Audit Quality Indicators: A Pilot Program Produces Valuable Feedback

By Michael Bailey February 1, 2016

Audit committees face a unique challenge in measuring the quality of audits. Once an audit is completed, is there a clear way to measure just how well the auditing firm performed? The Center for Audit Quality (CAQ) has spent the past couple years developing and assessing measurable indicators for just that purpose.

The CAQ is a nonprofit entity affiliated with the AICPA and fully funded by its approximately 600 members. Membership is open to U.S. Accounting firms registered with the Public Company Accounting Oversight Board (PCAOB) (Baker Newman Noyes is a member of the CAQ). The organization seeks to provide guidance and improve audit quality for the benefit of all stakeholders. While its recent work on Audit Quality Indicators (AQIs) is primarily geared toward public companies, this information may be worth a glance for smaller companies as well.

The AQIs developed by the CAQ fall into four main categories: firm leadership and tone at the top; engagement team knowledge, experience, and workload; monitoring; and auditor reporting. They range from quantitative factors such as the actual hours spent by the audit team to qualitative factors such as the engagement team’s ability to exercise professional skepticism. Recently, these proposed indicators ventured out of the conceptual realm and into a real world pilot testing program with audit committee members from across the globe on actual engagements. In a January report, the CAQ details what it has learned from this pilot program and its subsequent roundtable discussions.

In general, participants supported the idea of audit quality indicators in some form. Some participants explained that they already had their own extensive audit evaluation process without the addition of AQIs. Even supporters of AQIs stressed the importance of context when evaluating them. The report uses overtime hours as an example. Higher than expected overtime could be attributed to an unforeseen accounting issue, an understaffed audit team, or an unprepared client. The context changes the AQIs determination of audit quality. An important issue raised by the participants was the fact that a quality audit is dependent on more than just the quality of external auditors. An audit committee needs to also evaluate management and internal audit to determine whether or not those groups are conducive to a high quality external audit.

Aside from the issues noted above, the group had very positive things to say about the initiative. Some viewed the AQIs as a step in the right direction for the process of selecting an external auditor. The measurements could emphasize the quality of potential auditing firms in a stage of the process where audit fees historically reign supreme. Many participants also saw value in AQIs focusing the discussion on how external auditors allocate their resources to address potentially serious audit risks. The AQIs relating to experience and workload help to show whether or not a firm is truly equipped for the challenges of a particular audit.

As the AQI initiative is pushed forward, the participants expressed concerns over the impact that mandatory public disclosures could have on the market. If an audit committee’s AQI information was made public, the fear is that such information could mislead investors about the quality of audits when read without the complex dialogues and circumstances that developed them. This fear of miscommunication could cause audit committees to homogenize their AQIs into ones that are easily measured and understood as opposed to ones that are actually relevant to their unique business.

This pilot test and the associated roundtable discussion have provided the CAQ with valuable insight that it hopes to use to advance the discussion. The CAQ is one of many groups researching measurements of audit quality. The PCAOB is currently involved in a root cause analysis project which seeks to determine the underlying causes of low quality audits and evaluates the use of AQIs to address these problems. The combined research and effort of these groups will ideally lead to a future with more reliable financial information as audit committees become more adept at gauging the quality of their audits.

To read the full CAQ Report or learn more about their work, please visit the CAQ website.

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