ISA 220 and ISQC 1 (Redrafted)
Proposed redrafted International Standard on Auditing and International Standard on Quality Control issued for comment by the International Auditing and Assurance Standards Board of the International Federation of Accountants
Comments from ACCA
December 2007
Executive Summary
ACCA welcomes the opportunity to comment on the proposed redrafted International Standard on Auditing ISA 220 Quality Control for an Audit of Financial Statements (proposed ISA 220) and on the proposed redrafted International Standard on Quality Control ISQC 1 Quality Control for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements (proposed ISQC 1), issued for comment by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants.
We welcome the exposure of both documents at the same time as their subject matters are clearly related. Our comments are restricted to the matters on which the IAASB has requested specific comments and other changes proposed as a result of applying the Clarity project drafting conventions to proposed ISA 220 and, with adaption as necessary, to proposed ISQC 1.
We are concerned that the changes, which may be categorised as adding more-specific requirements, will add costs that will fall disproportionately on smaller audits. In particular, the rigorous application of drafting conventions suited to standards on auditing to a pronouncement having wider application has resulted in ISQC 1 no longer being capable of reflecting the different levels of public interest in the types of engagements that firms carry out.
Matters on which Specific Comments are Requested
In this section of our response we address the issues identified for specific comment in the Explanatory Memorandum forming part of the Exposure Draft.
Authority of the ISQC
Series
We agree with an approach whereby each series of IAASB standards deals with its own authority and the obligations of the firms and affected individuals. This facilitates adoption of a series in a jurisdiction by law or regulation. A series may explain the conventions used in its drafting insofar as is necessary to facilitate the clear communication of those matters.
At a time when some series do not contain such matters, it is necessary for the Preface to the International Standards on Quality Control, Auditing, Review, Other Assurance and Related Services (the Preface) to serve a dual purpose in both explaining the existence of, and interaction between, series and also setting out the scope and authority of those series that still following an older drafting convention. In the long term, we assume that the IAASB will wish to amend the Preface to remove aspects prescribing obligations; although it may still be appropriate to summarise such matters to promote an overall understanding. The status of the Glossary of Terms would also need to be addressed.
Application to types of engagement
ISQC 1 currently applies to firms that carry out engagements in accordance with series other than ISAs. In the long term, the IAASB may wish to change this in order to better reflect the different public interests in audit and non-audit engagements (which can be regarded as affecting the concept of ‘reasonable assurance’). In the section of our response headed Requirements – Proposed ISQC 1 we express concerns that the current proposed redrafting of ISQC 1 in accordance with the Clarity project drafting conventions has been over-influenced by its use in relation to ISAs.
Departure from a requirement
We note that, as currently in the Preface, no provision is made for departure from a requirement when this is deemed necessary by the firm. The reason that the IAASB reconfirmed this position is given as ‘. . . the generally principled nature of the requirements are not expected to give rise to circumstances in which departure would be appropriate.’
We find it difficult to accept that proposed ISQC 1 needs to take over fifty paragraphs to set out requirements that are ‘generally of a principled nature’. Many of the requirements, especially those elevated from guidance, involve considerable detail. It is inevitable that smaller firms will find it impossible to comply with all requirements and, therefore, some flexibility is necessary.
As a simple example, if a small firm does not have engagement quality control reviews because it has no appropriate engagements, it cannot comply with the requirement in paragraph 47 because there is no engagement quality control reviewer (similar issues affect other paragraphs in that section). An absolute need to comply with requirements must only be implemented if the requirements are written with sufficient conditions precedent to prevent unavoidable non-compliance. If it is felt that this would result in overly-difficult drafting, the alternative is to introduce some flexibility overall.
Date of Completion of Engagement Quality Control Review
We agree with the change of terminology whereby there is reference to the date of the auditor’s report, instead of the issuance of the auditor’s report. This is more clear and is also consistent with ISA 700 The Independent Auditor’s Report on a Complete Set of General Purpose Financial Statements.
Definition of Engagement Team
We believe that the definition of engagement team in the IFAC Code of Ethics for Professional Accountants (the Code of Ethics) should be the same as that in proposed ISQC 1. It makes no sense to define the same term differently. Having said that, the definition should not be artificial. It should accord with a reasonable plain language definition, unless there is a convincing reason for it not to do so.
