AAA INT – Chapter 3: Quality management

This comprehensive guide delves into the key aspects of quality management, advertising, and professional appointments within the ACCA Advanced Audit & Assurance (AAA) framework. It explores theoretical underpinnings and provides illustrations to enhance understanding.

Topic 1: Quality Management

a) Principles and Purpose of Quality Management:

Principles: International Standards on Auditing (ISAs) emphasize the importance of a firm establishing and maintaining a System of Quality Management (SoQM) to ensure audit quality. Core principles include:

i. Independence and Objectivity: Maintaining professional skepticism and freedom from undue influence.

ii. Audit Competence and Due Care: Possessing and applying relevant knowledge and skills.

iii. Performance of the Audit: Following ISAs and performing procedures to obtain sufficient appropriate audit evidence.

iv. Quality Control: Having policies and procedures to address risks and ensure audit quality.

v. Purpose: An effective SoQM fosters:

• Confidence in Audit Reports: 

Users rely on audit reports reflecting a true and fair view.

• Reduction in Audit Risk: Proactive measures minimize the risk of issuing an inappropriate audit opinion.
• Enhanced Efficiency and Effectiveness: Streamlined processes ensure timely and cost-effective audits.

b) Elements of a System of Quality Management (SoQM):

A robust SoQM typically comprises:

• Leadership Responsibilities: Partners demonstrate commitment to quality through policies, procedures, and communication.
• Ethical Environment: A culture of integrity and professional skepticism is cultivated.
• Acceptance and Continuance of Relationships: Client acceptance and continuance procedures ensure suitability and independence.
• Human Resources: Personnel are competent, receive training, and participate in continuing professional education (CPE).
• Engagement Performance: Engagement teams follow ISAs and documentation standards
• Monitoring: Quality control procedures identify and address potential deficiencies.
• Communication: Clear communication between engagement teams, partners, and clients.
• Documentation: Comprehensive audit working papers and quality control records are maintained.

c) Evaluation of the SoQM’s Effectiveness:

Evaluating the SoQM’s effectiveness involves:

• Internal Inspections: Regular reviews by independent partners assess compliance with SoQM policies and procedures.
• External Inspections: Regulatory bodies (e.g., ACCA) may conduct inspections to ensure compliance with professional standards.
• Engagement Reviews: Periodic reviews assess the application of ISAs on specific engagements and identify areas for improvement.
• Complaints and Investigations: Addressing complaints promptly and investigating potential breaches are crucial.

By analyzing these evaluation methods, firms can identify deficiencies proactively and enhance their SoQM’s effectiveness in preventing and identifying audit deficiencies.

d) Quality Management in Engagements

Introduction to Quality Management in Financial Reporting

Quality management in financial reporting ensures that financial statements meet regulatory, professional, and ethical standards. It encompasses policies, procedures, and monitoring frameworks at both the firm level (system-wide) and the engagement level (individual audit assignments).

Effective quality management is governed by:

• International Standard on Quality Management (ISQM) 1 – Firm-Level Quality Management
• ISQM 2 – Engagement Quality Reviews
• ISA 220 (Revised) – Quality Management at the Engagement Level

2. Quality Management at the Firm Level (ISQM 1)

2.1. Overview of ISQM 1

ISQM 1 establishes a risk-based approach for audit firms to design and implement a system of quality management (SOQM). The focus is on:

• Identifying quality risks
• Designing appropriate responses
• Monitoring and remediation

2.2. Components of Firm-Level Quality Management

ISQM 1 identifies eight interrelated components that collectively ensure a firm’s quality management system is effective.

