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The Financial Markets Authority says there's a big difference in quality between audit reports by the 'big four' accounting firms and their lower tier rivals, who will need to step up their game significantly to meet regulations overseeing the sector.
The market watchdog's first audit quality review report since the regulations came into play last year found "the majority of audit firms reviewed require significant improvements to fully comply with Auditing and Assurance Standards."
The regulator acknowledged the big four - PwC, KPMG, Deloitte and Ernst & Young - have already been subject to regulatory review by international bodies, while the rest have only been subject to the new regime since July last year.
"From the sample of firms reviewed over the period, there appears to be a significant gap between the Big Four firm and the other firms," the FMA said in its report.
The big four dominate audits for locally listed companies, accounting for almost 90 percent of the 110 domestic equities. PwC has the lion's shares with 45, followed by KPMG with 26, then Deloitte with 14 and EY with 12.
"FMA recognises that audit firms in New Zealand have not previously been subject to independent regulation and therefore, we expect more non-compliance in comparison with jurisdictions that have been subject to regulation for a number of years," it said.
The government had been working with the New Zealand Institute of Chartered Accountants to end the self-regulating auditing regime since 2001, when the collapse of Enron led to the dissolution of accounting firm Arthur Andersen and sparked concerns about the oversight of auditing processes.
It got a new lease of life in a 2009 report by former Companies' Registrar Neville Harris on the series of failed finance companies, which slated auditing of the local finance sector as lacking "the rigour and analytical depth one would expect one would expect for entities managing substantial public investments."
The big four firms largely left the sector alone, leaving second-tier accounting firms which lacked the capability and experience to review the "complex and elaborate company and business structures," the Harris report said.
From February this year until June, NZICA, acting as a delegate for the FMA, reviewed 33 audits by nine registered firms, of which 19 audits needed significant improvements. The regulator will conduct follow-up or spot reviews of those firms.
Audits were tagged with needing significant improvement if the FMA had concerns over the sufficiency or quality of audit evidence in key areas, if there were significant concerns over the appropriateness of audit judgements in key areas or if the implications of relating to other areas were seen as individually or collectively significant.
Just nine were acceptable with some improvement needed, while five were deemed to be good.
The FMA found the majority of small to mid-size firms hadn't established a monitoring programme to review issuer audit files to assess the quality of their control systems, which the regulator said can only be effective if reviewed on a risk-based framework by appropriate staff.
"We found instances where the internal review (where such reviews were performed) showed significantly more positive results than our inspection findings, and files selected for these reviews did not seem to focus on higher risk issuers," the report said. "The significant difference in these findings questions the robustness of these processes."
The FMA recommended audit firms issue proper guidelines and training for engagement quality control review (EQCR) partners and to ensure adequate documentation could show the reviews were performed properly.
The regulator found a significant number of areas where documentation of audit procedures and evidence could be improved, with some firms falling short of the required standards.
"A major concern in our reviews was the lack of documentation evidencing an organised audit process," the report said.
"Across a number of files, we were not able to confirm that the audit work undertaken was either appropriate or sufficient for the purpose of supporting the issuance of the audit opinion. We have not formed a view on whether this has resulted in the audit opinions being incorrect," the report said.