There has been a tension between ethical pronouncements, such as those dealing with independence, and pronouncements dealing with engagements. This has resulted in references in the Code of Ethics to the definition of an assurance engagement (in IAASB pronouncements) in a way that makes the definition of assurance engagement of importance to determining whether independence provisions are applicable. Similar thinking has resulted in the position reported in the Explanatory Memorandum, whereby the International Ethics Standards Board for Accountants (IESBA) has proposed a definition that excludes ‘an auditor’s external expert’ from the engagement team.
Where requirements differ for some members of a ‘team’, the drafting of requirements might be facilitated by defining the team as excluding those affected. Conversely, the definition of a term might be extended to include individuals for whom the same requirements are appropriate. A drafting solution through definition that is most convenient for one purpose may, however, impose very difficult drafting for other purposes. It is important that an overall solution is found and that terms remain broadly understandable to all users. We support, therefore, the continuation of dialogue between the IAASB and the IESBA.
We note that the IAASB intends to define ‘an auditor’s external expert’ in proposed ISA 620 (Revised and Redrafted) Using the Work of an Auditor’s Expert . We will comment separately on that. When considering proposed ISA 220, we have formed the view that the Application and Other Explanatory Material (A&OEM) section may need further redrafting to ensure that all references to ‘engagement team’ are correct as to their application or non-application to any auditor’s external experts.
Application of the Clarity Drafting Conventions
Objectives
The Objectives of proposed ISA 220 and proposed ISQC 1 are acceptable.
Requirements – Generally
Clarity
We do not find the requirements sections of proposed ISA 220 and ISQC 1 easy to understand. There are three main reasons for this:
- explanatory material is interspersed with the requirements,
- the wording of requirements makes no distinction between essential procedures and basic principles, and
- the requirements are not constructed in a simple fashion.
We have provided explanations of our concerns and commented at length on such matters in previous responses to proposed ISAs redrafted under the Clarity drafting conventions. As improvements in drafting have not been made and the clarity of successive proposed ISAs continues to be hampered by these faults, we see no point in continuing to argue these general concerns. We highlight in this response, nevertheless, several instances where in our view specific action should be taken to remedy specific defects.
Cost
The Explanatory Memorandum explains that the IAASB is seeking to clarify that there was some guidance in extant ISAs and ISQC 1 that was more in the nature of requirements and would already have been followed by many auditors.
On its own, we do not agree that this is a sufficient condition to justify any elevation of guidance material to a requirement. As we have argued in earlier responses, we believe that any proposed elevation must be justified by reference to its benefit to the quality of auditing as compared to the cost of implementation as a requirement (as opposed to being guidance that is already followed by many auditors).
The cost of including a new requirement should not be underestimated. Even if that requirement is conditional and is not relevant in the circumstances, it requires consideration by the auditor on every audit. This gives rise to a cost, which includes the related training and changes to audit manuals, programmes or software. Such costs fall disproportionately on smaller entities.
There is a public interest benefit in keeping such costs in check as the perception that an audit is not cost effective for smaller entities hampers both the global acceptance of ISAs and, more importantly, deters a vital sector of the economy from realising the economic benefits of an audit. 1
Requirements – proposed ISA 220
In relation to proposed ISA 220, we have concentrated on examining the proposed elevation of extant guidance material to requirements, as this is frequently where problems arise.
Our comments below should be read in conjunction with those under the heading Requirements – General . In particular, the specific comments do not repeat general arguments about cost, but concentrate on assessing the extent to which benefits may, or may not, arise.
Paragraph 8
Parts (a) and (b) of paragraph 8 have been elevated to requirements from extant guidance. We recommend that they be returned to the A&OEM section as their costs as requirements are not matched by any benefit.
There is no benefit from the new requirements because they duplicate the clear requirement on the engagement partner in the primary wording of paragraph 8. Bullet points (a) and (b) add nothing to it but state the obvious that he or she either does something (‘as necessary’) or just remains alert.
If left within the Requirements section, the wording of points (a) and (b) should be amended as it is not sufficiently clear as a multi-part requirement. The new wording invites confusion because the term ‘throughout the audit engagement’ is used only in relation to inquiry and observation (a) and not in relation to remaining alert (b).
