Audit quality: asking the right questions

I am, of course, delighted to read the headline Audit Committee Chairs believe audit is improving.  The Financial Reporting Council’s press notice about this year’s FRC Audit Committee Chairs (“ACC”) Survey says “ACCs scored their auditors highly across all questions. There was also evidence of improvement in all categories with the highest being that of independence and objectivity. The lowest overall scores, for a second year, were for questions on professional scepticism and the auditor’s response to regulatory oversight suggesting there is still some work for firms to do in this area.”

But how much does the survey really tell us about audit quality?  Not enough, in my view.

By asking about focus, approach, risk assessment, materiality, resources, scepticism, independence, communication and interaction,  the questionnaire effectively imposes its own answer to the question “What is a good audit?”  Each of those factors may be an important dimension of quality, but it seems to me that we’re limiting the survey to confirming what we think we already know, rather than risking uncovering a more challenging definition of audit quality.

The survey did go further this year in asking ACCs what other criteria they use to assess audit quality outside of the headings in the questionnaire.  But I’d also like to know which components of audit quality they regard as the most important.  Also, given there is an inherent tension between some of the factors, which way would the ACCs sway if they had to choose between factors?

I’d like to try to structure the questionnaire so that ACCs rate the components of quality in order of importance or are required to prioritise apparently competing factors.  As an example, they could be asked to choose between pairs of factors such as independence versus continuity; sector specialism versus breadth of experience; high level of coverage versus timeliness of identification of issues – both in terms of how important those factors are to quality and then in terms of which they felt their auditor exhibited more strongly.

Of course, given many ACCs will have completed this questionnaire before, they will be aware of what aspects of quality the previous surveys have enquired about.  So the questionnaire needs to actively probe to identify components of audit  quality other than the old comfortable favourites.  These other components might include firm sector specialism and individual (partner) sector specialism but ought also to include some of the aspects of quality that we all find it hard to acknowledge and talk about, for instance empathy, emotional resilience, a sense of proportion.

It would be particularly interesting to know to what extent “perceived calibre of individual” – one of the alternative components of audit quality volunteered by the ACCs – is made up of observable characteristics and behaviours as opposed to subjective impressions.  This could be illuminated by asking the ACCs to score individuals from the audit team across a range of observables and then to score individuals overall for “perceived calibre”.

Finally, while I don’t want to be cynical, I note that more than 10% of the respondents had changed auditor as a result of a competitive tender within the previous 12 months.  It’s reasonable to expect that ACCs who have recently selected a new auditor and, of course, done so on the basis of quality, will be satisfied with the quality of their auditor.

The debate around indicators of audit quality is largely being led by regulators, who have a vested interest in keeping the emphasis on indicators  that can be quantitatively measured – even where a measure may have a non-linear relationship to audit quality.  Indeed, the US regulator, the Public Company Accounting Oversight Board (PCAOB), says much of the information it measures might contain flaws, but it is still worth producing it in order to promote debate about the quality of the audit.  And I agree – it’s no bad thing for ACCs have market-level, firm-level and engagement-level data that they can use to frame a discussion with an audit engagement partner as to how their firm will deliver a quality audit.

It would be a mistake, however, to give too much weight to the things we can measure at the expense of broader and deeper insight into the nature of and drivers of audit quality.  And it could harm quality if the drive to achieve attractive audit quality metrics were to become a disincentive to audit firms to innovate.

Perhaps most important of all, though, the ACCs are just one of many stakeholder groups.  The ACCs represent those with direct equity investments in the company but there is a much wider group of “investors” who are exposed to the risk of loss of capital in public companies – society as whole.  The FRC recognises this – at least, that’s what I infer from their introduction of the concept of the “objective, reasonable and informed third party” in the consultation document Enhancing Confidence in Audit.  How does that objective, reasonable and informed third party judge the quality of an audit or the calibre of an auditor?  We need to ask a lot more questions – a lot more of the right questions – if we’re going to find out.


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