LONDON (Reuters) - KPMG, one of the world’s “Big Four” accounting firms, has shown an “unacceptable deterioration” in how it audits top British firms and will be first to undergo special supervision, Britain’s accounting watchdog said on Monday.

FILE PHOTO: The logo of KPMG pictured during the Viva Tech start-up and technology summit in Paris, France, May 25, 2018. REUTERS/Charles Platiau

The Financial Reporting Council (FRC) said the Big Four auditors - which also include PwC, EY and Deloitte - must act swiftly to reverse the decline in this year’s audit inspection results if they are to hit targets set by the watchdog.

It singled out KPMG, however.

“There has been an unacceptable deterioration in quality at one firm, KPMG,” the FRC said in a statement. “Fifty percent of KPMG’s FTSE 350 audits required more than just limited improvements, compared to 35 percent in the previous year.”

The decline reflects badly on action taken by the previous leadership, which was replaced during 2017, and not just on the performance of front line teams, the FRC said.

“Our key concern is the extent of challenge of management and exercise of professional scepticism by audit teams ... and more generally the inconsistent execution of audits within the firm.”

Increased scrutiny of KPMG will involve the FRC inspecting 25 percent more audits done by the firm in the 2018/19 financial year, the first time the FRC has taken such action.

Michelle Hinchliffe, head of audit at KPMG since October 2017, said she was disappointed with the FRC findings and that steps taken in previous years have not resulted in improvements to audit quality.

She said the findings mainly cover the time before KPMG’s new audit quality transformation programme began last October.

“We cannot and will not be satisfied with these results and, as a firm, we are already working to put this right,” Hinchliffe said.

KPMG was already being investigated by the FRC over its audit of Carillion, the outsourcing company whose collapse has triggered a call from lawmakers to break up the Big Four accounting firms. They said the FRC was “timid”, piling pressure on the watchdog to crack the whip.

BANKING AUDITS

The FRC inspected a sample of audits from the eight leading accounting firms for the 2017/18 financial year.

They showed that 72 percent required no more than limited improvements, down from 78 percent in the previous period. Among the FTSE 350 leading listed companies, 73 percent required only limited improvements, down from 81 percent in the previous year.

“Across the Big Four, the fall in quality is due to a number of factors, including a failure to challenge management and show appropriate scepticism across their audits, poorer results for audits of banks,” the FRC said.

The FRC said the audits of the other four accounting firms examined, BDO, Grant Thornton, Mazars and Moore Stephens, showed general improvements in quality, the FRC said.

The green light given by auditors to accounts of banks just months before taxpayers had to rescue them in the financial crisis triggered a reform of the sector.

Two of the four key findings on EY related to bank audits. EY said it would focus on how banks account for souring loans and conduct provisions.

The FRC said Mazars should also continue to improve the audit of banks’ loan loss provisions. Mazars said it would focus on improving the quality of bank audits.

“At a time when public trust in business and in audit is in the spotlight, the Big Four must improve the quality of their audits and do so quickly,” FRC Chief Executive Stephen Haddrill said.

“They must address urgently several factors that are vital to audit, including the level of challenge and scepticism by auditors, in particular in their bank audits.”

A government-ordered review of the FRC is underway to see if it needs more powers to bring bad auditors to book.