Chapter 5 - Quality

TUTORIAL Management
 1-2

The Need for Quality Management

• Audit firms establish a system of quality management (SOQM) to
ensure that:
➢ The firm and its personnel fulfil their responsibilities in accordance with
professional standards and applicable legal and regulatory
requirements and conduct engagements in accordance with such
standards and requirements.
➢ Engagement reports issued by the firm or engagement partners are
appropriate in the circumstances.
➢ Engagement risk is reduced to an acceptable level and therefore the
firm would be able to
❖ reduce the risk of negligence claims
❖ reduce the risk of disciplinary action
❖ maintain a strong reputation.
➢ Clients also benefit since they receive an acceptable level of service

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
 Designing SOQM
Incorporating the 8 components of ISQM 1 into the firm’s SOQM
A firm’s “Quality Control Procedures”
 Designing SOQM
Incorporating the 8 components of ISQM 1 into the firm’s SOQM
The firm’s risk assessment process

Acceptance and
continuance of client
Resources relationships and specific
engagements

Information and
communication
 Designing SOQM
Example, ISQM1 – Ethical Requirements
The firm should have policies and procedures designed to ensure that ethical
requirements are met
How does an audit firm make sure that ethical requirement
(let’s say on independence and objectivity) is met?

The firm and its personnel must:

❖ Understand the relevant ethical
Bias, unfair, subordinate
requirements judgement, conflict of
❖ Fulfil their ethical responsibilities interest
 Designing SOQM
Example, ISQM1 – Ethical Requirements
The firm should have policies and procedures designed to ensure that ethical
requirements are met
How does an audit firm make sure that ethical requirement
(let’s say on independence and objectivity) is met?
➢ Have specific policy in respect of employees’ shareholdings,
family relationship, loans etc. with clients.
 Designing SOQM
Example, ISQM1 – Ethical Requirements
The firm should have policies and procedures designed to ensure that ethical
requirements are met
How does an audit firm make sure that ethical requirement
(let’s say on independence and objectivity) is met?
➢ Have specific policy in respect of employees’ shareholdings,
family relationship, loans etc. with clients.
➢ At the beginning of every year, circulate a memorandum to all
staff employed and request that they disclose any
shareholdings, or family relationship, or loans etc. in a list of
named assurance clients.
 Designing SOQM
Example, ISQM1 – Ethical Requirements
The firm should have policies and procedures designed to ensure that ethical
requirements are met
How does an audit firm make sure that ethical requirement
(let’s say on independence and objectivity) is met?
➢ Have specific policy in respect of employees’ shareholdings,
family relationship, loans etc. with clients.
➢ At the beginning of every year, circulate a memorandum to all
staff employed and request that they disclose any
shareholdings, or family relationship, or loans etc. in a list of
named assurance clients.
➢ Emphasize the need for disclosure of such shareholdings/
relationships should they arise during the year.
 Designing SOQM
Example, ISQM1 – Ethical Requirements
The firm should have policies and procedures designed to ensure that ethical
requirements are met
How does an audit firm make sure that ethical requirement
(let’s say on independence and objectivity) is met?
➢ Have specific policy in respect of employees’ shareholdings,
family relationship, loans etc. with clients.
➢ At the beginning of every year, circulate a memorandum to all
staff employed and request that they disclose any
shareholdings, or family relationship, or loans etc. in a list of
named assurance clients.
➢ Emphasize the need for disclosure of such shareholdings/
relationships should they arise during the year.
➢ Ask every new staff member joining the assurance
department during the year to make such disclosures also.
 Designing SOQM
Example, ISQM1 – Ethical Requirements
The firm should have policies and procedures designed to ensure that ethical
requirements are met
How does an audit firm make sure that ethical requirement
(let’s say on independence and objectivity) is met?
➢ In assigning the audit work, ensure that staff affected are not
included in the engagement team.
➢ Ensure no gift from clients’ policy exist and proper ethics
training are given to all staff, existing and new, so that
everyone is aware of the ethical duties that are placed upon
them.
Designing SOQM
The firm’s risk assessment process
 Designing SOQM
Another example, ISQM1 – Acceptance and
continuance of client relationships and specific
engagements
The firm should have policies and procedures designed to ensure that only
appropriate clients are accepted and retained.
How does an audit firm make sure that only appropriate
clients are accepted in the first place and retained?
(a) To base acceptance decisions on:
(1) Whether the client has integrity and ethical values
(2) Whether the firm is able to perform the engagement to the required standard (ie,
in line with ISAs and other required professional standards)
(b) The firm’s financial/operational priorities should not lead to it accepting or continuing
engagements that should not be accepted
 Designing SOQM
Another example, ISQM1 – Acceptance and
continuance of client relationships and specific
engagements
The firm should have policies and procedures designed to ensure that only
appropriate clients are accepted in the first place and retained.
How does an audit firm make sure that only appropriate
clients are accepted in the first place and retained?
The big risk here is that the a) Affect engagement risk
firm may accept a client – • higher risk of misstatement
• risk that the auditor expresses an
because it wants the fee – that
inappropriate opinion
it should not accept. b) Affects reputational risk
• firm’s reputation may be tarnished by
association with an unscrupulous character
 Designing SOQM
Another example, ISQM1 – Acceptance and
continuance of client relationships and specific
engagements
The firm should have policies and procedures designed to ensure that only
appropriate clients are accepted in the first place and retained.
How does an audit firm make sure that only appropriate
clients are accepted in the first place and retained?
Proper client acceptance and retention procedures
(Chapter 6 – Accepting Engagements: Assurance firms should
perform risk analysis, consider ethical issues, consider staff and
resource requirements and consider legal issues before
accepting clients)
 5-15

