Written by Philip Wiles, Client Services Director
Earlier this year, the Financial Reporting Council (FRC) published a Thematic Review, entitled “The Use of Technology in the Audit of Financial Statements” 1 and made the statement, “Audit data analytics (ADA) is now routine at the largest UK audit firms”. The review was particularly drawn on how technology could be used to improve audit quality.
In this article we shall look at the principle findings from the review surrounding the use of ADA by UK’s 6 largest audit firms. The last review of this nature was carried out in 2017 and the executive summary recognises that ADA has largely become business as usual (BAU) for the firms in the review, having previously observed instances of ADA being classed more generally as ‘good practice’.
As we focus away from the 6 larger firms, where does that put your firm? Has ADA become BAU, or are you still looking for that starting point? How do the findings translate for firms using popular ‘off the shelf’ audit methodologies? Let’s have a look at the findings to understand why ADA has the potential to enhance the quality of financial statement audits.
Common Practice
Usage of ADA has increased in the profession since 2017. Journal testing remaining prevalent across all 6 firms, now being observed on typically over 80% of the audits inspected at each firm, with one firm demonstrating 100% usage on its inspected audits. Revenue testing is the next most common area, with 5 of the 6 firms demonstrating wide or regular use of ADA in this area.
Potential benefits
The FRC refreshed its definition of audit quality in the 2018 Development in Audit report 2 and this review suggests how technology might contribute to improving audit quality in each of the 3 main areas of the definition. From the eyes of investors and other stakeholders, auditors are expected to carry out their work with integrity and objectivity. The review explains how technology can aid professional scepticism, can demonstrate a lack of bias though analysing entire populations and can allow more time to be spent on areas of significant judgement where technology is used to create efficiency by automating routine audit procedures.
A high quality audit requires a thorough understanding of the entity and a robust risk assessment. Technology allows the auditor to test large and complex data sets and perform a risk assessment based on the entire population. Interestingly, the increased use of ADA to test revenue has not led to any increase in the identification and adjustment of significant differences, but the FRC did observe better understanding of the various revenue streams by audit teams and given the drive to improve audit quality, the FRC maintains revenue testing with ADA continues to play an important role.
A deterrent against actions that might not be in the public interest can be delivered by high quality audits. This review recognises how ADA contributes to identifying potential fraud and how the presence of ADA can act as a deterrent through management being aware that entire populations will now be analysed.
Practical observations
It is important for the audit methodology to reflect the use of ADA and the review explains how firms are ‘seeking’ to embed tools in their methodologies and workflows, suggesting the work to update methodologies is ongoing, whilst remaining fundamental to ensuring ADA is adopted successfully. Where ADA is used in the planning stage for risk assessment, the methodology should provide guidance that helps the audit team interpret the output appropriately. It is important for audit teams to be guided in the application of ADA to understand where the technique is suitable. The methodology should explain the assertions that are being addressed by the tool and whether further audit procedures are required alongside. It is also important to understand if any procedures are being made redundant by the technology to avoid performing unnecessary audit work and cost.
“Challenging” was the adjective used to describe compliance with the standards framework. Whilst the use of ADA has increased, there have been no explicit changes to the standards to reflect the use of technology. Firms are confidently applying ADA techniques and, but do need to apply effort in demonstrating how tools and techniques maintain compliance.
Data extraction remains a challenging area for all firms. The review recognises how larger firms are able to build specialist service teams focussing on the skills and technology required to extract and organise data into a suitable format for the audit work. It is important to note how this work must also be evidenced to demonstrate the dataset’s integrity, ensuring the auditor is working with complete and reliable data. Firms outside of, say, the 10 largest UK firms, are unlikely to be able to develop this level of in-house resource and may need to engage specialist 3rd parties. The ability of the client and the willingness of its management cannot always be assumed, whilst achieving the required level of granularity of data has been noted as a challenge for others, simply because the client’s accounting system is not far enough advanced to support ADA.
How to prepare your firm
- Scope your roll out of ADA to focus on a particular technique and identify its relevance to a particular audit area, such as journal testing
- Engage the client early to explain the use of ADA and to obtain their co-operation
- Provide support to the audit team for data extraction and risk assessment
- Explain to the team how ADA fits within your methodology and how a standard approach might be modified
- Consider adjusting your workflow to ensure results are used effectively and efficiently in the course of the audit
CaseWare has launched it's new ADA tool, “Analytics AI”. Our new cloud product has been designed to help firms with their move into this field and delivers a range of tests to support General Ledger and Journal testing across a large population with relative ease. We are progressing our cloud audit platform to achieve a strong integration between the audit working papers and the ADA techniques in use, meaning that as our partners’ methodologies are updated to reflect the use of ADA, the CaseWare Cloud audit will continue to offer even greater efficiencies. Further announcements will be made shortly.
- The use of technology in the audit of financial statements, AQR thematic review, March 2020 (frc.org.uk/getattachment/1c1478e7-3b2e-45dc-9369-c3df8d3c3a16/AQT-Review_Technology_)
- “Developments In Audit 2018”, FRC, Oct 2018 (frc.org.uk/getattachment/1c1478e7-3b2e-45dc-9369-c3df8d3c3a16/AQT-Review_Technology_20.pdf)