Overview
Audit quality in New Zealand shows troubling trends. Recent FMA reviews reveal non-compliant files have jumped from 26% to 36%. The Financial Markets Authority continues its work to promote fair, efficient, and transparent financial markets, yet these numbers keep rising. The latest audit quality monitoring found five non-compliant files, which marks a substantial increase from earlier periods.
Several key factors determine an audit’s quality. The audited entities must provide timely information while directors need to stay involved throughout the process to maintain high standards. An audit firm’s culture and its focus on professional skepticism also affect the overall quality. However, the recent increase suggests we need a closer look at how firms implement their audit quality management frameworks. This piece will get into the FMA’s oversight of audit quality, highlight identified deficiencies, and explain why these developments matter to businesses.
FMA’s Audit Quality Review Framework Explained
The Financial Markets Authority (FMA) uses a well-laid-out system to monitor financial audit quality. This system forms the foundation of auditing standards throughout New Zealand’s financial sector.
Annual review cycle for registered audit firms
The FMA reviews registered audit firms in cycles. Firms handling ten or more listed issuer audits get reviews every three years. Those with fewer audits face reviews every four to five years. This system will give a proper oversight based on each firm’s market effect and risk profile. New firms usually get their first review within a year of starting operations to set quality expectations.
Risk-based selection of audit files and firms
The FMA doesn’t pick audit files at random. Instead, they use a risk-based approach that looks at several key factors:
- The audited entity’s complexity
- The size and public interest of the audited entity
- Quality issues found at the firm before
- Changes in audit methods or staff
- Economic pressure on industry sectors
This targeted selection helps the FMA use its resources where they matter most. They focus on areas that might show quality issues or where improvements would make the biggest difference in the market.
Thematic reviews: Bank audits and climate assurance
The FMA also runs thematic reviews that look into specific industries or new audit challenges. They’ve done deep dives into banking sector audits over the last several years. These audits face unique challenges because of complex financial tools and regulatory rules.
The FMA has started to look at how audit firms handle climate-related disclosures and assurance requirements. This shift reflects growing investor interest in environmental risks and the need for reliable sustainability reporting verification. These reviews help spot patterns in audit quality across the industry and shape the FMA’s guidance and enforcement priorities.
This detailed framework helps the FMA raise auditing standards across New Zealand. As a result, investors and stakeholders can trust financial reporting more.
Evaluating Systems of Audit Quality Management (PES 3)
PES 3 (Professional and Ethical Standard 3) is the life-blood of quality management for audit firms. It replaces old compliance-focused approaches with an all-encompassing system. Firms just need to design, implement, and operate quality management systems that will give a reasonable assurance about meeting professional standards.
Governance and leadership under PES 3
Quality management systems are built on effective governance. Leadership must show clear accountability for quality through their actions and behaviors under PES 3. The standard expects firms to build an organizational structure that assigns roles and responsibilities so the system works well. PES 3 also requires leaders to plan, get, and allocate resources that match their steadfast dedication to quality.
Monitoring and remediation effectiveness
A robust monitoring and remediation process works as a vital feedback loop in PES 3. Firms must set up ongoing monitoring activities to get relevant, reliable, and timely information about their quality management system’s performance. Each year, firms must assess if their system gives reasonable assurance that they meet objectives. This review must look at both design and how well everything works. Teams must assess how severe and widespread deficiencies are, then analyze root causes to create the right fixes.
Reliance on network controls and documentation gaps
Audit firms often use network-level controls or third-party service providers. Yet PES 3 makes it clear that firms stay responsible for their quality management systems whatever their reliance. Firms must know exactly how network requirements and services work when they use them. Documentation gaps create big challenges during quality reviews. Common issues include weak password settings, slow system access removal, and poor user access right reviews. Firms need detailed documentation that shows how their quality management systems work daily, especially with network controls.
Common Audit Deficiencies Identified by the FMA
The FMA’s review process keeps finding several common problems that affect audit quality at registered firms. Auditors need to improve their procedures to protect stakeholders in these key areas.
Inadequate testing of related party transactions
Related party transactions raise the risk of material misstatement in financial statements. Some auditors failed to properly disclose these transactions as required by New Zealand’s financial reporting framework. One audited entity wrongly combined various transactions with its overseas parent and recorded them as a single entry. This practice went against accounting standards that ask for separate reporting of different transaction types. Clear disclosure helps users of financial statements understand these relationships’ nature and effects, especially when they need to know if the transactions helped the entity. The FMA has raised concerns about “little evidence of professional skepticism being applied when reviewing these types of transactions, and in particular, little challenging of management assertions”.
