Building Sustainable Audit Quality. June 2014

Transcription

1 Building Sustainable Audit Quality June 2014

2 The Issue The results of the Canadian Public Accountability Board s (CPAB) most recent inspections cycle have shown that the trend in audit quality is positive. While each audit firm occupies a different position on the audit quality spectrum, it is clear to CPAB that firms in Canada are taking the challenge to improve audit quality seriously. However, consistent, sustainable audit quality remains a concern to CPAB. Sustainable performance cannot be achieved without a culture that has a foundation built on audit quality. Firm culture should ensure that leadership, partners and professionals make the decisions that maintain an appropriate balance between commercialism (managing the economic business of the firm) and professionalism (sustainable high quality audits). Achieving the appropriate balance is essential to protecting the public interest and the long-term reputation of the profession, providing the resources to fairly compensate partners and professionals, and providing sufficient resources to make investments needed to support audit quality. A continued emphasis on audit quality is critical to the success of each firm. Key Recommendations 1 Firms need to embed quality into the audit process rather than bolting it on at the end; the sustainability of audit quality remains a challenge. Ensure audit teams have the technical competence and industry experience to match the complexity and business of reporting issuers We believe audit firms need to focus on four key areas to improve audit quality in a sustainable manner: 1. Build the right teams 2. Provide the right support 3. Conduct in-process reviews 4. Assign accountability for audit quality Build the Right Teams Assign Accoutability Sustainable Audit Quality Conduct In-Process Reviews Provide the Right Support Make consultation resources available locally Perform pre-issuance technical reviews of financial statements Conduct in-process reviews Assign accountabilities for audit quality Include audit quality on performance evaluations Develop and utilize audit quality metrics Our recommendations are based on observations from our inspections, as well as an analysis of the results of firm audit quality action plans. While each of the areas is important to building sustainable audit quality, it may not be possible to fully implement each initiative immediately. Audit firms should review the recommendations outlined in this publication and, based on individual firm circumstances, prioritize and develop a plan to implement the relevant recommendations over a period of time. 2

3 1 Build the right audit teams Firms need to build the right audit teams. More than any other factor, the people conducting the audit impact audit quality the most. Audit team skills and experience need to align with the complexity and business of their reporting issuers. Audit teams also need sufficient time to execute quality audits. Firm leadership needs to periodically perform a comprehensive review of all audit engagements and teams. Elements of a comprehensive review of the audit practice include: An honest assessment of the strengths and weaknesses of audit partners and staff, with a focus on technical competence and industry experience. Assessing workloads (both client and non-client related) of audit partners and staff. Additionally, when a firm is considering a new client, or an existing client is entering a new business or operating in a new foreign market, the risks related to the client need to be carefully considered in the firm s client acceptance and continuance decisions. If skills or experience within the firm are found lacking, the firm should commit to build the infrastructure to support the new line of work (i.e. by hiring a specialized resource or obtaining the technical training necessary). Outputs of a comprehensive review will likely include: Reassigning partners and staff away from certain audit engagements until they have acquired greater knowledge and expertise in the client s industry, which in turn should lead to more specific development plans for these individuals. Revising assigned engagement responsibilities, such as removing junior staff from areas of high risk and complexity. Re-aligning workloads for certain partners and staff to give them sufficient time to devote to assigned audit engagements. Concentrating the audit of reporting issuers in a smaller number of offices, reducing the number of partners with limited experience who are auditing reporting issuers. Where this is not practical, appropriate support should be provided at the local office level. Several firms have removed partners from auditing RIs due to lack of technical accounting and/or auditing capabilities. This has increased the quality of the audits performed for those RIs and for the firm as a whole. 3

