FRC Audit Quality Review 2025: What Went Wrong and What Your File Needs

The headline numbers: Tier 1 versus the rest

The FRC inspected audits across its three-tier classification system. Tier 1 comprises the Big 4 plus BDO and Forvis Mazars. The results for 2024/25: 86% of Tier 1 audits required no more than limited improvements, up from 74% the prior year. Five of the six firms achieved 90% or above. The exception was BDO, where 50% of 14 inspected audits required no more than limited improvements. Four of BDO’s inspected audits were assessed as requiring significant improvements, which the FRC called “unacceptably high.”

For Tier 2 and Tier 3 firms (smaller PIE audit firms inspected less frequently), the picture is worse. Over the last three years, 43% of Tier 2 inspections achieved adequate or better outcomes. For Tier 3, that figure was 20%. The FRC noted significant variation within these tiers: some individual firms achieved 100% adequate outcomes over three years, while others achieved 0%.

The FRC’s Executive Director of Supervision, Sarah Rapson, noted that audit quality has improved significantly since 2018 and compares favourably internationally. But she warned against complacency. The market should not assume that Tier 1 improvement will trickle down to smaller firms. The structural challenges are different: smaller firms face tighter staffing, less investment in methodology, and weaker quality management systems.

Impairment: the finding that will not go away

Impairment of non-current assets has been the FRC’s most common audit inspection finding for at least four consecutive years. In the October 2025 Key Findings and Good Practice report, the FRC confirmed it remains a top area of concern in the 2023/24 and 2024/25 inspection cycles.

The FRC’s corporate reporting review (September 2025) found impairment-related issues in 10% of companies reviewed, down from 12% in 2023/24. Audit-side findings mirror this. Auditors are not sufficiently challenging management’s impairment models. The specific weaknesses the FRC identified include:

• Failure to challenge key assumptions in value-in-use calculations (particularly revenue growth rates and discount rates)
• Failure to assess whether forecast assumptions are consistent with other forward-looking information in the financial statements (such as going concern assessments and viability statements)
• Insufficient sensitivity analysis on impairment models where headroom is narrow

IAS 36 requires the recoverable amount of an asset or cash-generating unit to be the higher of fair value less costs of disposal and value in use. The auditor’s job under ISA 540 (Revised) is to evaluate whether the estimate is reasonable. That evaluation requires challenging the inputs, not just recalculating the model. The FRC found that audit teams frequently recalculate management’s model without questioning whether the underlying assumptions are supportable.

Journal entry testing: still too shallow

Journal entry testing under ISA 240.33(a) continues to appear in the FRC’s key findings. The pattern matches what the AFM found in the Netherlands (see our AFM inspection findings post): auditors select journal entries, verify that they are authorised and described, but do not test whether the entries are supported by appropriate source documentation or whether the business rationale is consistent with the auditor’s understanding of the entity.

The FRC’s 2025 findings identify two specific weaknesses:

1. Selection criteria are too narrow. Teams select based on round numbers, entries posted near period-end, or entries above materiality. These criteria miss the entries that management override is most likely to target: entries posted to unusual account combinations, entries with vague descriptions, or entries posted by individuals who do not normally record transactions.
2. Depth of testing remains a problem. Verifying that a journal entry is authorised tells you who approved it. It does not tell you whether the transaction is real or whether the entry achieves the purpose described. The FRC expects teams to trace selected entries to underlying source documents and evaluate whether the entry makes business sense given what the team knows about the entity’s operations.

BDO’s individual inspection report is illustrative. The FRC noted that journal testing was one of BDO’s focus areas in its internal Audit Quality Plan, and there has been a reduction in grade-driving findings in this area. But findings still recur. BDO’s root cause analysis identified mindset and behaviours as causal factors. The FRC expects more than process improvement here. It expects auditors to approach journal testing with scepticism about why an entry exists, not just whether it was properly authorised.

Going concern and ethics: the Tier 2 and 3 problem areas

The FRC’s 2025 review identified going concern and ethics and independence as areas where Tier 2 and Tier 3 firms have particular weaknesses. These themes were less prominent in Tier 1 findings, where the main areas were impairment and journals.

Going concern

The FRC published updated guidance in February 2025 consolidating all requirements into a single document. The guidance reinforces that the auditor’s evaluation must consider whether assumptions used in management’s going concern assessment are consistent with assumptions used in other forward-looking areas (impairment models, viability statements, deferred tax recoverability). Inconsistency between these assessments is a red flag the FRC specifically looks for.

If management’s impairment model assumes 8% revenue growth while the going concern assessment assumes 2% growth, the auditor must understand and document why.

ISA 570.16 requires the auditor to evaluate management’s assessment of the entity’s ability to continue as a going concern. That evaluation is not satisfied by reading management’s paper and concluding “no material uncertainty identified.” The FRC expects challenge: stress testing of cash flow forecasts, evaluation of covenant compliance under downside scenarios, and assessment of whether the going concern period extends at least twelve months from the date the financial statements are authorised.

