accounting watchdog for an "unacceptable deterioration" in its auditing work.
Half of its FTSE 350 audits were found to be substandard by the Financial Reporting Council (FRC) in its annual report published yesterday, and the FRC said it will monitor the firm more closely, and hold its leadership to account.
The report, which is separate to the FRC’s ongoing investigation into KPMG’s and other auditors’ roles in the collapse of Carillion, criticised the other three firms in the so-called "Big 4" club of accountants for their growing failure to challenge company management and show the appropriate level of scepticism in their audits.
"Disappointed": Michelle Hinchcliffe, partner and head of UK banking at KPMG (KPMG)
Like KPMG, these three – Ernst & Young, PwC and Deloitte – saw drops in the percentage of inspected audits that met FRC standards.
They "must act swiftly to reverse the decline in this year’s audit inspection results", the FRC warned.
"At a time when public trust in business and in audit is in the spotlight, the Big 4 must improve the quality of their audits and do so quickly," said Stephen Haddrill, the FRC’s chief executive.
The report comes after all four were denounced last month by a joint select committee of MPs investigating Carillion’s collapse, who concluded that the four, all of whom had auditing or advisory roles with Carillion, repeatedly failed to flag up problems or challenge management.
MPs singled out KPMG for particular blame because the firm, Carillion’s external auditor for 19 years, had been "complicit" in signing off Carillion’s "increasingly fantastical figures".
Carillion’s internal auditor, Deloitte, failed to identify "terminal failings" in risk management and financial controls, or "too readily ignored them", said MPs, who asked the government to consider breaking up the auditing functions of the Big 4 to increase competition.
The FRC also singled out KPMG, saying it has undergone "an unacceptable deterioration in quality", with 50% of its FTSE 350 audits requiring "more than just limited improvements" compared to a score of 35% the previous year.
As a result, the FRC will inspect 25% more of KPMG’s audits in the coming year, and will monitor how the firm implements its Audit Quality Plan.
A KPMG spokesperson said the firm was "disappointed" by the quality score, but was "taking action".
Michelle Hinchcliffe (pictured), partner and head of UK banking at KPMG, told the BBC: "We are disappointed that our overall audit quality score for our 2016/17 audits has decreased by 4% and that the steps taken in previous years have not resulted in the necessary improvements to audit quality. We are taking action to resolve this."
The 4% drop Hinchcliffe referred to is the drop to 61% of all audits, including FTSE 350 audits and others, assessed as requiring no more than limited improvements, compared with 65% in 2016/17.
In its individual report on KPMG, the FRC said: "The overall quality of the audits inspected in the year, and indeed the decline in quality over the past five years, is unacceptable and reflects badly on the action taken by the previous leadership, not just on the performance of front line teams.
"Our key concern is the extent of challenge of management and exercise of professional scepticism by audit teams, both being critical attributes of an effective audit, and more generally the inconsistent execution of audits within the firm."
While the FRC’s report echoes investigating MPs’ sentiments over the Carillion scandal, those very MPs expressed anger over the FRC itself, and other regulators, for being "timid" in challenging Carillion on its "inadequate and questionable" financial information, and for being "wholly ineffective" in taking its auditors to task.
Top image by Alexey Novikov/Dreamstime