MAP InsightsColumn in BUSINESSWORLD
Auditing the auditors: enhancing audit oversightwritten by Mr. JESSIE C. CARPIO - October 3, 2023
Throughout my extensive career as an external auditor (including being the Head of the Audit and Assurance Division), I primarily viewed my role as that of a service provider. However, transitioning into a position on the Board of Directors with oversight responsibilities over external auditors, I am provided with a fresh perspective. I used to think that the audit would have been easier had the client been more cooperative and helpful.
Now, I recognize that a more collaborative and proactive approach from auditors can significantly contribute to a smoother audit process. The view is definitely different from the other side of the fence. This shift in viewpoint has led me to propose a fundamental re-evaluation of the traditional Audit Committee practices in the Philippines.
REASSESSING THE STATUS QUO: A CALL FOR EVALUATION
In the Philippines, the practice of audit committees proposing the re-appointment of existing external auditors, and stockholders routinely approving the proposal, has become customary. In recent years, however, there are increasing demands from investors, regulators, and other stakeholders, especially those from Western economies, for audit committees to take on a more proactive role in evaluating the performance of their external auditors. I propose that such evaluation be adopted locally.
This evaluation, ideally conducted on an annual basis, serves the dual purpose of enhancing audit quality and nurturing a robust auditor-client relationship through open and meaningful dialogue.
Assessment tools have been developed by different auditing firms and by different CPA organizations but almost all firms and organizations agree that the tool should cover the following areas:
the qualifications and performance of the external auditors (generally referring to the engagement team);
the audit firm’s quality processes and approaches (including Audit Quality Indicators or AQIs);
the interaction and communication between the auditors and the audit committee and company; and,
the independence, objectivity, and professional skepticism of the auditors.
QUALIFICATIONS AND PERFORMANCE
The engagement team, particularly the engagement partner, is the face of the audit firm to the audit committee/company. The quality of service and the sufficiency of resources provided by the engagement team will define the perception of the performance of the audit firm. Thus, in the evaluation process, questions like the following should be asked — Did the team possess the skills and expertise regarding the company’s industry and business? Did the team proactively identify the industry and business risks and make suggestions and insights to bear in the discussions with the audit committee? Did the team meet the committed deadline or proactively inform the audit committee why the deadline would not be met? Overall, did the team deliver value for money?
FIRM’S QUALITY PROCESSES
Having worked in one of the largest auditing firms in the country for over 30 years, I know that big firms have quality systems and processes in place. Generally, there are eight elements to quality processes of audit firms:
1. Leadership and Governance
2. Firms Risk Assessment Process
3. Ethics and Independence
4. Acceptance and Continuance Procedures
6. Engagement Performance
7. Information and Communication
8. Monitoring and Remediation
In some Western countries, audit firms prepare AQIs, more commonly referred to as Transparency Report, where they publish mainly the eight elements mentioned above as these apply to them. The AQIs, usually quantitative, include average partner load, staff oversight (i.e., ratio of partner to managers and staff), average years of experience per level, training hours, turnover rate, etc. and could also include qualitative like the academic qualifications and professional affiliations of the leaders of the firm, results of internal and external inspections, etc. These AQIs/Transparency Reports are used by audit committees as part of their evaluation of their auditors.
In the evaluation of the external auditors at a firm level, questions should be raised, like — How is the firm perceived in the business community? How are they perceived in the professional community where they belong? Which companies are engaging them?
Recently, the Securities and Exchange Commission (SEC) has been engaging different stakeholders (primarily audit committees and audit firms) about the implementation of AQIs on audits of publicly listed companies. While these large audit firms have the quality systems in place, they still need to set up a separate monitoring system for these indicators.
COMMUNICATION AND INTERACTION
There are several touchpoints during the engagement of an auditor — from planning meetings (where there are items required to be discussed with management and audit committee), to sudden meetings to discuss issues arising or noted during the audit, to finalization meetings (before the financial statements are finalized) and summary meetings (post audit) to discuss comments noted during the audit.
The timing and quality of communication is important in measuring the performance of the auditors. Are they proactive — are expected issues (say, arising from changes in standards effective in the coming year/s) and likely impact to the company communicated and explained to management and audit committee? Are items or circumstances that might prevent the company from meeting the regulatory deadline communicated in a timely manner? Are emerging trends (like ESG, cybersecurity, AI) included in the meetings with top management?
INDEPENDENCE, OBJECTIVITY, AND SKEPTICISM
The audit profession has identified the threats to independence — self-interest, self-review, familiarity, intimidation, and advocacy — and has also identified mitigating controls (or in extreme cases, avoidance or cessation). Indeed, the external auditors must be likened to Caesar’s wife: to be above suspicion.
The audit committee’s interaction with the auditors during the audit provides a window where independence and objectivity can be observed. Did the auditors explicitly state to the audit committee their independence to take on the engagement (as part of required communication to the client)? Was there an evident objectivity when they evaluated items subject to judgements and estimates (e.g., actively challenging some assumptions of management)? Did the auditors evaluate the adoption of accounting standards and assess its propriety over an alternative accounting treatment?
UTILIZING ASSESSMENT TOOLS: A PATH FORWARD
Incorporating assessment tools into the evaluation process can effectively measure auditors’ strengths and identify areas for improvement. These tools provide audit committees with a structured framework to engage in informed discussions regarding auditors’ performance. By openly sharing the results of these assessments, audit committees can foster better coordination and elevate the overall quality of audits.
As the dynamics of audit oversight evolve, it is imperative for audit committees in the Philippines to embrace a more proactive and comprehensive approach. By undertaking rigorous evaluations, grounded in key performance areas and supported by assessment tools, audit committees can wield their oversight responsibility to their fullest potential. This transformation promises to elevate audit quality, enhance auditor-client relationships, and ultimately reinforce the integrity of financial reporting in the business landscape.
Jessie C. Carpio is a member of Boards of Directors with some oversight over external auditors. He sits on the Boards of some US subsidiaries in the Philippines. He was the head of audit and assurance of one of the top auditing firms in the country prior to his retirement.