Auditors are too trusting of managers' explanations of financial reporting when looking into company accounts, the Audit Inspection Committee (AIU) says.
The AIU, part of the Financial Reporting Council, also berates firms for failing to act on its previous warnings to improve fraud risk assessments during audits.
Such assessments are particularly relevant during the economic downturn given the "increased likelihood of fraud", it says in its 2009/2010 annual report for the year ended 31 March 2010
Of particular concern to the AIU is the failure of some firms to identify fraud related to revenue as posing a "significant" risk, despite the presumption in Auditing Standards that this would normally be the case
The AIU report states: "Firms sometimes approach the audit of highly judgmental balances by seeking to obtain evidence that corroborates rather than challenges the judgments made by their clients."
The AIU also identified situations where differing and conflicting judgments were accepted by the same firm for clients operating in similar industries.
It says auditors should exercise "greater professional scepticism", particularly when reviewing management's judgments relating to fair values and the impairment of goodwill, and other intangibles and future cash flows relevant to the consideration of going concern.
PricewaterhouseCoopers, Grant Thornton UK, Ernst & Young, Deloitte, KPMG and Baker Tilly are among the major firms subject to the full scope of AIU inspections.
Its inspections of smaller firms are limited to a review of individual audits.
The AIU says its 2010/11 inspections will focus on the impairment of goodwill and intangibles, going concern, fair value accounting estimates, compliance with ethical standards, segmental reporting, revenue recognition and fraud.
"These areas of focus reflect the challenges auditors face in the current economic downturn and changes in financial reporting", it says.
It says it will also increase its focus on banking audits.
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