Audit Quality Flashcards
What are the key elements of a High Quality Audit
Assurance & Compliance
Delivers true/fair view of financial statements
Meets both technical standards and ethical principles
Rigorous Process
Risk-based approach with deep entity understanding
Professional skepticism + independent challenge of management
Sufficient, documented evidence
Clear Reporting
Unambiguous audit opinion
Disclosure of key audit matters (KAMs)
FRC 2024 Verdict: “The hallmarks are skepticism, evidence, and transparency.”
Why It Matters: Prevents misstatements and builds market trust.
What consitutes as High quality Audit according to the FRC
True/Fair Assurance
Example: Auditor verifies 90% of a bank’s loan portfolio (vs. just sampling) to confirm proper impairment accounting.
Why? Ensures investors can trust reported numbers.
Ethical Compliance
Example: Auditor refuses to accept a client’s luxury gifts, maintaining independence.
Why? Prevents conflicts of interest (like in the Enron-Arthur Andersen scandal).
Risk-Based Approach
Example: Focuses testing on a tech company’s R&D capitalization (high fraud risk) over routine payroll.
Why? Allocates resources to material areas.
Professional Skepticism
Example: Challenges management’s optimistic sales forecasts during a recession.
Why? Avoids “tick-box” mentality that missed Patisserie Valerie’s £94M fraud.
Clear Reporting
Example: Audit report highlights Key Audit Matters (KAMs) like inventory obsolescence.
Why? Helps investors understand risks (as now required by EU reforms).
How did audit quality standards evolve over the years
Driven by Regulatory Responses after Scandals: Events like Enron led to demands for further legislation.
USA - Sarbanes-Oxley Act (SOX) (2002): Response to Enron. Aimed to enforce sound internal control, documentation of financial processes and risk management, and evidence of control environment evaluation by management, auditors, and audit committees.
Established the PCAOB to monitor audit quality. Included CEO/CFO certification of financial reports, disclosure of off-balance sheet transactions, independent audit committees, strengthened auditor independence, internal control reports signed off by auditors, and rapid disclosure of material changes.
EU Regulatory Overhaul: Aimed to restore confidence in financial markets and improve the quality/reliability of financial information.
Included mandatory audit rotation for PIEs, stricter rules on auditor independence, and reinforced national audit oversight bodies. Encouraged the adoption of International Standards on Auditing (ISA).
UK Reforms (March 2021 Proposals): Response to collapses like Thomas Cook, Carillion, and BHS.
Aim to modernise the audit regime. Led to the proposal of ARGA to replace the FRC with enhanced powers.
The FRC’s ‘Audit Quality Framework’ (2008) and the IAASB’s ‘A Framework for Audit Quality’ (2014) represent formal attempts to define and promote good audit quality.
What are the 5 Drivers for the FRC to show what a quality audit is
Firm Culture
Environment where high quality is valued and rewarded. Emphasises prioritisation, incentives, recognition, and leadership tone. Embedding a culture promoting quality and ethics
Good: PwC rewards teams for rejecting risky clients (like Wirecard pre-collapse).
Bad: KPMG’s “Drive for Fees” culture during Carillion’s collapse.
Auditor Competence
Includes high ethical standards, competence, knowledge, experience, scepticism, and integrity. Maintaining high professional ethics, skills, and competencies
Good: Auditor with CFA + data analytics training spots crypto valuation flaws.
Bad: Junior staff auditing AIG’s derivatives without training (2005).
Process Effectiveness
Includes good planning, thorough risk assessment, appropriate evidence gathering and evaluation, and adherence to auditing standards. FRC assesses if firms enhance quality through a fair and evidence-based approach.
Good: Benchmarking a retailer’s margins against competitors to detect manipulation.
Bad: BHS’s auditors accepted unrealistic turnaround plans (2016).
Reporting Value
Includes discussions with the audit committee about issues arising from the audit. Focuses on the audit report and communication of key findings. Clear and informative reports and effective communication
Good: Audit report flags going concern risks 18 months before bankruptcy.
Bad: Generic reports on FTX’s financials pre-collapse.
External Factors
Includes rigorous corporate governance structures operating in the audited entity. Acknowledges that audit quality is not solely the auditor’s responsibility; strong governance contributes
Good: Strong audit committee questions related-party transactions.
Bad: Weak governance at Parmalat allowed €14B fraud.
What does the IAASB believe is a good quality audit
IAASB View (2011, 2014): Audit quality is a complex and multi-faceted concept without a universally accepted definition. Believes it is best achieved when all stakeholders (‘participants in the financial reporting supply chain’) are actively involved in enhancing and demanding audit quality. This inclusive understanding aims to reduce the audit expectations gap.
Framework for Audit Quality (2014): Encourages audit firms, regulators, audit committees, investors, universities, and other stakeholders to challenge themselves on what more they can do to increase audit quality.
PCAOB Approach: Saw the audit quality problem as too big and sought to break it down into smaller parts by defining Audit Quality Indicators (AQIs) and monitoring the quality of audits
What is the PCAOB’s Approach to Audit Quality
The PCAOB’s primary aim is to deliver audit quality through setting and enforcing auditing standards and overseeing the practices of audit firms.
Established by the Sarbanes-Oxley Act (SOX) of 2002 to monitor the quality of audits following financial scandals.
The PCAOB employs a two-pronged strategy:
Defining Audit Quality Indicators (AQIs).
Monitoring the quality of audits through inspections of audit firms’ working papers and passing judgement on their findings.
SOX mandated the creation of the PCAOB specifically to monitor audit quality.
What are the 3 main Audit Quality Indicators (AIQs)
Audit Professionals
Audit Process
Audit Results
PCAOB AQIs - Audit Professionals
Focuses on the individuals involved in the audit. Examples include:
Availability of audit staff.
Competence (skills, knowledge, experience) of the audit team.
Focus, such as the allocation of audit hours to different phases of the audit, indicating sufficient attention to high-risk areas
PCAOB AQIs - Audit Process
Relates to the audit firm’s operations and methodologies that support audit quality. Examples include aspects of:
Tone at the top and leadership: Ethical culture and commitment to quality from firm leadership.
Incentives: Whether compensation and promotion systems encourage high-quality audits.
Independence: Policies and procedures to safeguard auditor objectivity.
Infrastructure: Resources, technology, and methodologies used for audits.
Record of monitoring and remediation: Example AQI: Audit firms’ internal quality review results, showing how the firm identifies and addresses quality issues
PCAOB AQIs - Audit Results
Concerns the outcomes of the audit process and can signal potential issues. Examples include:
Financial statements: Example AQI: Frequency and impact of financial restatements, where a high number or significant impact could indicate prior audit failures.
Internal control: Issues reported regarding the effectiveness of the client’s internal controls.
Going concern reporting: Instances where the auditor’s opinion was later proven incorrect.
Communications between auditors and audit committees: Effectiveness and clarity of communication on audit matters.
Enforcement and litigation: Legal or regulatory actions against the audit firm or the audited company.
What is Audit Quality Monitoring
Processes and activities undertaken by regulatory bodies and the audit profession to assess and oversee the quality of audit work. Aims to ensure audits are conducted effectively and in accordance with relevant standards, thereby enhancing the reliability of financial reporting and protecting the public interest.
For example, FRC and PCOAB