Paragraph 9
Paragraph 9 is an elevation to a requirement of existing guidance. We do not believe that the potential benefit to audit quality is sufficient to outweigh the cost of the change. In this instance, there are already specific requirements dealing with necessary actions where audit-related ethical issues may be significant (for example: independence (paragraph 10) and compliance with professional standards (paragraph 13)).
The proposed elevation gives rise to a section that: (1) reproduces an existing requirement to make an evaluation, (2) introduces a requirement to ‘determine the appropriate action’, but (3) contains no general requirement to actually take that action (or remain inactive if that is determined appropriate). We do not suggest introducing such a general requirement, nor do we believe that to do so would be a legitimate application of the Clarity drafting conventions. This deficiency is an additional reason why we recommend transferring paragraph 9 to the A&OEM section.
Paragraph 13
The requirement includes reference to ‘auditor’s external experts’. This is a consequence of the expected change in definition of engagement team referred to in the Explanatory Memorandum.
Paragraph A7, refers to ‘the engagement team as a whole’ and to ‘the team’s [understanding etc.]‘. We suggest that, when the final definition is known, it will be necessary to revisit this guidance to confirm whether such terminology is appropriate and whether matters such as ‘Understanding of the firm’s quality control policies and procedures’ are equally valid for any auditor’s external experts.
As a general point, we believe that the A&OEM section should be reviewed for a similar purpose to ensure that all references to ‘engagement team’ are correct as to their application or non-application to any auditor’s external experts.
Paragraph 15
In earlier responses we have pointed out the dangers of confusion arising from drafting in which the wording of requirements makes no distinction between essential procedures and basic principles. Paragraph 15, which is elevated from guidance material, is an example of this.
We are aware of a published response to the Exposure Draft that falls into the trap of treating the basic principle set out in paragraph 15 (how review responsibilities are to be determined) as a procedural requirement. The response then argues that such a procedural requirement is wrong.
In our view, the real problem is that this is actually guidance material that, for reasons already enumerated generally, does not merit elevation to a requirement.
Paragraph 16
The insertion of the words ‘a timely [review]’ is unnecessary as the review is required to take place ‘before the date of the auditor’s report’. If paragraph 15 is retained, it contains the words ‘on a timely basis’, which are further duplication.
Paragraph 17
We can see no benefit in imposing the requirement proposed in paragraph 17 as it would be impossible for an engagement partner to do anything else in the circumstances without breaching other requirements. It overlaps with the requirement already in paragraph 16 (for all engagement partners).
The cost of the requirement would also be disproportionately high as it would only be relevant in a tiny fraction of all audits. 2
Engagement quality control review (paragraphs 19 to 24 and 27)
We are concerned that the elevation of much guidance material to requirements, combined with the explicit extension of the requirement to ‘other audit engagements for which an engagement quality control review is performed’ (paragraph 19) will damage the quality of auditing globally rather than promote it. This is because it will deter voluntary reviews that could fall within the definition of engagement quality control review in paragraph 6(b).
In many small firms, a quality control review carried out before the date of the auditor’s report is undertaken to benefit not only the particular audit but also the overall auditing quality of the firm. To bring such reviews explicitly within the scope of ISA 220 will involve much extra work that is not justified as being in the public interest.
Large firms that currently perform such reviews on a wide range of audits irrespective of the external need to do so might also radically reduce the number of such reviews to manage the risk of perhaps not complying with
ISA 220 in some way.
It is difficult to suggest a solution to this problem within the constraints of the Clarity drafting conventions other than that the wording ‘the engagement partner follows’ (extant paragraph 36) should not be elevated to a requirement, or that no other elevations should be made.
Ideally it should be possible for firms to perform ‘hot reviews’ on other audits at their discretion without ISA 220 applying in the circumstances. We recommend therefore that ‘engagement quality control review’ be clearly defined as ‘a review that is mandatory under the firm’s quality control systems for the reason that the particular audit is judged to be of significant public interest’.
Paragraph 25
Paragraph 25 provides guidance on what ISQC 1 requires and introduces specific requirements. We suggest rewriting to remove ambiguity from the wording, as is not clear whether the process necessary to address the requirement at 25(b) is only that referred to earlier in the paragraph.
Paragraph 26(a)
The documentation requirement should be reconsidered in the light of our comments above on paragraph 8.
Requirements – proposed ISQC 1
In relation to proposed ISQC 1, we have concentrated on examining the proposed elevation of extant guidance material to requirements, as this is frequently where problems arise.
