This document discusses audit quality control and measures taken to maintain audit quality. It analyzes the Audit Quality Review (AQR) approach and main concerns identified from 2012-2014, which include auditor independence, audit quality, financial services audits, and fair value measurements. It also discusses quality control at the firm level through leadership, ethics, human resources and acceptance of engagements. At the individual audit level, quality is maintained through directing, supervising, reviewing and monitoring engagements. Finally, it outlines changes from the 2014 European Directive, such as expanded audit reports, audit rotation requirements, restrictions on non-audit services, and increased oversight of public interest entity audits.

1. AUDIT & ASSURANCE
AF 3100 – COURSEWORK 2015
ANH HO
120005724
APRIL 5, 2015

2. 1
INTRODUCTION
Auditor surely plays important role in assuring the reliability and credibility of financial
information and financial annual report, which contribute to the interests of (potential)
shareholders and bondholders. The purpose of this report is to evaluate different approach towards
audit quality control and measures so as to maintain such approach. The details are divided in 3
sections as follows:
Word count: 2,128
INDEX Page
1. Audit Quality Review (AQR) ..........................................................................................02
1.1 AQR approach ............................................................................................................02
1.2 AQR main concerns in 2012/13/14.............................................................................03
2. Audit quality control........................................................................................................06
2.1 Firm audit level...........................................................................................................06
2.2 Individual audit level ..................................................................................................08
3. European Directive 2014/56/EU......................................................................................09
4. References .........................................................................................................................11
LIST OF FIGURES
1. Figure 1: Summary of area of concerns in 2011/12, 2012/13 and 2013/14 .....................03
2. Figure 2: Summary of prohibited NAS to PIE audit clients. ...........................................10

3. 2
1.1 Audit Quality Review (AQR)
Audit Quality Review (AQR) is defined as a team under the Financial Reporting Council (FRC),
whose primary role is to inspect the quality of major audit firms in the UK independently. By
quality of the UK’s audit firms, AQR emphasized their role of reviewing how audit was performed
rather than examining the correctness of audited information.
1.1 AQR approach
Primarily, AQR makes assessment for each individual audit engagement based on audit fees
disclosed under the audit files, while taking into account explanation provided to them by the audit
teams on gathering the evidence of the audit files. AQR sets out different types of grades to define
the quality of the audit work that they inspected, and through grading profile (Section 2 and 3),
they are able to evaluate whether audit quality has been maintained or improved at good standard
from the overall grade. The four grades are:
(1) Grade 1: Good;
(2) Grade 2A: Limited improvements required;
(3) Grade 2B: Improvement required; and
(4) Grade 3: Significant improvements required. This grade is given when AQR has significant
concern in relation to quantity (sufficiency) and quality of audit evidence.
The grades have yet changed overtime but the grouping to different levels has. Initially, there are
3 threshold levels set out by the AQR: Good with limited improvement required (Grade 1 and
2A), Acceptable with improvement required (Grade 2B) and Significant improvement required
(Grade 3). Since 2013, AQR decided to report all four grades separately to increase the
transparency of their findings.
As for quality control, the audit inspection works is initially monitored at peer review staff level
and finally reviewed and approved by independent non-executives.

4. 3
1.2 AQR main concerns in 2012/13/14
Figure 1: Summary of area of concerns in 2011/12, 2012/13 and 2013/14
Source: AQR (2012, 2013 and 2014).
Area of
concerns
2011/12
Audit quality
Professional
scepticism
Financial
services
Impairment
Going concern
Group audit
consideration
Revenue
recognition
Materiality
thresholdUse of experts
and specialists
External
confirmations
Testing
effectiveness
of internal
control
Auditor
independence
Reporting to
audit
committees
Engagement
quality control
review
Financial
statement
review process
Perfomance
evaluation
Area of
concerns
2012/13
Audit quality
Professional
scepticism
Financial
services
Auditor
independence
& ethical issue
Group audit
consideration
Auditor quality
monitoring
Area of
concerns
2013/14
Ehanced
reporting
by auditor
Letterbox
comapny
audits
Banks and
building
societies
Auditor
independence
& ethical issue
Group audit
consideration
Fair value
measurements
and
impairments
IT
controls