4 2 Provide the right support to audit teams Teams need the right support. For many firms, a permanent increase in technical and specialist support is required. This will likely result in a shift in work force, with increased resources being based out of local offices and fewer being flown in from national technical headquarters. In particular, the following activities should be prioritized: Make consultation resources available locally It is not realistic to expect audit partners and staff to have specialized knowledge and experience in all areas. Engagement teams need an appropriate level of consultation to assist in executing a quality audit. The main barriers to consultation are availability and approachability. In particular, audit partners and staff may hesitate to ask questions of technical specialists. Reaching out to other professionals to seek advice and guidance should be viewed as a strength and not a weakness. When consultation resources are located outside of a local office or region, there may be reluctance to consult because of the lack of an informal, collegial relationship with the subject matter experts. Consultation resources at a local or regional level allow for technical leaders to walk the halls to support engagement teams, have more timely input and to gain more practical knowledge of the issues engagement teams face. This builds trust and encourages a culture of consultation and collaboration. These resources may be available to local offices on a full- or part-time basis however, in all cases, face to face interactions must be frequent enough to develop collaborative relationships with local partners and staff. Partner and staff familiarity with technical leaders helps break down barriers to asking questions, builds more effective teams and improves audit quality. A truly sustainable consultation culture only exists when there is a real demand for consultation requested or pulled by engagement teams, as opposed to being mandatory or pushed by national offices. One firm with audit quality issues at a local office brought in additional people, including a professional practice partner, to work full time in that office, resulting in significant improvements. Perform pre-issuance technical reviews of financial statements The complexity of accounting and the level of judgment required for auditing estimates, fair value measurements and complex financial instruments has increased the risk of error along with audit risk. We have found that a preissuance review of the financial statements by technical experts, external to the engagement team and Engagement Quality Control Reviewer (EQCR), can improve audit quality and mitigate audit risk. These reviews can identify financial reporting errors before the financial statements are issued and significantly reduce the risk of error. The performance of these technical reviews should be mandatory for clients above a certain risk threshold, or where accounting issues have been noted in past internal or external inspections, and built into the annual audit process. This may require additional investment by firms to ensure there are sufficient expert resources to perform these reviews in addition to their regular consultation work. 4

5 3 Conduct in-process reviews Identify problems before it s too late. Several firms have introduced in-process reviews, which are reviews of audit files by technically strong assurance staff or partners in real time, throughout the audit, prior to the issuance of the audit opinion. These reviews allow engagement teams to change the audit approach and/or perform additional or different audit procedures before the audit is complete. They are also an effective teaching opportunity, showing partners and staff what audit quality looks like on a real-time basis. Examples of benefits arising from in-process reviews include the identification of new risks and improvements to the audit strategy The need for, and the scope of, in-process reviews will depend on how successful other audit quality initiatives have been. By identifying and mitigating key risks and issues prior to the issuance of the audit opinion, these reviews can be a powerful tool to improve audit quality. However, in-process reviews can be invasive to engagement teams and costly to the firm. While we question the sustainability of the in-process reviews over the longer term, we believe they have value in the short term. They can ensure the level of audit quality is acceptable until longer-term structural and cultural changes are made to embed audit quality into the work performed by the engagement team. In-process reviews are most effective when: The emphasis is on helping engagement teams improve and building a collaborative culture with a continuous improvement mindset. There are no negative consequences to findings, unlike internal quality monitoring reviews. Feedback is received by the engagement teams in a timely manner, allowing them to take action prior to the end of the audit. The review covers all stages of the audit including planning, execution and conclusion. The process is separate from the EQCR s role. The engagement team, including the engagement partner and EQCR, retains accountability for audit quality. In-process reviews at firms have identified new significant risks, changes to the audit strategy, unanticipated consultations, and material accounting and disclosure errors. 5