Unverified data in substantive analytical procedures
Substantive analytical procedures review financial information by looking at relationships between financial and non-financial data. These techniques don’t work well when they use unverified information. The FMA found cases where auditors used system-generated reports without checking if the data was reliable. One auditor used system-generated overhead cost allocations but didn’t document their review of whether the allocation stayed reliable from earlier periods. Another case with an actuary report showed the auditor didn’t check if the assumptions made sense when comparing prior-year outstanding claims to reinsurance receivables. These oversights reduce the value of analytical procedures as a substantive test.
Insufficient fraud risk assessment linked to variable remuneration
Auditing standards require teams to evaluate fraud risk factors and think about management override controls. The FMA found problems in how auditors review variable remuneration as a potential fraud risk factor. Bank audits showed CEOs’ fixed remuneration made up just a small part of their total pay package. Financial targets that determine variable remuneration components can create incentives for fraud. Yet “the audit files reviewed lacked evidence to demonstrate if the firm assessed the elements of variable remuneration and how these impacted the risk of fraud”. This gap in analysis makes it harder for auditors to see if variable compensation structures create higher fraud risks.
Global Comparisons and Regulatory Implications
New Zealand’s audit environment follows a global regulatory framework that sets quality assessment standards.
IFIAR standards for Big 6 audit firms
The International Forum of Independent Audit Regulators (IFIAR), which includes the FMA, runs yearly surveys to check inspection findings from audit firms linked to the six largest global networks. These surveys track deficiency rates in more than 50 jurisdictions and are a great way to get international comparisons. The global EY IFIAR survey deficiency rate climbed to 28% from 20% in 2022. The global EY all-in deficiency rate dropped from 18% to 13% during the same period, which presents an interesting contrast.
Oversight of overseas auditors under TTMRA
The Trans-Tasman Mutual Recognition Arrangement (TTMRA) lets Australian-registered auditors work in New Zealand without extra testing. This non-treaty arrangement makes shared professional mobility possible between both countries. The FMA revoked a Sydney-based auditor’s license in 2023 after repeated failures, which shows that overseas practitioners must meet New Zealand’s regulatory requirements.
International recognition’s effect on New Zealand audit standards
The European Commission’s recognition of New Zealand’s audit oversight regime matches EU standards and proves our regulatory framework meets international quality benchmarks. New Zealand auditors can now audit EU and Swiss-listed entities. This recognition builds investor trust in New Zealand’s capital markets. The UK-NZ agreement on reciprocal arrangements creates a path for auditors to practice in both countries.
Conclusion
Trust in New Zealand’s financial markets depends on quality audit oversight. The FMA’s cyclical reviews create vital safeguards, but a worrying trend shows non-compliant files jumping from 26% to 36%. This rise points to a pressing need to improve quality management frameworks across the sector.
Professional and Ethical Standard 3 brings a complete system-based transformation to quality management. Companies must build stronger governance structures and set up better monitoring systems. They need to fix documentation gaps, particularly when they rely on network controls.
The FMA’s findings reveal areas that need quick fixes. Related party transactions need more skeptical review instead of just accepting what management says. Auditors must check the data before they run analytical procedures. You can’t ignore variable pay structures as possible fraud risks either.
New Zealand fits into a bigger global picture where international standards help measure quality. The European Commission’s recognition shows our rules match global standards. Agreements like TTMRA let professionals work easily between Australia and New Zealand.
Companies gain a lot by understanding these checks and common problems. Quality audits protect investor confidence and make financial markets stronger. They safeguard everyone’s interests in the economy. We face challenges, but staying watchful and following these time-tested standards will keep New Zealand’s reputation for strong financial oversight and openness intact.
FAQs
Q1. What is the FMA’s role in ensuring audit quality in New Zealand?
The Financial Markets Authority (FMA) implements a structured framework to monitor the quality of financial audits in New Zealand. This includes conducting cyclical reviews of registered audit firms, employing a risk-based approach to select audit files and firms for examination, and conducting thematic reviews of specific industry sectors or emerging audit challenges.
Q2. How does Professional and Ethical Standard 3 (PES 3) impact audit quality management?
PES 3 requires audit firms to design, implement, and operate comprehensive quality management systems that provide reasonable assurance about meeting professional standards. It emphasizes effective governance, leadership accountability, rigorous monitoring and remediation processes, and proper documentation, especially when relying on network controls.
Q3. How does New Zealand’s audit oversight framework compare globally?
New Zealand’s audit oversight regime has been recognized by the European Commission as equivalent to EU standards, affirming its alignment with high international benchmarks. The FMA also participates in global forums like IFIAR, which provides valuable comparisons and benchmarks for audit quality across major firms.
About the Author: Jonathan Maharaj