Ethics and independence

The findings at Tier 2 and 3 firms relate to situations where the audit firm also provides non-audit services to the audited entity. The FRC found instances where the independence assessment did not adequately consider whether the non-audit service created a self-review threat.

This is a particular risk for smaller firms. Firms that provide tax compliance, accounting advisory, and audit services to the same client must produce a specific independence assessment for each service. Listing the non-audit services provided, identifying the threats each creates, and documenting the mitigating measures applied is the minimum. The FRC found files where this documentation was absent or generic.

Worked example: Harper Reid LLP

Harper Reid LLP is a fictional UK mid-tier audit firm with 12 partners and PIE audit registration. The firm audits Thornbury Holdings plc, a FTSE SmallCap company with £145M revenue, material goodwill of £32M from a 2022 acquisition, and a going concern assessment that relies on a revolving credit facility expiring in 18 months.

1. Impairment review

Management’s IAS 36 impairment model for the acquired business uses a 6.5% revenue growth rate for years 1–5 and a 9.2% pre-tax discount rate. The engagement team recalculated the model and confirmed the arithmetic is correct. No headroom sensitivity analysis was performed. No specialist was involved.

2. Journal entry testing

The team selected 40 journal entries using three criteria: entries above £500K, entries posted in the last five days of the reporting period, and round-number entries. The working paper shows each entry with a description, amount, posting date, and a “reviewed” tick mark.

3. Going concern

Management’s going concern assessment assumes continued access to a £20M revolving credit facility with a February 2027 expiry. The going concern period extends to September 2026 (12 months from the expected authorisation date). The team reviewed management’s paper and concluded no material uncertainty exists. No downside cash flow scenario was tested. No comparison was made between the going concern assumptions and the impairment model assumptions.

4. Ethics and independence

Harper Reid also provides tax compliance services (£18K annual fee) and a one-off accounting advisory engagement (£12K) to Thornbury Holdings. The file contains a generic independence confirmation signed by the engagement partner. No specific threat assessment appears.

The file now addresses the four most common FRC findings. A reviewer sees specific challenge of management’s assumptions, journal testing with documented source verification, stress-tested going concern work, and a non-generic independence assessment.

What to fix before your next PIE audit

1. For every material impairment assessment, perform a sensitivity analysis on the key assumptions (revenue growth, discount rate, terminal growth rate). Document the point at which headroom reduces to zero. If that point is within a reasonable range of management’s assumptions, involve a valuation specialist.
2. Expand your journal entry selection criteria beyond the standard three (materiality, period-end, round numbers). Add unusual account combinations and entries by non-finance personnel. For every selected entry, trace to source documentation and document the business rationale assessment.
3. On going concern, test at least one downside scenario against the entity’s borrowing covenants. Compare the going concern assumptions to the impairment model assumptions. If they differ, document the reason. The FRC will look for this consistency check.
4. For every PIE audit where your firm also provides non-audit services, document the specific threat each service creates and the specific safeguard applied. A generic independence letter does not satisfy the Ethical Standard.
5. If you are at a Tier 2 or Tier 3 firm, review your System of Quality Management against ISQM 1 with these findings in mind. The FRC’s future supervisory approach will place more weight on firms’ own quality management systems. Getting your SoQM right now pays off when the new approach takes effect.

The end of the tiering system

The 2025 Annual Review is the last to use the Tier 1, 2, 3 classification system. The FRC acknowledged that the tiering approach risks creating a de facto league table that overly focuses on individual file reviews. Under the Future Audit Supervision Strategy (FASS), the FRC will shift toward proportionality, outcomes-based assessment, and evaluation of firms’ own quality management systems.

For mid-tier firms, this is a double-edged development. A move away from individual file gradings could reduce the stigma of a single bad inspection result. But an outcomes-based approach also means the FRC will expect firms to demonstrate that their own internal monitoring identifies and fixes quality issues before the regulator finds them. The firms that perform strong root cause analysis, run effective internal quality reviews, and act on the results will do well under the new regime. The firms that rely on the FRC inspection cycle to tell them where the problems are will not.

Common mistakes

• Recalculating management’s impairment model without challenging the underlying assumptions. The FRC has flagged this for four consecutive years. Arithmetic accuracy is necessary but not sufficient. ISA 540 (Revised) requires evaluation of whether the estimate is reasonable, which means evaluating the inputs.
• Using the same journal entry selection criteria on every engagement without considering entity-specific fraud risks. If the criteria do not change between a manufacturing company and a financial services firm, they are not designed to detect management override at either one.

Related tools and reading

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Frequently asked questions

Source references

• FRC Annual Review of Audit Quality (July 2025): Headline inspection results across Tier 1, 2, and 3 firms.
• FRC Key Findings and Good Practice Report (October 2025): Detailed findings on impairment, journals, going concern, and ethics from the 2023/24 and 2024/25 inspection cycles.
• BDO Individual Inspection Report (2025): Firm-specific findings and root cause analysis.
• FRC Going Concern Guidance (February 2025): Consolidated auditor guidance on going concern evaluation.