AUDIT QUALITY MATURITY MODEL – WHAT IS YOUR SCORE?

Quality has always been the focus of ICAI. Recently, the Hon’ble Supreme Court told Bar Council of India’s lawyer, while asking to refrain from lowering the standards of entrance exams for law schools, “Look at how ICAI does it for Chartered Accountants. They control intake and also the quality.” The audit profession always had an enhanced focus on quality. The Model spells out the expectations from the audit firms in terms of audit quality, and Peer Review Board can test the implementation of these standards.

AQMM is initially recommendatory. In the Explanatory Memorandum on Applicability of AQMM, it is stated that the ICAI Council will review, after one year, the date from which it would become mandatory. Its applicability to firms is determined based on the firm’s audit clients. If a firm has the below types of audit clients, AQMM applies to them:
– A listed entity; or
– Banks other than co-operative banks (except multi-state co-operative banks); or
– Insurance companies.
Firms auditing only branches are not covered in the applicability.

MODEL TO MEASURE AUDIT QUALITY OF DIFFERENT FIRMS
When the user or consumer selects any service or product, he looks for the highest quality. Then why should audit as a service not have the highest quality that audit firm can deliver? It should have. However, how to measure the quality of audit that different firms provide? The final output, i.e. the audit report, is written based on Standards on Auditing. Nevertheless, the underlying audit on which it is based is a quality that stakeholder expects. Has the firm evaluated its audit quality? To answer these questions, ICAI has issued AQMM – the Model that has a scoring system based on the firm’s competencies. With this, the firm will be able to evaluate, in an objective manner, the quality of its audit and will also get guidance on its quality improvement areas. Every competency against which the firm scores low points indicates room for improvement.

Even though it is recommendatory, the drive has to come from within. By very nature itself, the audit profession has far-reaching consequences if quality is not followed. It is not similar to any other generic service available in the market. Through his audit report, the auditor assures various stakeholders of the financial statements of entities that carry out businesses affecting the entire economy. Every audit firm should regularly evaluate whether its service is of the highest quality. Just like good product brands enjoy a good reputation in the market due to their highest standards on quality, audit as a service also need to go through rigorous quality checks before it is delivered to the stakeholders. One may argue that when auditing standards are followed, it is good enough to ensure that audit quality is maintained. However, such an argument is not correct. The auditing standards help the auditor obtain reasonable assurance on the financial statements that he seeks to provide his opinion. However, complying with auditing standards, which is bare minimum expectation from auditor, by itself does not speak of audit quality. If one understands the difference between a product and another similar product that has gone through quality tests, AQMM exactly does that to the audit as a service. It adds quality tests to an audit being delivered by the auditor.

For an audit firm’s quality system, a quality audit is a critical part of the system. The audit landscape has changed over the years and is changing rapidly. Technology supports the audit in a big way – be it data analytics, various audit software being used by the audit firms or artificial intelligence in various audit tools.

VARIOUS QUALITY CONTROL MEASURES
There are several initiatives taken by the regulators to improve and review the audit quality. For example, ICAI has already issued Standard on Quality Control (SQC) 1, which requires the firms to establish system of quality controls. ICAI has also established the Financial Reporting Review Board (FRRB) that reviews general purpose financial statements and auditor’s reports to determine compliance with disclosure and presentation requirements. ICAI has also established Peer Review Board to conduct peer reviews. Since 2007, the Central Government has constituted Quality Review Board. AQMM is another such initiative that aims to improve audit quality.

AUDIT COMPETENCIES INCLUDED IN AQMM
AQMM is meant to identify which audit competencies are good, which are lacking and develop a roadmap for upgrading where the competencies are lacking. It is a self-evaluation guide for the audit firms to know their level of audit maturity. The guide looks at the overall firm as a whole and not only audit process. It considers the firm’s HR department, administration, IT support, legal department, etc. From an operations perspective, it considers the engagement team, leadership team, audit tools, networking team, MIS, etc.

