Critical Evaluation of the Quality and Effectiveness of Audits

Assignment Brief

Governance and Auditing

Assignment Title: Risk Management: A critical evaluation of the quality and effectiveness of audit

Description of the assignment:

The audit engagement environment is significantly changing.

“Currently, auditors must be changed every 20 years and audits must be re-tendered every 10 years. The CMA decided that it would not increase the frequency of rotation as one of its remedies. It accepted that this “could interrupt the close relationship that may develop among management, audit committees and the audit firms, over a long audit tenure”, and increase the independence of auditors, while it could also promote greater competition. However, the CMA was concerned that more frequent audit tenders and auditor rotation would increase the costs for the audit firms and companies” .. ’”whilst reducing audit quality if recently appointed audit firms did not fully understand the businesses of their audit clients.

Your essay should include the following elements, and marks are awarded as follows:

• An introduction of risks and potential consequences facing audit practices when acquiring new audit engagements.  You should make reference to at least two corporate examples. One example should be a FTSE100 company which has changed auditors in the last 24 months, and the second example must be Fraser Group Plc (formerly known as Sports Direct Plc) (30%)

• An explanation of three key procedures adopted to reduce the risks to audit practices, when dealing with new client engagements.  Reference should be made to potential risks connected to the specific example in the element above (30%)

• A critical evaluation of the effectiveness of those procedures, including any recommendations you would make to improve those procedures (30%)

The remaining 10% of marks is split evenly between presentation/grammar and referencing. Please note that although these elements are awarded 10% of the marks, poor presentation/grammar and referencing will impact on the readability and credibility of all areas of your essay, and therefore may affect other marks.

Sample Answer

A Critical Evaluation of the Quality and Effectiveness of Audit

Introduction

The landscape of audit engagement is becoming increasingly complex. Audit firms today face significant risks when acquiring new engagements, ranging from challenges to auditor independence, reputational damage, regulatory scrutiny, and difficulties in understanding new clients’ business models. The Competition and Markets Authority (CMA) has highlighted these issues in its call for greater rotation and re-tendering of auditors, raising questions about whether such changes improve audit quality or increase risks. The experiences of FTSE100 companies and Fraser Group Plc demonstrate the potential consequences of such transitions, while also providing insights into how risk management procedures can mitigate them.

Risks and Consequences of New Audit Engagements

One of the major risks when taking on a new client is the limited knowledge auditors initially have about the company’s operations and internal controls. This knowledge gap can result in ineffective risk assessment, insufficient testing, or material misstatements being overlooked. For instance, Barclays Plc, a FTSE100 company, changed its auditors from KPMG to PwC in 2022 after more than 120 years with the former. The transition created immediate challenges, as the new auditors faced the complexity of assessing extensive global banking operations within a short timeframe. Any failure to understand risk exposure in such a context could undermine confidence in financial reporting.

A second example is Fraser Group Plc (formerly Sports Direct Plc), which appointed RSM as its new auditor after Grant Thornton resigned in 2019, citing challenges over the company’s governance and disclosures. This change illustrated reputational risks: Fraser Group struggled to secure a replacement due to its controversial governance practices and issues with transparency. Such a case shows that auditors risk reputational harm by associating with companies whose governance raises public or regulatory concern.

The potential consequences in both examples are significant. Errors in financial statements can damage auditor credibility, attract regulatory sanctions, and undermine investor confidence in markets. Furthermore, reputational risks may deter future clients and reduce audit firms’ competitiveness.

Procedures to Reduce Risks in New Engagements

Audit practices employ several procedures to manage risks when acquiring new clients.

Rigorous Client Acceptance and Continuance Procedures

Before accepting a new engagement, audit firms conduct extensive background checks on prospective clients. This involves assessing financial stability, governance practices, management integrity, and potential conflicts of interest. In Fraser Group’s case, many firms declined engagement due to the reputational risks involved, highlighting how client screening acts as a safeguard against exposure to high-risk companies.

Engagement Quality Control Reviews (EQCR)

Independent partners within the audit firm often review the audit plan and major judgements, particularly when dealing with new clients. This ensures that risks are properly identified and addressed at an early stage. For example, PwC’s takeover of Barclays’ audit would likely have involved enhanced EQCR due to the complexity of the client’s operations.

Knowledge Transfer and Specialist Involvement

When auditors rotate, a major challenge is the transfer of client-specific knowledge. Audit firms mitigate this through structured knowledge handovers, staff training, and by engaging specialists (e.g., IT auditors, tax experts, forensic teams) to bridge understanding gaps. This reduces the risk of misinterpretation and allows new teams to handle complex operations such as banking or retail.

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