Audit & Assurance

Enhancing Quality Management – Your Views Are Important

Klaus Bertram, a member of IFAC SMP Committee and Managing Partner of Delta Revision GmbH based in Mannheim, Germany and Johnny Yong, Technical Manager, Global Accountancy Profession Support, IFAC

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Introduction

Presently, the International Standards on Quality Control (ISQC) 1 – already in place for the past 10 years, requires firms to establish and maintain a system of quality control and specifies the policies and procedures that firms are required to maintain. Under the proposed new Quality Management (QM) standards, the intention is to move from an essentially standardized quality control approach to a more flexible QM approach designed to address firms’ individual circumstances once they have identified and assessed their particular factors that could be a risk to delivering high quality services. In adopting this new risk-based approach, the new requirements being proposed will focus on proactively identifying and responding to risks to quality, firm-wide.

Back in March 2009, the International Auditing and Assurance Standards Board (IAASB) completed its Clarity Project, designed to improve the clarity and understandability of the International Standards on Auditing (ISAs) and ISQC 1. The post-implementation review was completed in 2013, and the findings formed the basis for the IAASB’s Strategy for 2015–2019 and the IAASB Work Plan for 2015–2016: Enhancing Audit Quality and Preparing for the Future. The results suggested that additional guidance was needed to demonstrate how ISQC 1 could be applied proportionately by small- and medium-sized practices (SMPs) and that there were calls to make various aspects of the standards more robust. Subsequently, these were included in the Board’s planned quality standards work for 2015-2016.

The IAASB (the Board) also released the Invitation to Comment (ITC), Enhancing Audit Quality: A Focus on Professional Skepticism, Quality Control and Group Audits, in December 2015 to obtain stakeholder views on key issues regarding quality control, group audits, and professional skepticism. Respondents generally agreed that the Board should take action to address the issues presented in the ITC. In December 2016, the Board approved the project to revise ISQC 1 and ISA 220 and develop other outputs, as necessary.  The project proposal included engagement quality reviews as one of the issues to be addressed.

Quality Management (QM) Exposure Drafts (EDs)

The Board issued four QM EDs in February 2019. They consist of a covering explanatory memorandum providing background on each proposed standard and the possible effective dates, International Standard on Quality Management (ISQM) 1 (which previously was ISQC 1), a new ISQM 2 on engagement quality review, and a revised ISA 220 which addresses the management of engagement quality at the engagement level. Comments are invited by July 1. It is important that all stakeholders, including SMPs worldwide, are aware of the EDs and respond accordingly as the changes are significant and will drive how firms manage quality going forward.

In addition to the new risk-based approach, other notable enhancements to address key issues (as highlighted in the ITC) to improve the robustness of firms’ systems of QM are also proposed; these include  enhanced requirements and focus on governance and leadership, monitoring and remediation, dealing with circumstances when a firm belongs to a network, and a greater emphasis on resources in the form of technology and methodology.

The IFAC SMP Committee (SMPC) is in the process of responding to all the EDs and commends the Board for the significant effort taken in the past three years, culminating with the release of these EDs for comment. In addition, the SMPC is pleased to have the opportunity to be involved throughout this journey. The SMPC has identified a number of areas that SMPs may particularly like to reflect upon and some of these are articulated below.

Risk Assessment

ED-ISQM 1 includes a process for identifying and assessing quality risks that includes a threshold for identifying quality risks and a requirement to assess those risks identified, such that the nature, timing and extent of the responses designed and implemented by the firm are appropriately focused on what is important for the system of QM. The threshold for identifying quality risks is those risks for which (a) there is a reasonable possibility of the risk occurring, which, according to application material, means a “more than remote likelihood of the risk occurring”; and (b) if the risk were to occur, it may individually or in combination with other quality risks, have a significant effect on the achievement of a quality objective(s).