The Model considers a firm’s competencies in the following three main areas:

1. Practice Management – Operation.
2. Human Resource Management.
3. Practice Management – Strategic / Functional.

Each of these areas is further sub-divided into specific elements in that area. The Model provides a scoring mechanism, i.e. the firm shall based on self-evaluation, calculate its score based on the score criteria and basis given in the Model. Therefore, this Model is like a marking mechanism for the audit firms to understand their Audit Quality Maturity. The Model provides various competencies that the firm should have. A score is given based on the presence or absence of such competency. For example, if the firm has the stated competency, it will get the score indicated in the Model. If the firm does not have such competency, it gets a zero score for such (non)competency. The Model also provides negative points for certain negative observations, which are described later in the article. The total maximum score that the Model provides is 600 points divided as a maximum of 280 points for Practice Management – Operation, a maximum of 240 points for Human Resource Management and a maximum of 80 points for Practice Management – Strategic / Functional. However, the Model does not give the basis for allotting a specific score to a particular competency. Therefore, there could be differing views where one may argue that a specific competency should have been given more weightage than to the other.

Let us understand the competencies included in each of the above areas.

1. Practice Management – Operation
The total of 280 points in this area is sub-divided into the following competencies:

As expected, this area has maximum scoring because a large part of audit quality is reflected in the operational practice management of the firm. Within this, quality control for engagements carries the highest score. Quality control includes: competencies related to partner / quality review; percentage of engagements with ‘satisfactory’ rating based on a quality review; proportion of engagements without findings requiring significant improvements by ICAI or other regulatory bodies; audit documentation in compliance with Standard on Quality Control (SQC) 1; availability of accounting and auditing knowledge resources in soft copy archive form for Q&As, thought leaderships, dedicated technical desk, etc.; time spent on understanding the business of the client, identification of risks and planning audit engagement, etc.
How can firms improve their score in this area?

Though the scoring matrix gives a detailed break-up for various competencies, there are specific competencies that, in my view, the firms should focus on initially. These are very important from an audit quality perspective and will help them significantly improve the score.
These are:

1. Develop standard templates for the firm for engagement letters, management representation letters, audit documentation, audit reports, etc. The firms can also consider using templates issued by ICAI.

2. Develop standard checklists to ensure compliance with accounting and auditing standards.

3. Develop a practice manual of the firm that contains audit methodology ensuring compliance with auditing standards and their implementation.

4. Focus on the audit planning stage, including maintenance of documentation for hours budgeted, etc. Discuss and document client’s business understanding, risk assessment of material misstatement in accordance with Standard on Auditing 315, Identifying and Assessing the Risk of Material Misstatement through Understanding the Entity and its Environment.

5. Monitor audit progress, backlogs, unfinished engagements and client interactions so that audit can be completed within agreed timelines.

6. Use of audit tools, analytics, artificial intelligence-based audit procedures, etc.

7. Implement quality review process in the firm.

2. Human Resource Management
The total of 240 points in this area is sub-divided into the following competencies:

As this area relates to Human Resources (HR), its focus is on resources turnover and compensation. This competency has a maximum score compared to any other competency in the three main areas. Audit quality largely depends on the staff working on the engagement. Therefore, HR forms a critical area to ensure that quality staff is available for audits and resources turnover is well managed to ensure timelines are met. It is given that resources turnover cannot be eliminated, and therefore, the Model recognises this fact by stating the question as “Does the firm identify measures to keep the employee turnover minimal?” Compensation structuring goes hand in hand with resources turnover. This also includes building appropriate team structure, maintaining minimal employee turnover ratio, retention policy, identification of employee relationship with the firm, statutory contributions and other benefits made available by the firm, revolving door for audit staff, engagement level reviews and performance evaluation, access to technology and favourable remote working policies, gender diversity, holiday policies, staff well-being policies, employee surveys, recruitment policies and compensation mapped to knowledge and experience, etc. Many firms run specific programs to increase gender diversity. With additional family responsibilities compared to men, women may find path to leadership difficult which demands more of their time. There could have been more specific parameters to assess the quality of the resources and score based on such parameters, for example, the average number of years of audit experience per person the firm has, industry specialisation of the firm, etc.

