Audit Quality Indicators: What Have We Learned on Our Journey?

Cindy Fornelli | February 9, 2016 | 3

Available Languages: English | Spanish

Audit committees serve an essential role in corporate governance through their oversight of companies’ financial reporting processes and audits. The Center for Audit Quality (CAQ) believes that reliable quantitative metrics regarding the audit—commonly referred to as audit quality indicators (AQIs)—could be used to better inform audit committees about key matters that may contribute to the quality of an audit.

This belief has developed and strengthened as the CAQ has proceeded on a multiyear, multistage AQI journey. As documented in a detailed new report, and summarized here, we have learned a great deal on this journey. Much more, however, remains to be done to strengthen our ability to assess audit quality with the help of AQIs.

Stage One of the Journey: Consulting with Stakeholders

To develop perspectives on the key elements of a quality audit and a sample set of quantitative indicators regarding the performance of those elements over time, in 2012 the CAQ formed a Stakeholder Advisory Panel composed of investors, audit committee members, former standard setters, auditors, and others. The CAQ also consulted with quality experts in the medical and aviation fields—and considered simultaneous efforts, including the IAASB’s Framework for Audit Quality.

The CAQ and the Stakeholder Advisory Panel identified a set of potential AQIs they believed would best be able to enhance audit committees’ ability to fulfill their audit oversight responsibilities. In January 2014, the CAQ assembled a roundtable of audit committee members to get their reactions to these indicators; based on these reactions, the indicators were further enhanced, in particular by making them more risk-based.

Stage Two: Publishing the CAQ Approach

Leveraging this stakeholder input, the CAQ Approach to Audit Quality Indicators was published in April 2014. The report set forth a potential approach to communicating a set of AQIs.

At its core, the CAQ's Approach recognizes the roles and responsibilities of audit committees and reinforces the importance of the auditor’s communications with the audit committee. The Approach focuses on the communication of engagement-level indicators that can be tailored to the information needs and interests of a specific audit committee to support its oversight responsibility. Firm-level indicators, which address an audit firm’s overall strategies and initiatives, complement these engagement-level indicators.

The focus on communication of AQIs to audit committees is appropriate because AQIs:

  • Provide relevant information to audit committees – AQIs are most relevant to those who have direct oversight responsibilities for the audit.
  • Increase the quality of the dialogue with audit committees – Audit committees are uniquely positioned to engage in dialogue with the auditor to obtain the context necessary to give meaning to AQIs and potentially take actions that might help maintain or increase audit quality on an engagement.
  • Assist with selection/evaluation of the external auditor – Given their governance authority and knowledge of the particular circumstances of the audit engagement, audit committees are in a position to act upon the information communicated to make decisions about reappointing the auditor, appointing a new auditor, and selecting a lead engagement partner.

Stage Three: Pilot Testing the CAQ Approach

The CAQ coordinated with 10 audit firms of various sizes to pilot test the Approach during the 2014 audit cycle. A total of 30 audit engagements, encompassing a broad range of operations and industries, were included in the pilot test. None of the selected audit engagements were identified to the CAQ, and participating audit firms shared the pilot testing results on a confidential basis.

During the pilot testing, audit committees were asked for feedback on the usefulness of the proposed AQIs in fulfilling their auditor oversight responsibilities. Overall, the audit committee members ranked AQIs related to engagement team experience and workload as the most useful indicators, including years of industry experience relevant to the audit engagement, years on the engagement, changes in audit hours between years, and audit hours spent on the audit engagement by engagement team members grouped by their seniority in the audit firm. Some AQIs were more relevant to certain audit committees than others. Many audit committee members expressed a preference for flexibility in the approach to discussing AQIs and a desire to be able to tailor the discussion to the AQIs most relevant to their company and its audit.

The CAQ shared its pilot-testing insights in comment letter to the Public Company Accounting Oversight Board in response to the board’s AQIs concept release.

Stage Four: Holding AQI Roundtables across the Globe

To continue to evaluate the set of potential AQIs and suggested communication approach, the CAQ convened a series of summer 2015 roundtable discussions with audit committee members in Chicago, New York, London, and Singapore. At the events, roundtable participants considered the findings from the pilot testing and shared their views on the potential benefits and challenges of identifying and developing a set of AQIs.