The Board is of the view that a consistent approach to identifying and assessing risks across the IAASB’s standards helps to reinforce key concepts of a risk-based approach. Hence, SMPs should note that this approach for identifying and assessing quality risks in ED-ISQM 1 is echoing the principles in the IAASB’s recently published Exposure Draft, ISA 315 (Revised), Identifying and Assessing the Risks of Material Misstatement (ED-315), recognizing that this ISA has yet to be finalized.

Scalability

In order to improve the robustness of firms’ systems of quality control and address the scalability of extant ISQC 1, the QM standards are proposing a new approach that encourages proactive management of quality. This approach would enable the firm to focus on achieving quality objectives that are outcome based.

The ED-ISQM 1 emphasizes the need for the firm to consider the nature and circumstances of the firm and the engagements it performs when designing, implementing and operating its system of QM. Similarly, ED-220 has been drafted to increase the focus on taking into account the nature and circumstances of the audit engagement in managing quality at the engagement level.

Para 88 of the ED-ISQM 1 has demonstrated how the Board is addressing or emphasizing the scalability concept in various ways throughout the standard. The same drafting convention has also been used for ISA 220 (Revised). Where considered useful and appropriate, examples specific for SMPs have been included. It is hoped that the SMP community will find these helpful in aiding their understanding of the proposed standards.

Interrelationship between the Standards & A Robust Two-Way Communication

Although a new QM approach has been introduced in ED-ISQM 1, the nature and spirit of the relationship between ED-220 and ED-ISQM 1 has not changed. The firm is responsible for establishing its system of QM, which provides the foundation for managing quality at the engagement level, and the engagement partner is responsible for managing and achieving quality at the engagement level.  

One of the more significant public interest issues highlighted in the ITC was reinforcing the need for robust communication and interactions during the audit. Ongoing communication between the firm, its engagement quality reviewers and its engagement teams are necessary for the firm’s system of QM to operate effectively and to support the performance of engagements. Hence, the Board is of the view that the importance of this communication should be emphasized and therefore ED-ISQM 1, ED-ISQM 2 and ED-220 now include various requirements and application material that address the required communications between these parties.

Effective Date of the Standards

In finalizing the three EDs, the Board has considered the possible effective dates for each of the standards, recognizing that the effective dates would need to be aligned because of the interrelationships of the standards. The Board has proposed an implementation period of approximately 18 months following the approval of the standards by the Public Interest Oversight Board. The SMP community may want to consider if this implementation timeline is reasonable.

Implementation Support

The Board is currently in the process of developing its strategy for 2020–2023, with an increased focus on other mechanisms other than standard setting for addressing issues and challenges on a more timely basis, including implementation support. Recognizing the increasing demand for implementation support, the IAASB plans to develop materials to accompany the standards, in particular ED-ISQM 1, to facilitate an improved understanding of the standards. The IAASB has developed examples to facilitate input from respondents on the nature of implementation support that is most useful (these are all housed in a dedicated web-page created by the Board). This includes:

(a)     Practical examples that demonstrate how the requirements of ED-ISQM 1 may be scaled according to the nature and circumstances of the firm and its engagements.

(b)    Frequently asked questions that provide additional explanations and examples of more complex aspects of the proposed ISQM 1.

In addition, videos and webinars have also been published. The SMP community may also want to comment on the types of implementation support that may help firms to transition from the extant ISQC 1 to these QM standards. IFAC will also co-ordinate with the IAASB in developing support material and explore updating the existing Guide to Quality Control for SMPs.

Conclusion

The era of ISQC 1 is winding down. SMPs, like it or not, will have to herald in the new era of ISQM, together with a revised ISA 220 and should therefore take the opportunity to provide input on the EDs by July 1. QM, like many other business endeavors, is a continuous journey. But, like all journeys, it all begins with the first step. So, while submitting a response to the IAASB is important, SMPs should start thinking about developing an implementation plan to consider the fundamental concepts of QM at as early a stage as possible. In all probability, an SMP will need to soon establish and implement a new firm-wide QM process (as well as at the engagement level) – in a little less than three years from now.