PCAOB Audit Quality Indicator (AQI) Exposure Draft – SVA Response

Note: You can read our entire comment letter to the PCAOB on the Audit Quality Indicator Exposure draft

The PCAOB recently released an exposure draft for a set of proposed Audit Quality Indicators.    In releasing the exposure draft for comment, the Board stated the following goals:

The goal of the AQI project is to improve the ability of persons to evaluate the quality of audits in which they are involved or on which they rely and to enhance discussions among interested parties; use of the indicators may also stimulate competition by audit firms based on quality.

Why is this project needed in the first place?  Well, as we pointed out in our recent quarterly PCAOB update webinar,   a significant number of audits, perhaps as high as 30%, have one or more deficiencies.   Add to this, the simple fact that audit costs continue to rise,  and the need for audit committees to have a better understanding of the quality of their audits starts to become clear. As the board states:

The manner in which the audit is conducted lies primarily under the surface, and the strengths and weaknesses of the process are opaque. The sole observable output of the audit is a standardized report that cannot be used to distinguish auditors from one another. Since this is so, it is difficult to evaluate the elements of audit quality (although Board members have learned that some audit committees are experimenting with various kinds of AQIs to inform discussions with their companies’ auditors), or to understand how it might be strengthened; it is also hard to recognize and reward audit quality when it is pres

We begin by acknowledging the quality of the overall document which was prepared by the PCAOB. The document and approach are clear, concise and well-conceived.  We do have several comments that we believe would enhance and extend the work.  Some of our comments include:

We believe that the most significant measures are performance related at the engagement level. The determination of the specific measures that should be monitored would be agreed to by the Audit Committee and the Audit Firm for each engagement.

Internal controls at each firm would monitor for compliance and remediate any circumstances where the firm was unable to achieve the agreed upon quality measures.

Audit Quality Indicators (“AQIs”) are likely to provide insights as long as it is possible to use the data collected to drive action and make a changes in real-time. Since the majority of deficiencies in audit quality originate at the engagement level, we believe that AQIs will lead to improvements in audit quality if they are applied at that level. Further, in order to be effective at improving quality, the primary focus of the effort must be directed towards improving quality, not data aggregation. We believe that if the AQIs are used as a tool to measure performance and make changes at the audit engagement level in a real-time fashion, audit quality will be improved significantly.

Throughout our response, we focus on the need for measurement at the engagement level is stressed.  Failures occur at the engagement level.  As we have seen in the PCAOB reports, most firms will perform both acceptable quality  and substandard audits.  The variation occurs at the engagement level.   Context for the audit and indicators will also vary at the engagement level.

We recommend basing the program on frameworks that already exist, such as COSO and Sarbanes Oxley.

the standards used on management’s financial reporting control quality of Sarbanes-Oxley are far more exacting and have proved significantly more effective than the current audit quality control practices of the audit firms.

Ultimately, we believe that audit firms will need to implement programs of continuous improvement of their audit processes.

It is ironic that the same audit firms that produce quality improvement education materials, consult on quality improvement, and test to determine the existence of material weaknesses in quality controls seem to struggle overcoming quality issues in their own work. The focus of improvement efforts needs to be on sustained improvement in quality controls because it is almost impossible to achieve anything less and avoid occasional catastrophic failures. Interestingly, achieving the near perfection quality levels will cost less to achieve than the savings from reductions in the overall cost of audits, audit quality monitoring, and insurance, which combined are significantly less than the cost incurred from a single catastrophic failure.

There is a lot more  –  You can read the entire exposure draft and our response to it.