Quality at The Core - The FRC's Shift From Inspections to Systems

On 13 August 2025, the Financial Reporting Council (FRC) published a discussion paper launching the second phase of engagement on its Future Audit Supervision Strategy (FASS).

The FRC's latest discussion paper represents a significant evolution in the FRC's approach to audit oversight, moving towards a framework that places greater emphasis on a firm's systems of quality management (SoQMs) and proportional, risk-based supervision.

The latest discussion paper builds on the first phase of engagement from earlier this year and invites stakeholders to continue engaging to help shape how the FRC and Recognised Supervisory Bodies (RSBs) regulates the market in the future. Written submissions are sought by 30 September 2025, with a series of targeted roundtable sessions throughout September.

Key Features of the FASS Proposals

Central to the proposals is a shift from inspection-heavy oversight, towards assessing the effectiveness of a firm's SoQMs. Whilst audit firms are already required to maintain such systems under ISQM (UK) 1, the FRC now intends to make these the core aspect of oversight.

The FRC plans to make use of graded audit file inspections, scaled to reflect each firm's market position and the nature of its audit portfolio. This is said by the FRC to allow supervisory attention to be directed where it is most needed, without imposing unnecessary burdens on firms with lower risk profiles.  The assessment of a firm's risk profile will look at a firm's audit business risk and its operational and financial resilience. Graded inspections will then be supplemented with three other types of file inspections:

• corroboratory inspections – to obtain confidence on the effectiveness of the firm's internal quality monitoring programme;
• follow up inspections – where there are specific areas or entities with specific quality findings;
• thematic inspections – where there appears to be an issue with a particular element of audits.

This multi-level review process is intended to produce a more continuous understanding of audit quality, as opposed to a one-off file review.

The discussion paper also proposes the removal of the current "tiering" structure, which has long categorised firms publicly according to their size and role in the market. Whilst the FRC intended this to assist with resource allocation, it has often been seen externally as a form of league table, which the FRC acknowledges has impacted the market. 

For the 12 largest Public Interest Entity (PIE) audit firms, a transitional period is proposed in which the regulator proposes to scale back direct inspections of ISQM (UK) 1 and during which the regulator will reduce the overall number of graded file inspections for these firms. Currently such a transitional period is not proposed for smaller firms, though the FRC are considering the impact of a transitional period for smaller firms based on where they are in the regulatory cycle – the FRC intends to share details with such firms in Autumn 2025.

Alongside these changes, the FRC intends to revise its audit market reporting model to deliver more relevant, accessible information to investors, audit committees, businesses, and the public. This is part of a broader ambition to enhance transparency and accountability across the profession.

Implications for Firms and Professionals

For large PIE audit firms, the proposals see a row back from the current inspection regimes. However, any reduction in direct oversight will be contingent on demonstrating that internal SoQMs are both robust and effective in practice. These firms will need to ensure that their governance, documentation, and internal review processes can stand up to scrutiny in a more system-focused supervisory model.

For smaller and mid-tier practices, the removal of the tiering structure may help reduce perceptions of hierarchy within the profession, but the expectations around quality management will remain high. While graded inspections should offer a more proportionate regulatory approach, the emphasis on SoQMs means that even modestly sized firms will need to invest in maintaining strong internal systems.

RSBs, meanwhile, will be required to align their own supervisory models with the FRC's revised framework.

Considerations

As the FRC moves towards a more risk-based and principles-driven regulatory approach, firms that can demonstrate a culture of quality, supported by well designed and documented systems will likely be best placed to benefit from the more flexible, proportionate approach envisaged by the FRC. Conversely, weaknesses in governance or internal controls may be more exposed in a model that focuses on how a firm manages audit quality in practice, rather than on the outcome of individual inspections alone.

The shift also means a greater focus on management – with a focus on SoQMs – with the FRC noting that this does not mean it will be doing less work – just the correct work to respond to risk.