September 2021 saw the Financial Reporting Council (FRC) impose sanctions against Grant Thornton (GT) and Audit Engagement Partner David Newstead, in relation to their audit of Patisserie Holdings Plc for the financial years ended 30 September 2015, 2016 and 2017. Cases of this nature are often of limited interest to those auditing small SME type businesses – but this is a big exception. Here are six important lessons that all auditors can learn from this sad tale of auditing incompetence.
- Don’t forget basic risk analysis
One of the problem areas flagged up the by the FRC review involved GT’s audit of sales cut-off. For a number of companies in the group, large numbers of vouchers for ‘afternoon teas’ were sold by third party companies and the monies remitted to Patisserie Holdings, net of commissions retained. For some companies, sales of this type recorded as year-end adjustments were very significant. In the case of one company such adjustments represented 217,788 afternoon teas – when only 124,779 afternoon teas were sold by the company during all the other months of the year combined.
The FRC were critical of the work performed in this area but also highlighted that misstatement of sales cut-off was often not flagged as a key risk and specific audit tests not planned, despite the very strange transaction profile. The learning here is quite basic. If the profile of transactions looks odd there is a risk it might be incorrect. If so, flag it as a risk and do some proper testing!
- Ask basic questions – and document the answers
Following on from the previous point, the FRC identified that testing was ultimately performed on the voucher sale adjustments referred to above, but that this testing did not always involve asking the client why the period end adjustments were so significant and out of line with expectations.
The requirements of paragraph 10 of ISA (UK) 230 on Audit Documentation are quite clear here. ‘The auditor shall document discussions of significant matters with management …. including the nature of the significant matters discussed and when and with whom the discussions took place.’
A materially odd sales profile is surely a significant matter for any auditor. Very important then to ask why it is odd, understand the answer coming back – and then validate this. Crucially this information was simply missing from some of the files the FRC reviewed.
- Review documentation with a critical eye
In respect of sales cut-off testing and testing in other areas of the files reviewed, the FRC report makes regular reference to documents of ‘dubious provenance’. For a number of statements, invoices and other third party documents contained on file to substantiate figures being tested, the following issues were highlighted:
- Missing logos
- Missing website addresses
- Spelling mistakes
- Unusual format/fonts on documents reviewed
- Addressees other than the client
- No date/date wrong
This is all pretty basic and stuff that we’re taught about as trainees. The learning here is to remember that where fraud is perpetrated it’s not always hugely sophisticated – and a continued focus on common sense, taking a step back and asking yourself is the evidence we’re presented with reasonable in the circumstances will often get you a long way, even when you’re auditing a listed Plc.
Interestingly the FRC report only focusses on the shortcomings in GT’s audit work, not any fraud that may or may not have been perpetrated within Patisserie Holdings.
- Keep important papers on file
When training junior auditors on compiling audit sections we often encourage them not to retain too much superfluous paperwork on file. As long as there is a documented audit trail on file that enables testing to be potentially reperformed by, say, an audit manager then that’s fine.
In the case of the voucher sales referred to above, these were, in some cases, audited by reference to statements from third party partner organisations of Patisserie Holdings – with a small number of companies accounting for a significant portion of the period end adjustments. The FRC commented that whilst the statements were referred to, these could not always be located on file. The learning is surely that where an individual statement or source of evidence is integral to the audit of a very significant figure, it’s always worth retaining a copy for the file – just in case.
- Beware the perils of large sample sizes
As with a number of high profile disciplinary cases of late, the FRC were not hugely impressed with how GT had audited journals. Interestingly, in setting its parameters for a detailed review of journals, the firm had used ‘inappropriate criteria’ which resulted in it having ‘an excessively large number of journals to test, which in turn comprised the quality and depth of the testing as entries were left untested and inconsistencies arising from testing went unexplained’.
There’s been a lot said about changes in sampling methodologies recently and about how the removal of sample size caps within some audit methodologies has let to large (and unpopular!) increases in sample sizes. This sorry tale shows the risks of setting sampling sizes too high. It that happens, then with the best will in the world, no one is going to have the energy to fastidiously explore, explain and validate every item picked.
- Remember how bank reconciliations work
We learn as accountancy students how a bank reconciliation works and we are told that an uncredited lodgement is an item which is entered in the cash book in one period but that then clears the bank in the following period. In case of Patisserie Holdings such items actually entered the accounting and banking system post year end. Staggering stuff. Either audit staff were inadequately trained on accounting fundamentals, hoodwinked or inadequately supervised on the job. Either way this would surely not be expected to be an issue on any audit – least of all that of a listed Plc.
The overall learning from the Patisserie Holdings debacle is perhaps to get the basics right. Many, if not all, of the audit areas highlighted by the FRC as being deficient were ones that staff could expect to look at early in their audit career. For a more detailed review of the report itself (or at least its executive summary), which is well worth a read, go to News I Financial Reporting Council (frc.org.uk)
Peter Herbert, January 2022