Profession debates audit quality indicators

Written on Jan 22, 2016

Microscope

By Laura Hay, CPA, CAE

The Public Company Accounting Oversight Board on June 30 issued a Concept Release seeking public comment on a group of potential audit quality indicators (AQIs). The proposed AQIs are quantitative measures thought to be important to high quality audits that could support audit committees and others, such as firms, investors and regulators, in carrying out their responsibilities.

AQIs have been a focus of the profession in recent years, including Center for Audit Quality (CAQ) research and voluntary public reporting by some public company audit firms. The CAQ and a number of audit firms and audit committees conducted a pilot project to consider the benefits, challenges and unintended consequences of AQIs, which will inform PCAOB deliberations.

The U.K. Financial Reporting Council (FRC) and the International Auditing and Assurance Standards Board (IAASB) have issued audit quality frameworks suggesting that auditors and audit committees discuss AQIs, many of which are similar to those in the PCAOB proposal.

PCAOB’s proposed audit quality indicators

The PCAOB Concept Release proposes AQIs in 28 areas, with more than 70 illustrative calculations.

AQIs should meet three principles:

•  Quantifiable to provide for consistency and comparability
•  Generate data that enables users to pose critical questions
•  Should be used as part of a “balanced portfolio” as no single indicator is likely to be a sole determinant of audit quality

While it is proposed that AQIs be quantifiable and measurable, the PCAOB emphasizes that AQIs are intended to initiate discussion, and further qualitative context should be provided. The PCAOB sought feedback to inform identification of a manageable number of indicators.

The proposed AQIs are classified into three categories:

Audit professionals
– including competence, training and availability of resources (including workload)
Audit process – including tone at the top, incentives, independence and objectivity, quality control, and monitoring and remediation activities
Audit results – including restatements, internal control over financial reporting, going concern reporting, communications between auditors and audit committees, and enforcement and litigation.

The proposal does not specify to whom AQIs should be reported or in what form, but the PCAOB sought feedback on:

•  Whether a program should be voluntary or mandatory
•  To whom AQIs should be reported, including audit committees or any public reporting
•  The scope of firms and engagements that should be subject to a requirement
•  Whether measures should be engagement-level or firm-level
•  A possible phase-in of steps toward broader AQI use


Reactions

The comment deadline for the Concept Release was extended to Nov. 30, 2015 to provide for broader feedback.

In general, comment letters from the major public audit firms acknowledged the merits of the concept and its potential to support audit committees in filling their role. Commenters urged that the program should remain voluntary, flexible and driven by audit committees for a variety of reasons:

•  Audit committees were in the best position and role to monitor and assess AQIs
•  Audit committees should be able to select the most relevant measures based upon the facts and circumstances of the client and the engagement decision-useful information
•  Auditors and audit committees require a certain degree of flexibility and confidentiality in discussions for a sufficient assessment to take place

These comments are consistent with PCAOB efforts to strengthen audit firm communications with audit committees.

Regarding potential public disclosure, sample comments included:

•  Disclose publicly a small number of select measures (derived from data points already publicly available, or market driven) to enhance transparency
•  Audit committees could disclose in general terms the factors considered during auditor selection to investors CPA sentiment was largely in favor of engagement-level, rather than firm-level AQIs as most relevant to the audit committee, although some firm-level measures may provide context.


Outlook

While a timeline has not been specified, many urged a scaled and initially voluntary approach. AQIs could be requested by the PCAOB in the future in its firm inspections as part of its root cause analysis.

PCAOB representatives stated that AQIs as outlined in the Concept Release are a tool with inherent limitations, which do not lead directly to formulas for determining the quality of an audit. AQIs may enhance understanding, but do not communicate a full picture, as certain important elements of audit quality, such as professional skepticism and due care, cannot be quantified.

Overall, the profession is committed to working with PCAOB and other key stakeholders in achieving the highest quality audits. Exploration of the effectiveness of quantitative measures as a tool in that mission is under way.

Laura Hay, CPA, CAE is executive vice president of The Ohio Society of CPAs and staff liaison to the Accounting & Auditing Committee. She can be reached at lhay@ohiocpa.com or 800.686.2727, ext. 2241.

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