Prospective Client Acceptance

In general, assurance firms consider whether the firm has the
capabilities to perform the engagement, whether the acceptance
complies with legal and relevant ethical requirements, and the integrity
of the client before accepting clients.
Specific procedures include:
1. Inquire of predecessor auditor
The firm should obtain the following information from the predecessor
auditor prior to acceptance of the engagement:
• Information that might bear on the integrity of management.
• Disagreements with management concerning accounting principles,
auditing procedures, or other similarly significant matters.
• Communications to those charged with governance regarding fraud
and noncompliance with laws or regulations by the entity.
• Communications to management and those charged with
governance regarding significant deficiencies and material
weaknesses in internal control.
• The predecessor auditor's understanding about the reasons for the
change in auditors.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
 5-16

Prospective Client Acceptance

2. Obtain and review available financial information (annual reports, interim

financial statements, income tax returns, etc.).
3. Inquire of third parties about any information concerning the integrity of
the prospective client and its management. (Such inquiries should be
directed to the prospective client’s bankers and attorneys, credit
agencies, and other members of the business community who may have
such knowledge. To also perform a Companies search).
4. Consider whether the prospective client has any circumstances that will
require special attention (such as state of records, systems, internal
control and source of contact) or that may represent unusual business or
audit risks (such as litigation or going concern issues).
5. Determine if the firm is independent of the client and able to provide the
desired service.
6. Determine if the firm has the necessary technical skills and knowledge of
the industry to complete the engagement.
7. Determine if acceptance of the client would violate any applicable
regulatory agency requirements or the Code of Professional Conduct.
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
The rest… Refer to ICAEW
Designing SOQM workbook for more
info.
The firm’s risk assessment process

Acceptance and
continuance of client
Resources In summary, ensure: relationships and specific
➢ specific policies exist on each of the engagements
ISQM(UK)1 components in order to
meet their objectives
➢ all staff trained and briefed

Information and
communication
Short Notes - 1

Explain why it is important for an external audit firm to

assess the integrity of a prospective client’s management
prior to accepting an audit engagement.
(4 marks)
 5-19

Ans: Reasons it is important to assess management integrity

• Required by ISA 220/ISQM 1
• Reduces engagement risk
Reduces risk of:
• investigations by regulatory bodies
• claims for damages
• loss of firm’s reputation
• inappropriate opinion
Lack of integrity may indicate:
• aggressive interpretation of accounting standards/window dressing/
bias/inappropriate judgements/audit risk
• weak control environment/override of controls
• inappropriate limitation on scope of work/intimidation
• criminal activities/money laundering/fraud/breach of laws and
regulations
• aggressive tax avoidance/evasion
• unreliable management representations
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
 Short Notes - 2

For each of the situations below, identify the relevant component of

quality management involved and recommend the corrective action

a. Freda, an audit trainee, was sent to a client’s year end

inventory count alone.

b. The audit planning memorandum for some of the audit clients

were reviewed after the audit teams have commenced the
audit.