Our comments below should be read in conjunction with those under the heading Requirements – General . In particular, the specific comments do not repeat general arguments about cost, but concentrate on assessing the extent to which benefits may, or may not, arise.
Paragraphs 13, 14 and 15
ISQC 1 is currently a series of only one standard. This has resulted in its Requirement section being used to house requirements relating to Applying, and Complying with, Relevant Requirements (paragraphs 13, 14 and 15). We would prefer that such requirements were more clearly separated from those directly relevant to quality control for firms. This may also facilitate redrafting to address the issue identified below in relation to paragraph 14 (and paragraph 4).
Paragraph 14
Taken together with the first sentence of paragraph 4, this paragraph could be interpreted as allowing a firm to chose whether it is outside the scope of ISQC 1 as a whole. We recommend that an explicit statement be included that:
‘Firms that provide services in respect of audits and reviews of financial statements, and other assurance and related services engagements shall comply with the requirements of this ISQC.’
This would allow paragraph 14 to be clearer on the interaction between the objectives and the relevance of specific requirements.
The suggested redraft does not resolve the remaining ambiguity of the original wording – whether ISQC 1 applies only to firms that carry out all such specific types of engagements or to firms carrying out one or more. We suggest that this be an explicit statement.
Paragraphs 16 to 67
The remaining paragraphs of the Requirements section of proposed ISQC 1 include many elevations of guidance material (some as requirements; some as essential explanatory material). The overall effect is to make a standard that is already unsuited to use in smaller firms even more so.
It is clear that the separation of proposed ISQC 1 and ISA 220 is predicated on there being engagement teams that are only part of a firm. In many smaller firms (the sole practitioner) this is not the case. As proposed ISQC 1 still applies in such circumstances, it must be capable of application. Realistically, such application should be feasible at a reasonable cost and not involve artificial activities and documentation with no purpose but compliance.
Proposed ISQC 1 also applies (where adopted) to firms that perhaps only carry out compilations. Although quality is important to such engagements, it is not , in terms of the public interest, as important as it is in auditing. Proposed
ISQC 1 includes specific requirements for audits of listed entities (for example, paragraph 29(a)) and so already takes account of differences in the public interest, but does not otherwise include such considerations.
We welcome the material for smaller practices already included in the A&OEM section (paragraphs A24, A25, A36, A45, A46, A64, A67 and A68). Much of this relates to the need to use external resources and we recognise that, especially where smaller firms are involved in auditing, such external expertise is necessary to maintaining quality. Such material could usefully be extended to include consideration of the position of firms that do not undertake assurance engagements (for example in respect of independence requirements).
The drafting convention dictates that material for smaller practices is placed by reference to the sequence of requirements and it is difficult, therefore, to gain an overall view. Ideally we would like to see some preliminary material to explain how the smaller practice can apply proposed ISQC 1. This is particularly important in the light of the decision that a firm may not depart from a requirement, even when it is deemed unnecessary. We deal with this further in the earlier section of this response headed Authority of the ISQC .
Other Matters
The Explanatory Memorandum forming part of the Exposure Draft invites comments on the following other matters:
- Special considerations in the audit of small entities and considerations specific to smaller practices
- Special considerations in the audit of public sector entities and considerations specific to public sector audit organisations
- Developing nations
- Translations (see below)
- Undue costs
Our response contains comments that are relevant to the above, especially undue costs, except we have not made a distinction between developing nations and others, as smaller firms may be present in both. We have no separate comments on public sector aspects of the proposed standards.
Translations
We draw attention to two matters that have arisen as part of our review:
- In proposed ISA 220, the definition 6(d) ‘Engagement team’ includes the word ‘engaged’ in the context ‘engaged by the firm’. Definition 6(o) of ‘Staff’ includes ‘any experts the firm employs’. We suggest redrafting to eliminate potential translation difficulties arising from confusion over the precise meanings of ‘engage’ and ‘employ’.
- In proposed ISA 220 paragraph 25 the word ‘circulate’ is used. We suggest changing this to conform to the word used in proposed ISQC 1 paragraph 58 ‘communicate’.
1 Our comments of November 2007 on the IAASB Consultation Paper Proposed Strategy for 2009 – 2011 include suggestions as to how such matters might be addressed.
2 See the arguments under the heading Requirements – Generally, in relation to costs of conditional requirements.