FRC Quality Inspections and Materiality Judgment

Abstract

This study examines the impact of Financial Reporting Council (FRC) inspections on audit materiality decisions. Using data from listed UK companies between 2017 and 2022— following the adoption of ISA 700—we investigate whether FRC inspections influence materiality thresholds in both inspected and non-inspected audit engagements. Our results indicate that auditors reduce materiality following an inspection. However, this adjustment is not accompanied by improvements in audit quality, suggesting symbolic compliance. We also find spillover effects: non-inspected engagements within inspected offices similarly reduce materiality level, indicating that the informational impact of FRC inspections extends beyond the engagements directly subject to review. Our findings contribute to the literature on regulatory oversight, audit quality, and materiality, highlighting the dual role of inspections as both a signaling and disciplinary mechanism. Policy implications suggest that while auditors respond to regulatory scrutiny through materiality adjustments, these changes may not result in substantive quality enhancements