How can firms improve their score in this area?

To start with, firms may consider implementing the following steps:
1. Develop a pyramid structure required to carry audits.
2. Determine training hours in a year per employee.
3. Maintain minimal employee turnover ratio, develop revolving door policy, holiday policy, compensation
policy.
4. Develop written key performance indicators for employees and partners.

3. Practice Management – Strategic / Functional
The total of 80 points in this area is sub-divided into the following competencies:

Though this area shows a lesser score than the other two areas, this also has negative scoring. For negative scoring (non)competencies, the score considered is zero when such criteria are absent. If such criteria are present, it will give a negative score to the firm in this Model. For example, if the practice has an advisory as well as a decision, to not allot work due to unsatisfactory performance by the CAG office, it gets a negative five score. But if the firm does not have such non-competency, then the score is zero. Similar is the case if the firm has a negative assessment in the report of the Quality Review Board or if there has been a case of professional misconduct on the part of a member of the firm where he has been proved guilty.

Therefore, though the total shows a lesser maximum score in this area, there are many attributes that need to be considered here. Infrastructure competency in this area has a lot of significance. It includes branch network, centralised/decentralised branch activities, information security, data analytics tools, adequate infrastructure such as internet, etc., for remote working. As the name of the competency goes, it covers both types of infrastructures – physical and others. In the current times, physical infrastructure is losing relevance. As we have seen during the Covid pandemic, remote working has become a new normal. Technology has overcome the need for having a physical infrastructure, office space, meeting rooms, etc. For similar reasons, it is possible for the firms to work for clients in different geographies globally without having a branch presence in such geography. During Covid times, many global companies have outsourced their work to low-cost countries. It is possible for such country entrepreneurs to deliver the output only because of technology, without having any place of business in the client’s country/region. Therefore, the competency of physical infrastructure has become irrelevant now. Another concern over this competency is its relevance to audit quality. Having more branches and, therefore, getting higher score in the Model has no relation to the firms’ audit quality. A small firm with no branch may also have a very good quality in its audits. Therefore, keeping other factors the same, if such a firm scores less than other firms with more branches, does such score really speak of audit quality? Of course, not. The other competency of Practice Management includes balanced mix of experienced and new assurance partners, the firm’s independence as per ICAI Code of Ethics, Companies Act, 2013 and other regulatory requirements, whistle-blower policy, etc.

If based on the evaluation of performance by a government body or regulatory authority has resulted in debarment or blacklisting of the firm, it will have negative scoring.

How can firms improve their score in this area?

Some of the initial steps firms can consider in this area are:
1. Develop network through branches, affiliates, etc.
2. Get good connectivity through an intranet, internet, VPN and other means.

DETERMINING A FIRM’S LEVEL
Based on the total score, the Model defines four levels of firms. Level 1 is very nascent, and level 4 is a firm that has adopted standards and procedures significantly. These four levels are based on percentage in each section as less than 25%, 25% to 50%, 50% to 75% and above 75%. AQMM also clarifies that the status should not be publicised or mentioned by audit firms on any public domain such as professional documents, visiting cards, letterheads or signboards, etc., as it may amount to solicitation in view of the provisions of the Chartered Accountants Act, 1949.

CONCLUSION
Though AQMM is recommendatory, it is an excellent tool for self-evaluation by audit firms. Having said that, one may argue that a lesser score does not necessarily mean that audit quality is not ensured by the firm. But there needs to be an objective assessment of the quality, and AQMM would go a long way in such assessment. If audit firms follow the Model and improve their competencies, it will bring high quality across the audit profession. Therefore, it is a welcome step of providing such a standard Model to audit firms. In the coming years, if the firms voluntarily adopt this Model and improve their competencies, they will gain higher credibility in the eyes of the client given that their product, i.e. audit, has assured quality.

[The views expressed in this article by the author are personal.]