(i) The Firm’s Risk Assessment Process

• Establishing quality objectives
• Identifying and assessing quality risks
• Designing responses to mitigate identified risks

(ii) Governance and Leadership

• Leadership’s role in promoting quality culture
• Accountability of top management
• Ethical requirements and professional skepticism

(iii) Relevant Ethical Requirements

• Compliance with IFAC Code of Ethics (Integrity, Objectivity, Professional Competence, Confidentiality, Professional Behavior)
• Avoidance of conflicts of interest
• Independence policies

(iv) Acceptance and Continuance of Client Relationships

• Assessing client integrity
• Evaluating risks before accepting engagements
• Periodic reevaluation of continuing relationships

(v) Engagement Performance

• Use of standardized methodologies
• Professional skepticism in audit execution
• Review and supervision procedures

(vi) Resources (Human, Technological, and Intellectual)

• Competency frameworks for auditors
• Training and professional development programs
• Adequate IT infrastructure and technical tools

(vii) Information and Communication

• Effective internal communication within the firm
• Communication with regulatory bodies and external stakeholders

(viii) Monitoring and Remediation

• Ongoing evaluation of the quality management system
• Root cause analysis for deficiencies
• Remediation of identified weaknesses

3. Quality Management at the Engagement Level (ISA 220 Revised)

3.1. Overview of ISA 220

ISA 220 (Revised) outlines the auditor’s responsibility for quality at the engagement level. It requires engagement teams to implement quality management processes aligned with the firm’s quality objectives.

3.2. Key Responsibilities of the Engagement Partner

The engagement partner has primary responsibility for:

• Overseeing audit planning and risk assessment
• Ensuring proper execution and review
• Promoting an ethical culture within the team

3.3. Engagement-Level Quality Risks and Responses

(i) Ethical and Professional Considerations

• Ensuring auditor independence and objectivity
• Managing conflicts of interest
• Addressing threats to compliance with ethical requirements

(ii) Assignment of Team Members

• Matching personnel skills with engagement complexity
• Ensuring appropriate supervision and mentoring

(iii) Audit Planning and Execution

• Comprehensive risk assessment procedures
• Selection of appropriate substantive and analytical procedures

(iv) Supervision and Review

• Clear documentation of audit work
• Engagement partner and senior reviewers assessing judgment calls

(v) Engagement Quality Review (ISQM 2)

For high-risk engagements, a separate engagement quality reviewer (EQR) evaluates:

• Compliance with ISAs and firm policies
• Key judgments and risk assessments
• Whether the audit opinion is appropriate

4. Evaluating Whether Appropriate Quality Management Has Been Applied to a Given Engagement

4.1. Evaluating Compliance with Quality Management Policies

To assess whether appropriate quality management has been applied, consider:

Firm-Level Assessment:

• Does the firm have a robust system of quality management under ISQM 1?
• Are ethical policies and independence safeguards effective?
• Are monitoring and remediation procedures in place?

Engagement-Level Assessment:

• Did the engagement partner ensure proper supervision and review?
• Was professional skepticism applied throughout the audit?
• Were key audit risks appropriately addressed?
• Was an engagement quality review conducted when required?

4.2. Root Cause Analysis of Quality Deficiencies

If deficiencies are identified, conduct a Root Cause Analysis (RCA) to determine:

• Whether deficiencies arose from systemic issues
• Whether they were due to engagement-specific factors
• Whether corrective actions have been implemented

Illustration:
A firm conducted an audit of a financial services client. Post-audit quality control reviews identified insufficient documentation for valuation estimates. A root cause analysis revealed:

• The audit team lacked experience with complex financial instruments.
• The firm’s training programs had not adequately addressed this knowledge gap.
• Remediation: The firm updated its training curriculum and implemented stricter engagement-level review processes.

4.3. Regulatory Reviews and External Inspections

• Review by external regulators (e.g., PCAOB, FRC)
• Internal inspection results and their implications
• Implementation of regulatory recommendations

Conclusion

Quality management is critical at both the firm and engagement levels to ensure compliance with auditing standards and maintain stakeholder trust. A risk-based approach under ISQM 1 and ISA 220 ensures that auditors proactively address quality risks, enhancing the reliability of financial reporting.

