Financial Reporting Council Consultation Response: Firm-level Audit Quality Indicators

On 18 August 2022, UKSA and ShareSoc submitted a joint response to the Financial Reporting Council with our comments on their consultation on firm-level Audit Quality Indicators (AQIs). We made the following key points:

Definition of audit quality

We understand from its various recent publications that the FRC has a definition of high quality audits as audits that:

  1. provide investors and other stakeholders with a high-level of assurance that financial statements give a true and fair view;
  2. comply with both the spirit and the letter of auditing regulations and standards;
  3. are driven by a robust risk assessment, informed by a thorough understanding of the entity and its environment;
  4. are supported by rigorous due process and audit evidence, avoid conflicts of interest, have strong quality management, and involve the robust exercise of professional judgement and professional scepticism;
  5. challenge management effectively and obtain sufficient audit evidence for the conclusions reached; and
  6. report unambiguously the auditor’s conclusion on the financial statements.

While we generally agree with this definition, we have some issues with it. The first is (and this may be just semantics) that we would look for good quality, as opposed to bad quality, audits; not high or low quality. As a result we would change the word high to good in front of quality.

The second is with the idea of avoiding conflicts of interest. Conflicts of interest should be managed, not necessarily avoided, in a way that aligns the auditors’ interests with those of its primary audience, members of companies they report to. As a result they will always have a conflict of interest with the management of companies and therefore should focus on shareholders’ and creditors’ interests being theirs and not managements’. Also, any conflicts with key stakeholders of companies other than their shareholders should be mitigated against. If financial statements give a true and fair view, this will be sufficient for investors and therefore should also be sufficient for other stakeholders.

Lastly, AQIs should derive from trying to measure good quality audits and therefore relate to the definition of good quality audits. We notice that this AQI consultation does not start with the definition of good quality audits and suggest it should.

Measuring audit quality

We recognise how difficult it is to measure audit quality, which is why we suggest that AQIs should focus on the definition of a good quality audit. Good quality audits tend to be instinctively obvious to shareholders from reading annual reports and audited financial statements and feeling that they have a high level of assurance that what they are reading is reasonably accurate and understandable and not obfuscated by too much irrelevant information. This is then validated over time provided no scandals or questionable accounting or material omissions come to light in subsequent periods.

Your proposed AQIs will only be worth reporting if they evidence any component of a good quality audit as defined.

Providing AQIs at the firm level is also more efficient for the main users of audits as they will provide a more holistic and balanced view of the quality of audits a firm provides. The quality of individual audits is far too granular to be useful.

The full response (9 pages) can be read here.

The Consultation Document: Firm-level Audit Quality Indicators can be read here.

This is an official ShareSoc News item written by ShareSoc Director Cliff Weight.

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