Key findings from the roundtables include the following:

  • Participants expressed a desire for information that can assist audit committees in their assessment of the more qualitative aspects of the audit, such as the engagement team having the right mindset to bring forth professional skepticism and auditor judgment.
  • Audit committee members recognized that AQIs can help them oversee the quality of their external audit, even if external audit is just one aspect of quality financial reporting.
  • Most participants endorsed a flexible approach that allows an audit committee, working with the external auditor, to tailor or customize the selection and portfolio of AQIs that best suit its specific information needs.
  • While supporting the concept of AQIs, some roundtable participants said they already have the tools necessary for them to gauge the quality of their audit.
  • Audit committee members agreed that AQIs alone, without context, cannot adequately communicate factors relevant to any particular audit engagement or audit firm.
  • There was agreement that the process of identifying and evaluating AQIs needs to be audit committee-driven and iterative, and will require continuous assessment and refinement in order to meet the changing information needs of audit committees.
  • Audit committee members expressed strong concerns that public disclosure of engagement-level AQIs could lead to unintended consequences. A strong consensus emerged that any disclosures of engagement-level AQI information should be voluntary.

The Journey Continues

While the CAQ has learned and accomplished much since the launch of its AQI initiative, more work remains to be done. For example, because audit committee members are interested in more qualitative information to evaluate audit quality at the engagement level, a potential path forward is to create a tool for audit committees that guides their assessment of both quantitative and qualitative information.

Further dialogue and continued collaboration among all stakeholders is needed. The CAQ urges you to participate in the dialogue, and share your comments below, as we continue toward this vital goal.

The Gateway signposts various resources, including those of the CAQ, to help improve audit quality here.

 

Cindy Fornelli

Executive Director, Center for Audit Quality (CAQ)

Cindy Fornelli is a former Deputy Director of Investment Management at the SEC and Senior Vice-President at Bank of America. A securities lawyer, she has served as the Executive Director of the Center for Audit Quality since its establishment in 2007. See more by Cindy Fornelli

 
 

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Mohammad Shbeilat May 15, 2016

Great efforts Cindy. I have a proposal for strengthening audit committee effectiveness. Your valuable comments about the practical applicability of this model are much appreciated For any person interested, please email me at shbeilat@ttu.edu.jo to have a copy of the article. A brief summary Corporate scandals hit most countries and these non-stopping scandals imply a message that relying on the perceived independence of external auditors may not be sufficient and, therefore, corporate governance systems must be restructured because financial collapses may harm society and cost the government both economically and socially. This analytical research paper proposes a new model for audit committee to reinforce the effectiveness of the corporate governance structure. The proposal recommends a Governmental Representative Member (GRM), appointed and supervised by the "GAO" or "Audit Bureau", to be among the audit committee members of listed companies. The study model suggests that the presence of the GRM among audit committee members strengthens their effectiveness and, therefore, reinforces external auditors’ independence, performance, and their ability to operate in the face of pressure from company management to issue a favourable audit opinion, thus, increasing the integrity and the soundness of the financial reporting system. The model is outlined through this paper

Mohammad Shbeilat May 15, 2016

Thanks Cindy. I have a proposal for strengthening audit committee effectiveness. For whom interested in my study please email me at shbeilat@ttu.edu.jo Corporate scandals hit most countries and these non-stopping scandals imply a message that relying on the perceived independence of external auditors may not be sufficient and, therefore, corporate governance systems must be restructured because financial collapses may harm society and cost the government both economically and socially. This analytical research paper proposes a new model for audit committee to reinforce the effectiveness of the corporate governance structure. The proposal recommends a Governmental Representative Member (GRM), appointed and supervised by the "GAO" or "Audit Bureau", to be among the audit committee members of listed companies. The study model suggests that the presence of the GRM among audit committee members strengthens their effectiveness and, therefore, reinforces external auditors’ independence, performance, and their ability to operate in the face of pressure from company management to issue a favourable audit opinion, thus, increasing the integrity and the soundness of the financial reporting system.

Twaha Kaawaase April 2, 2016

Excellent work you are doing at CAQ ! We shall have to continue working closely with the ARCs of organisations to see the uptake and effects of the outcomes of efforts on AQ. Goodwork !!!

 

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