5. 4
7 key areas that are consistent for 2 or 3 years from Figure 1:
(1) Auditor independence and ethical issue
AQR identify non-audit service as the problem that would impair the audit independence when
firm try to cross-sell non-audit services to audited entities. AQR also suspects problem associated
with ‘letterbox companies’, where there has been insufficient group company or auditor
involvement in control, supervision and review of audit work from other auditor.
As for ethical issue, across all firms, there has been cases for failure to consult to Ethics partner
on appropriateness of contingent fee and arrangement for tax service. Cases where key partners
involved is not being identified or subject to potential audit rotation and shareholdings in audited
entities were not disposed on timely basis are also identified as ethical problem. Most recently,
there has been cases when partners hold financial interests in their clients.
(2) Audit quality
One of the main concern AQR points out in 2011/12 and 2012/13 is that the related parties seek
action to reduce the audit fees and thus exerts pressure and forces the practitioners to achieve
efficiency by reducing audit hours. For example, AQR (2013) finds sample that are not
representative and fails to cover the entire period or total population.
(3) Auditor quality monitoring
Through inspecting regular identified issues such as timeliness of completion and extent of
coverage, it is evident that overall findings from auditor quality monitoring internal audit quality
monitoring shows more positive results than inspection findings. Thus, AQR questions the
robustness of audit quality monitoring process and the standard or expectation set by audit firms.
(4) Fair value measurements and impairments
There have been deficiencies in the audit of fair value measurements and impairment suspected,
where 5 out of 20 audits need significant improvement (Grade 3). In particular, there is
inadequate challenge in relation to the appropriateness of key assumption and other judgments in
tangible and intangible assets, potential impairment and feasibility of business plan.

6. 5
(5) Financial services (Banks and building societies)
Auditing quality of financial services remains an issue as the overall grading for Banks and
Building societies continued to be below other types of entity, where no audit was graded at good
and more than half requires improvement.
AQR has discovered there was not enough challenge to the key assumption, adjustment and inputs
in models used to define both specific and collective provision, in which loan loss provisioning
and testing IT control continues to be the main concerns. For instance, AQR suspects insufficient
verification of management’s explanation and supporting calculation on credit risk for loan loss
provisioning and insufficient testing on automated application controls in relation to IT control.
This concern raises problem of completeness of information in respect of forbearance
arrangements in a number of audits and deficiencies in testing of general IT controls.
(6) Group audit consideration
There has been concern relating to group auditor’s involvement in planning stage of the audit,
however, AQR (2014) analyses the problem is no longer significant and in fact, contribute to Good
grade to audit firms.
(7) Professional scepticism
Professional scepticism continues to be one of the main concerns as audit firms fail to provide
sufficient challenge as analysed above.

7. 6
2. Audit quality control
PCAOB (2013) defines audit quality as the ability for audit firm to meet fundamental roles of the
audit work, in which, investor demands independence, reliability and robustness of audit, including
communication with audit committee for any related subject matters. In order to increase quality
control ICAEW (2014:102) separates in to small categories (red coloured section), while ISQC 1
provides the details requirement for quality control system (blue and green coloured section). The
procedures implemented by audit firms are taken (F: firm- & i: individual-audit level), as follows:
2.1 Firm audit level
Audit quality as firm level provides fundamental infrastructure with a set of policies, guiding
partners and staff towards the audit objectives. Thus, it is vital to regard audit quality as culture of
the firm. Quality- the foundation of profession as a key stone no matter what environment (PwC,
2014:4).
2.1.1 Leadership responsibilities for audit quality
This infrastructure should ensure there is sufficiency and efficiency in allocating resources to the
development of quality control policies and procedures.
While giving staff incentive to incorporate quality work to through strong and robustness
remuneration and promotion policy, it is important to isolate commercial consideration from the
quality of work perform. Audit staffs received appropriate bonus, salary and promotion are less
tempted to go against the rules and standards of the company and be more competence to be
recognised. Share-based payment scheme as to align staff with the objective of company, since
profit from the employees stocks relies upon the audit firm’s performance.
Only suitable clients are taken & retained
Professional competence (both partner & staff)
Ethics & Professional scepticism guidance
Communication skills
Briefing & supervising skills
Monitoring
Leadership responsibilities for audit quality
Ethical requirement
Acceptance of engagement
Human Resources
Engagement of performance
Monitoring