6 4 Assign accountability Audit quality is not just up to the engagement partner. Audit quality will only improve if there is appropriate accountability for quality throughout the firm. Accountability generates personal motivation to focus on audit quality and assists with shifting firm culture. Audit firms have made the least amount of progress here than in any of the four areas. Here are three ways to develop accountability for audit quality: Accountabilities for audit quality should be specifically assigned to individuals and included within their job descriptions In cases of audit failure, we have seen instances where accountability was unjustly placed solely with the engagement partner. We do not believe this is fair because various functions at the firm that contribute to audit quality are not controlled by the engagement partner. For example: The CEO sets the tone at the top which impacts the priorities set across the firm and influences attitudes towards audit quality. Human resource departments and audit leaders are responsible for hiring appropriately qualified professionals. Office leaders are responsible for allocating resources to the areas of greatest need. Professional practice partners are responsible for training, developing tools and guidance, and technical consultation. Audit leaders are responsible for allocating partners to reporting issuer audits, based on experience and expertise, and overall hiring and resource allocation decisions across the firm. Risk management oversees the client acceptance and continuance decisions which have a significant impact on the quality and risk profile of the firm s audit clients. Clearly audit quality is dependent on the actions of a team, not just one individual. To achieve sustainable improvement in audit quality, accountabilities should be assigned appropriately. Also, the allocations must be clear so that each party involved is aware of his/her responsibilities. For example, in the case of consultation, the responsibilities and expectations of both the engagement partner and the consultation resource should be specified so that both parties understand their accountabilities. One firm formed an Audit Quality Committee, composed of senior audit leaders, that was responsible for addressing audit quality issues on a proactive and timely basis. The Committee meets monthly to perform a comprehensive root cause analysis on identified auditing deficiencies and to propose and implement solutions on how to improve. 6

7 Include audit quality in performance evaluations Audit quality needs to be recognized and rewarded at an individual level. Firms should develop and implement goals with respect to audit quality that impact an individual s performance evaluation, compensation and promotion. For example, some firms request their technical experts, EQCRs and/or consultation resources to provide input on partner performance ratings with respect to audit quality; others include a quality component in the evaluation of firm leadership. In considering promotion and partner admissions, we have found instances of promotion decisions at firms that were based primarily on business development to the detriment of candidates who are strong in accounting and/ or auditing. Firms need to continue to better align their incentives and reward systems to drive audit quality and reinforce accountability. We also encourage firms to avoid implementing monetary penalties against individual audit partners for audit quality issues, including poor internal or external inspection results, without a thorough root-cause analysis to understand the issue. A penalty imposed on a partner for an issue outside of their control is not consistent with an assigned accountability and continuous improvement approach to audit quality. Measure it Firms should continue to explore ways to develop more comprehensive metrics for assessing and monitoring audit quality. Audit quality measures that rely on the number of deficiencies in internal or external inspections do not measure audit quality on a real-time basis. Developing and implementing real-time measures enables firms to truly assess the effectiveness of quality initiatives. Quantitative and clearly defined metrics support accountability for audit quality by enabling appropriate performance measurement. While the development of such metrics is challenging, we strongly encourage audit firms to closely monitor research in this area and to explore the issue internally. Audit firms should be a source of innovative audit quality metrics that drive high quality auditing. 7

8 ? Top 10 Questions for Audit Leaders Does our firm prioritize professionalism over commercialism? How can we be sure that we have the right balance between the two? Have we made a sufficient investment in audit quality? Are we satisfied that our current audit quality program will result in sustained high quality auditing? Do we have a culture of audit quality at our firm? Is it consistent geographically and across industry groups? How does our firm s current organizational structure promote and contribute to consistent execution of quality audits? Do our local offices have the resources available, and the support they need, to execute high quality audits? Do we have a reactive or proactive approach to audit quality and risk management? Do we proactively monitor audit risks and mitigation activities at the local office level and by region? How do we measure audit quality? Do we improve the quality of an audit in real time, or do we do so only after the audit is completed? Who has accountability for audit quality in the firm and how is it assigned? Who, in addition to the engagement partner, is held accountable for audit quality? Do we measure and evaluate our people s performance related to audit quality? Is achieving professional and audit quality objectives weighted appropriately compared to business development? Are our partner admissions decisions unduly influenced by business development goals? Do we set our engagement teams up for audit quality success? Do our teams have the right experience for their assigned engagements? Are members of our audit teams overtasked with other client obligations or non-client related work? Do we support our teams in achieving audit quality? Do we provide enough opportunities for engagement teams to reach out to technical resources? Do we encourage partners and staff to ask questions? This publication is not, and should not be construed as, legal, accounting, auditing or any other type of professional advice or service. Subject to CPAB s Copyright, this publication may be shared in whole, without further permission from CPAB, provided no changes or modifications have been made and CPAB is identified as the source. CANADIAN PUBLIC ACCOUNTABILITY BOARD, ALL RIGHTS RESERVED / info@cpab-ccrc.ca 8