Cindy Fornelli
Cindy Fornelli

Importance of an Audit Firm's System of Quality Control

Six key issues revealed.

June 2, 2011
by Cindy Fornelli

The foundation for a quality financial statement audit is the audit firm’s system of quality control. An audit firm’s leadership is critical in setting the proper “tone at the top,” conveying through words and actions that quality work is of paramount importance.

An audit firm’s system of quality control consists of all the activities undertaken by the audit firm to promote audit quality and includes, for example:

  • The establishment of firm policies for the implementation of professional standards, including standards of objectivity, integrity and auditor independence requirements.
  • Personnel management, which includes policies and procedures related to hiring, assigning personnel to engagements, training, professional development and advancement.
  • The establishment of firm policies for acceptance and continuance of clients and engagements.
  • The development, maintenance and deployment of firm-specific methods and tools for conducting audits.
  • Monitoring of audit quality, including multiple levels of review on each engagement and the regular performance of in-firm quality inspections.
  • Regular review of other elements of the firm’s quality control system.

These activities are driven by professional standards, the audit firm’s own standards of quality and feedback from external inspections of the auditor’s work by the regulator of public company auditors, the Public Company Accounting Oversight Board (PCAOB).

How Does the Auditor Plan the Financial Statement Audit?

If, after the engagement acceptance or continuance assessment, the independent auditor decides to accept or continue the engagement and the company’s audit committee decides to hire or reappoint the independent audit firm, the audit team spends additional time with the audit committee and company management to further understand the company’s business and industry for the purpose of identifying and assessing the risks of material misstatement in order to plan and set the scope of the financial statement audit. The outcome of the planning and scoping process is an audit plan which is followed in order to complete the audit. Audit plans are modified as circumstances occur during the course of the audit engagement.

Reasonable Assurance and Materiality

All audits are guided by two important factors: reasonable assurance and materiality. These two factors impact the way in which the independent auditor examines, on a test basis, transactions that occurred and controls which functioned during the year. The extent or scope of the testing is also driven by the auditor’s risk assessment. Because it is not practical for independent auditors to examine every transaction, control and event, there is no guarantee that all material misstatements, whether caused by error or fraud, will be detected. Instead, the audit is designed to provide a level of assurance that is reasonable but not absolute. Absolute assurance from the audit is, practically speaking, impossible. Independent auditors cannot test 100 percent or, in most cases, even a majority of transactions recorded by a company; it would preclude timely financial reporting and be prohibitively expensive and resource intensive.

The concept of materiality is applied in planning and performing the audit, in evaluating the effect of any identified misstatements and in forming the opinion included in the independent auditor’s report. Determining materiality involves both quantitative and qualitative considerations. Instead of using a specific quantitative threshold in evaluating materiality, a combination of factors, both quantitative and qualitative, are considered. The determination of materiality is a matter of professional judgment and is affected by the independent auditor’s assessment. Inherent in reaching judgments about materiality is the concept of what a reasonable investor would deem important.

Assembling the Right Engagement Team

To properly carry out its responsibilities, the audit firm assembles a team of independent auditors that has skill and knowledge commensurate with the needs of the engagement. Audit team members are then assigned areas of responsibility that are appropriate based on their capabilities. The more senior team members typically take responsibility for planning and directing the audit and for the supervision and review of the work performed by less experienced members of the team. Audit team leaders also manage the timing of the engagement and the performance of the audit team to ensure a timely and efficient audit.

In some instances, audit procedures may be performed throughout the year, not just
after year-end.

When auditing a company that operates in an industry with specialized business practices and accounting standards, the team includes members who have the proper training and experience in those specialized practices. Engagement teams are typically staffed with varying levels of experience and therefore supervision and review by more senior auditors is important to the promotion of audit quality.

Some financial statement audits require the expertise of specialists to supplement the work of the core engagement team. Those specialists may either be within the audit firm itself or engaged from outside the firm to supplement the audit team. For example, audit engagement teams may involve information technology specialists, income tax specialists, appraisers, business valuation specialists or actuaries, among other such professionals. These individuals bring not only additional expertise to the audit but also a fresh perspective that often helps the audit team to appropriately make audit judgments. Any work performed by a specialist is reviewed by the audit partner.

For more information, visit The CAQ’s website.

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Cindy Fornelli is the executive director for the Center for Audit Quality (CAQ), which was founded in 2007 to serve investors, public company auditors and the markets. She has twice been honored by Directorship magazine as one of the 100 most influential people on corporate governance and in the boardroom and in 2010, Accounting Today named her one of the 100 most influential people in accounting for the fourth consecutive year. Prior to becoming the Center’s Executive director, Fornelli was the Regulatory and Conflicts Management Executive at Bank of America. Before joining Bank of America, Fornelli was deputy director of SEC’s Division of Investment Management.