8. 7
2.1.2 Ethical requirement & Acceptance of engagement
At firm level, there must be sufficient policies and procedures to assure the extent whether ethical
requirements are maintained and whether only suitable clients are accepted and/or retained.
For example, at PwC, there are various technology-based tools to support the company’s auditor
in maintaining their independence along with independence consultations with in-house expert,
dedicated experienced partners and staff (PwC, 2014:6). There is a policy at PwC that requires
auditor to disclose all their possible interests in clients, including holding a personal bank account
at client’s entity as a safeguard to prevent self-interest and possibly, familiarity threat. In addition
to lower litigation threat, there is rotation of partners for non-public companies audit engagements
every five years.
2.1.3 Human resources
All audit firms should ensure a strict hiring and recruitment procedure, such as professional
education is required for trainees, continuing professional development for every one and work
experience and coaching for a more experienced senior position.
At all time, audit staffs are required to have relevant experience (practical or understanding),
appropriate technical, industry knowledge, professional scepticism and understanding of firm’s
quality control procedures and policies. This would be maintained through creating policy and
procedure to evaluate performance, capabilities and competence amongst staff members, which
can be under self-appraisal or peer-appraisal.
There should be policy and procedure to disclose and identify the identity, role and responsibilities
of the engagement partner, in which his capabilities, competence, authority and timeliness are
specified.
At PwC, there is annual assessments which evaluate the performance of non-partner professionals
while non-partner are entitled to bonus plan performance based to align with the achievement of
quality targets (PwC. 2014:5).

9. 8
2.2 Individual audit level
At individual audit level, audit quality are maintained under four main steps:
2.2.1 Directing & Supervising
At individual audit level, engagement partners remain the key in directing their staff towards the
approach of audit engagement; albeit, the duty is delegated to the most senior team member on
site at the engagement. Before the engagement, partners are required to provide team members
guidance on the work they are supposed to do, matter in relation to the nature, risk or any problems
that might possibly arise during engagement of business entity and details of the approach.
During the engagement, staff must be strictly supervised through progress tracking, while,
competence, capabilities and independence of each audit team member are consistently
considered. Additionally, ISA 220 requires audit team to disclose and address any significant
matter and the extent whether specialists should be appointed.
2.2.2 Reviewing (‘Hot’ review) & Monitoring (‘Cold’ review)
The effectiveness of these two stages relies on second partner, who is not involved in the
engagement of the audit team either directly or indirectly through third party OR a suitably
qualified consultant for a ‘cold’ review.
A ‘hot’ review is defined as a file review carried out by the defined second partner BEFORE the
date audit report is signed so as to assure audit work complies with relevant rules, professional and
legal standards and regulation and finally, the extent audit work meets audit strategy. Other matters
include any significant suspects, revision of nature and timeliness, and the adequacy and
appropriateness of audit report in gathering audit evidence.
The final stage is monitoring, which is also known as a ‘cold’ review by second partner or external
consultant AFTER the audit report is signed in order to determine key weaknesses in quality
control procedure and the measures to mitigate overall shortcomings, which increases efficiency
and effectiveness of later audit work.
Directing Supervising Reviewing Monitoring

10. 9
3. European Directive 2014/56/EU
EU Directive 2014/5/6EU reform issued to resolve current affairs in audit market to enhance
public confidence, which takes 2 years for EU members to adopt the new rules (16 June 2016).
Changes are as follows:
3.1 Audit report:
Audit reports are required to be more detailed and informative. In particular, details assessing risk
of material misstatements and explanation on the capability statutory audit in suspecting
irregularities, such as fraud, are required; thus, increase the transparency and supervision of audit
report.
3.2 Audit rotation:
Audit rotation as a safeguard to prevent threats of litigation which impair the independence of the
auditors. The requirement is as follows:
Audit contract Allowable years before switching new auditor
More than 20 years old 6
11-20 years old 9
Less than 10 years Re-tender contract required in year 10
However, empirical evidence (Jackson et al., 2008; Jenkins et al., 2013) argue audit tenure
increases audit quality while audit rotation impair the quality.
3.3 Audit committees:
There is requirement for audit committee to have at least one member who has competence in
accounting and/or auditing and members as whole to have competence in the sector the entity
operates. Further roles are granted to audit committee in relation to audit tender.
Empirical evidence finds audit committees with member having financial experience (Abbott et
al., 2003; Ho Yong et al., 2007; Zaman et al., 2011) and industry knowledge (Cohen et al., 2014)
increase audit quality.