c. Stephen, an audit manager, has been assigned to a client

company where his brother is the financial controller.
(9 marks)
 Short Notes - 2
For each of the situations below, identify the relevant component of
quality management involved and recommend the corrective action

a. Freda, an audit trainee, was sent to a client’s year end

inventory count alone.
 Short Notes - 2
For each of the situations below, identify the relevant component of
quality management involved and recommend the corrective action

a. Freda, an audit trainee, was sent to a client’s year end

inventory count alone.
Proper staff recruitment, training and appraisal to ensure
QM component capabilities, competencies and commitment are maintained
Resources Job assignments matches the experience and competencies
of the staff
Corrective Action
The inventory count should also be attended by more senior
audit staff who have the relevant competency and experience
 Short Notes - 2
For each of the situations below, identify the relevant component of
quality management involved and recommend the corrective action

b. The audit planning memorandum for some of the audit clients

were reviewed after the audit teams have commenced the
audit.
 Short Notes - 2
For each of the situations below, identify the relevant component of
quality management involved and recommend the corrective action

b. The audit planning memorandum for some of the audit clients

were reviewed after the audit teams have commenced the
audit.

QM component Proper execution of the audit process,

supervision, direction, review,
Engagement performance
documentation, consultation and resolution
of disputes
Corrective Action
The audit planning memorandum must be reviewed before the
audit team commence the audit
 Short Notes - 2
For each of the situations below, identify the relevant component of
quality management involved and recommend the corrective action

c. Stephen, an audit manager, has been assigned to a client

company where his brother is the financial controller.
 Short Notes - 2
For each of the situations below, identify the relevant component of
quality management involved and recommend the corrective action

c. Stephen, an audit manager, has been assigned to a client

company where his brother is the financial controller.
The firm should have
QM component policies and procedures
Ethical requirements designed to ensure that
ethical requirements are
Corrective Action met
 Short Notes - 2
For each of the situations below, identify the relevant component of
quality management involved and recommend the corrective action

c. Stephen, an audit manager, has been assigned to a client

company where his brother is the financial controller.
The firm should have
QM component policies and procedures
Ethical requirements designed to ensure that
ethical requirements are
Corrective Action met
Stephen should be removed from the audit to ensure that the
threats to independence is reduced or eliminated
Short Notes - 3

Your firm has been the external auditor of Pharma plc (Pharma) for a
number of years. Pharma, a company operating in the
pharmaceutical sector, has recently listed on the London Stock
Exchange. Consequently, the audit work undertaken by your firm will
be subjected to an engagement quality review.

Requirement

Set out the attributes required of the individual who is appointed to

undertake the engagement quality review.
(3 marks)
 5-29

Answer

Attributes required:
➢ Senior person/partner within the firm or a suitably
qualified external person
➢ Experience of the pharmaceutical industry
➢ Experience of listed companies
➢ Independent of the engagement team
➢ Not connected to Pharma

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
Elephant Five

Requirement

Identify and discuss any audit quality management issues

arising from Brian’s email.
(10 marks)

Which ISQM1
component is
this case about?
 5-31

Answer:
This appears to be a “human resources failure”
ISQM (UK) 1, Quality Management for Firms that Perform Audits
and Reviews of Financial Statements or other Assurance or
Related Services Engagements
➢ Component - Resources
➢ Characteristics that should be considered in determining the
appropriate staff for a task should encompass:
✓ an understanding of / practical experience with similar engagements
✓ appropriate technical knowledge
✓ knowledge of the relevant industry
✓ ability to apply professional judgement.
➢ Brian
➢ Just graduated
➢ Most junior member and just begun working as an accountant
➢ First audit, yet, “in-charged” of audit of prepayments and accruals
➢ No sufficient training / no sufficient supervision
➢ Very unlikely to have sufficient experience and technical
competency
➢ His email proves that he is uncertain and struggling Fraud?
McGraw-Hill/Irwin
What’s going on? Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
 5-32

Answer:

ISA (UK) 220, Quality Management for an Audit of Financial

Statements
➢ Consider competency and capabilities of audit team members in
assigning and supervising work
➢ This appears to be a “failure” too

Fortunately, in this instance, Brian has raised his concerns with

a more experienced member of the audit team enabling a
review by them, thereby reducing the potential adverse impact
on audit quality.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
 21-33

THE END

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.