As examples of recent accounting failures, the FSA said, "A credit institution incorrectly netted down derivatives in the balance sheet leading to a misstatement of circa £900 billion... A thematic review recently undertaken on arrears reporting revealed errors by 29 out of 30 of the credit institutions investigated."
Most auditors had done decent jobs, the regulator wrote, but it reiterated that "it is the auditor's responsibility to challenge management when it believes the disclosures are inappropriate". The FSA listed several areas where, it said, auditors had been too ready to accept management's accounts at face value.
Its own research, the FSA said, "has led it to question whether auditors are sufficiently skeptical when challenging management's basis for determining the models and assumptions used to derive ranges of fair-value estimates - in particular, the selection of particular estimates from within such ranges of probable estimates - where key inputs may be unobservable." In particular, fair-value accounting and the calculation of credit valuation adjustments showed more variation between and even within firms than was justifiable. "This diversity should trigger auditors to be more skeptical and to challenge management's judgments about modeling approaches and inputs," the FSA added.
In loan-loss provisioning, too, the FSA said it had seen more variation than seemed justified, adding: "Bank auditors should have placed greater importance on the disclosure requirements in 2007 and 2008. This could have mitigated some of the uncertainties that unsettled the markets."
In future, the FSA suggested, it could impose stricter reporting requirements on auditors, including more frequent meetings, higher transparency requirements, and trilateral meetings between auditors, bank audit committees and the FSA. It might also require all regulatory returns to be audited - it noted that the rate of errors is significantly lower in the returns of insurers, for whom this is already a requirement.