Topic 2: Advertising, Tendering, and Obtaining Professional Work and Fees

a) Appropriateness of Publicity Material:

• ACCA Logo: 

Use of the ACCA logo signifies membership and adherence to the professional code of ethics. However, it shouldn’t imply guaranteed audit quality.

• Fees: Reference to fees is generally discouraged as it might promote competition based on price rather than quality.

b) Determinants of Fee-Setting and Bases for Charging Fees:

Several factors influence fee setting:

• Complexity of the Engagement: Time required, expertise needed, and level of risk.
• Client Size and Industry: Larger clients and specialized industries often demand higher fees.
• Geographic Location: Costs may vary based on the location of the firm and client.
• Experience Level of Staff: More experienced staff typically command higher fees.

Fees can be charged for various services, including:

• Audit and Assurance Engagements
• Review Engagements
• Compilation Engagements
• Tax Services
• Management Consultancy Services

c) Ethical Issues in Fee Setting:

• Lowballing: 

Offering unrealistically low fees to win an engagement can compromise audit quality.

• Contingent Fees: 

Linking fees to the outcome of the engagement (e.g., a successful lawsuit) can undermine auditor independence.

• Excessive Fees: Charging excessive fees can damage client relationships and reputation.

d) Considerations Before Tendering and Information in Proposals:

Before submitting a tender for an audit or other engagement, firms should consider:

• Client’s Reputation and Industry: Understanding the client’s business and potential risks is crucial.
• Firm’s Expertise and Resources: Matching the firm’s capabilities with the client’s needs is essential.
• Compliance with Ethical Requirements: Avoiding conflicts of interest and maintaining independence.

Tender proposals should include:

• Firm’s experience and qualifications
• Understanding of the client’s business
• Proposed approach and methodology
• Fee structure and estimated timeline
• References from previous clients (if permitted)

Topic 3: Professional Appointments

a) Professional and Ethical Considerations and Procedures:

Before accepting a new client or continuing an existing engagement, audit firms and professional accountants should follow these procedures:

i) Client Acceptance:

• Background Checks: Assess the client’s reputation, financial stability, and litigation history.
• Conflicts of Interest: Identify potential conflicts (e.g., pre-existing relationships with competitors) and take appropriate safeguards.
• Client’s Understanding of the Engagement: Ensure the client understands the scope, limitations, and expected fees of the engagement.

ii) Engagement Acceptance (New and Existing Engagements):

• Risk Assessment: Evaluate the inherent and control risks associated with the client and the engagement.
• Team Competence: Consider the team’s experience and whether additional training is necessary.
• Continuing Relationships: For existing clients, assess whether the relationship remains appropriate and independent.

iii) Preconditions for an Audit:

• Management’s Willingness to Comply with ISAs: Management must demonstrate commitment to providing all necessary information and facilitating the audit process.
• Existence of an Adequate Accounting System: A robust system allows for reliable financial recordkeeping.
• Use of an Ongoing Concern Basis: The client must be considered a going concern unless evidence suggests otherwise.

iv) Agreeing Terms of Engagement:

• Engagement Letter: 

This formal document outlines the scope of the engagement, fees, reporting deadlines, and client responsibilities.

• Clear Communication: Both parties should understand the terms and expectations to avoid future disputes.

b) Key Issues in Scope and Terms of Agreement:

Several critical issues require careful consideration when agreeing on the scope and terms of an engagement:

• Nature and Extent of Procedures: Clearly defining the audit procedures to be performed ensures a sufficient understanding of the client’s financial position.
• Client Representations: The client’s representations regarding the completeness and accuracy of information provided are crucial for audit evidence.
• Management’s Responsibilities: Responsibilities such as providing complete financial records and disclosures should be clearly stated.
• Limitations of the Audit: The inherent limitations of an audit, such as the risk of undetected material misstatements, should be communicated to the client.
• Disclaimers and Limitations of Liability: These may be necessary in specific circumstances to manage client expectations.

By following these procedures and addressing key issues, audit firms and professional accountants can ensure ethical and professional client acceptance and engagement practices.