11. 10
3.4 Audit and non-audit services:
There is a restriction on the term ‘Big Four only’ requirement by third parties so as to increase the
diversity of audit firms, increasing competition in audit statutory market. Additionally, there is a
cap of 70% of average fees paid by client in the previous three years to reduce the reliance of audit
firms on clients and impairment of the independence of auditor.
3.5 Public interest entities (PIEs):
Due to significant increase in size and complexity of public interest entities, EU directive insists
on corroborating the credibility of audited financial statement.
Firstly there will be mandatory rotation of auditor rule applies to PIEs, which is similar to other
entities. Secondly, shareholder with at least 5% voting rights of audited entity are allowed to
bring claim before national court in the event of dismissal of auditor. Thirdly, there will be
restrictions and cap on fees on certain non-audit services (see Figure 2) to PIEs audit clients
either directly or indirectly. A prohibition of non-audit services to ensure PIEs perform ‘societal’
role (not for profit).
Figure 2: Summary of prohibited NAS to PIE audit clients.
Source: KPMG (2014).
Overall, after weighting all the possible pros and cons, European Directive 2014/56/EU is
expected to increase audit quality and effectiveness in audit quality control.
Prohibited NAS
to PIE audit
clients
Tax services
Management
or Decision
making
Bookkeeping
& Preparing
finanical
statements
Payroll
Internal audit,
internal
control & risk
management
Valuation,
Legal service,
financing &
HR advice

12. 11
4. References
1) Abbott, L., Parker, S., Peters, G. and Raghunandan, K. (2003). The Association between Audit Committee
Characteristics and Audit Fees. Auditing: A Journal of Practice & Theory, 22(2), pp. 17-32.
2) Cohen, J., Hoitash, U., Krishnamoorthy, G. and Wright, A. (2014). The Effect of Audit Committee Industry
Expertise on Monitoring the Financial Reporting Process. The Accounting Review, 89(1), pp. 243-273.
3) Financial Reporting Council, (2012). Audit Quality Inspections: Annual report 2011/12. [Online] Available at:
https://www.frc.org.uk/Our-Work/Publications/AIU/Audit-Quality-Inspections-Annual-Report-2011-12.pdf
[Accessed 3 Apr. 2015].
4) Financial Reporting Council, (2013). Audit Quality Inspections: Annual report 2012/13. [Online] Available at:
https://frc.org.uk/Our-Work/Publications/Audit-Quality-Review/Audit-Quality-Inspections-Annual-Report-
2012-13.pdf [Accessed 3 Apr. 2015].
5) Financial Reporting Council, (2014). Audit Quality Inspections: Annual report 2013/14. [Online] Available at:
https://www.frc.org.uk/Our-Work/Publications/Audit-Quality-Review/Audit-Quality-Inspections-Annual-
Report-2013-14.pdf [Accessed 3 Apr. 2015].
6) Ho Young, L. and Mande, V. (2005). The Relationship of Audit Committee Characteristics with Endogenously
Determined Audit and Non-Audit Fees. Quarterly Journal of Business & Economics, 44(3/4), pp. 93-112.
7) ICAEW, (2014). Quality control. Audit and Assurance: Study manual, pp. 94-110.
8) Jackson, A., Moldrich, M. and Roebuck, P. (2008). Mandatory audit firm rotation and audit quality. Managerial
Auditing Journal, 23(5), pp.420-437.
9) Jenkins, D. and Vermeer, T. (2013). Audit firm rotation and audit quality: evidence from academic research.
Accounting Research Journal, 26(1), pp.75-84.
10) KPMG, (2014). Fact sheet: Restriction on certain non-audit services to public interest entity audit clients.
[Online] Available at: http://www.kpmg.com/BE/en/IssuesAndInsights/ArticlesPublications/Documents/EU-
Audit-Refrom-Fact-Sheet-NAS.pdf [Accessed 12 Apr. 2015].
11) Public Company Accounting Oversight Board (PCAOB), (2013). Standing advisory group meeting –
discussion – audit quality indicators. [Online] Available at:
http://pcaobus.org/news/events/documents/05152013_sagmeeting/audit_quality_indicators.pdf [Accessed 12
Apr. 2015].
12) PwC, (2014). Our focus on audit quality: 2014. [Online] Available at: http://www.pwc.com/en_US/us/audit-
assurance-services/publications/assets/2014-audit-quality-report.pdf [Accessed 13 Apr. 2015].
13) Zaman, M., Hudaib, M. and Haniffa, R. (2011). Corporate Governance Quality, Audit Fees and Non-Audit
Services Fees. Journal of Business Finance & Accounting, 38(1-2), pp. 165-197.