Audit Quality Maturity Model (AQMM) – The way forward

V. Balaji

Founder and Managing Partner

True and Fair Professionals Network

The Institute of Chartered Accountants of India (ICAI) has mandated the firms to undertake audit quality maturity evaluation through AQMM rev v1.0 w.e.f. 1st of April 2023. The mandate covers the firms auditing (a) A listed entity; or (b) Bank other than co- operative bank (except multi-state co- operative bank); or (c) Insurance Company. However, those firms which are conducting only branch audits are excluded from this mandate.

With this the scores and the level arrived by the firms also need to be reviewed by a Peer Reviewer under Peer Review Mechanism of ICAI, which will be carried out alongside the peer review of the firm. Alternatively, the firm(s) may also choose to get their AQMM levels reviewed even before the peer review cycle gets due through an AQMM Reviewer. The level of the firm after being reviewed by the Peer reviewer/ AQMM reviewer shall be hosted on the website of the ICAI alongside the details of the peer review certificate.

As of now, around 2000 chartered accountancy firms are proposed to be covered under this mandate. To help the firms take up the assessment an implementation guide and the FAQs have also been made available along with a detailed announcement regarding its applicability.

While the model is still mandatory for a certain set of firms, it would be in the interest of the other firms to take up self-evaluation using AQMM for assessing its level and identifying the strength and the concern areas for improvement.

The Audit Quality Maturity Model (AQMM) is an amalgamation of a well- researched set of Audit Quality Indicators (AQIs). It is a cross- functional evaluation model covering key areas of not only audit engagements but also audit practice atthe firm level. It includes operations of the firm viz. revenue budgeting and pricing, audit practice manual, budgeting of engagements, time sheet, use of technology adoption, quality control for engagements, Human Resource Management including resource planning and monitoring, performance evaluation and compensation, physical and IT infrastructure. The model has been developed after deep international research on systems to enhance audit quality and after widespread outreach activities conducted across India.

The AQMM model is structured into 3 sections namely Practice Management (Operation), Human Resource Management and Practice Management - Strategic/ Functional with a total score of 600 points. Based on the score(s) obtained under each of the sections, the firm shall arrive at a level ranging from Level 1 to 4. While Level 1 depicts that the firm is very nascent, Level 4 indicates that the firm has made significant adoption of standards and procedures. Accordingly, all firms must strive to achieve level 4 under the AQMM.

The Institute of Chartered Accountants of India (ICAI) through its Centre for Audit Quality (CAQ) has come out with an Implementation Guide for Audit Quality Maturity Model (IG) providing guidance to the CA firms for adopting the AQMM and carrying out assessments / evaluation. In this article, I try and cover some of the important consideration points in the AQMM.

To start with, the AQMM does not restrict itself to audit quality. It also expands its coverage to other aspects which are not reflecting audit quality by themselves but are enablers to audit quality. For example, the factors around human resources, IT infrastructure, monitoring of budgeted versus actual hours and related fees, each of which by themselves do not relate to audit quality but are factors which enable CA firms enhance audit quality levels. AQMM is also forward looking and enables CA firms set the direction in which they aspire to proceed by asking the CA firms to set a Vision and Mission statement which is forward looking.

The AQMM does not just focus on the design of the quality attribute but also focusses on the actual operation / implementation of that attribute in the audit practice / performance. Therefore, CA firms would need to demonstrate actual implementation and usage of the quality attribute in audit performance whereby the quality attribute does not remain just in paper. Whilst AQMM is a significant step in the right direction and is probably the need of the hour emphasising the importance of audit quality, there are certain matters in the AQMM and implementation guidance that need to be evaluated further. In addition the responses to some of the factors in a client audit engagement may also impact the audit opinion! Some of such factors are enumerated below:

1. Revenue from Audit and Assurance services

This is a criteria based on which a CA firm is scored in the AQMM. It would be ideal if clarity is provided to CA firms as to which engagements will be classified as Audit and Assurance engagements. I understand that a valuation engagement is considered as an assurance engagement by the ICAI. Further firms, for operational reasons split the audit and non- audit services under different firms, though having common ownership / brand. It also needs to be clarified if the % of revenue from audit and assurance services should be determined solely based on the revenues of the audit firm or all firms that are under a common ownership / brand (similar to the explanation of an auditor provided in section 144 of the Companies Act, 2013).

It is possible that a firm currently providing significant non-audit services may be heavily investing in audit quality to grow or enhance its audit practice. One of the relevant evaluation factors would be assessing the investment made in audit quality vis-à-vis the revenue from audit and assurance service to better understand the firm’s commitment to audit quality

2. Availability of standard formats relevant for audit quality

Whilst standard formats are important to ensure consistency in audit quality, deviations thereto are normally permitted based on facts and circumstances of each instance. Apart from making available standard formats, there should be guard rails to monitor deviation from the standard formats which also should be assessed and evaluated to understand the efficacy of the standard formats.

3. Presence of Audit Manual

The IG requires the CA firms to track changes and updates to the audit manual. CA firms should therefore set up a mechanism to track changes to the audit manual as part of the audit manual maintenance process. Further, the IG states that the Audit manual should join all the dots from the client and engagement acceptance to the closing meeting with the client. It needs to be noted here the evaluation of availability of an audit manual need not be just restricted to the audit manual only but should also extend to the manual on System of Quality Control (SQC) maintained by the firm since some of the aspects like client and engagement acceptance, Engagement Quality Control Reviews (EQCR), etc. are maintained in the SQC manual.

4. Standardised working papers

The IG considers a permanent audit file to be part of the significant working papers and prescribes various documents that are expected in such a permanent audit file. It needs to be appreciated that in today’s concept of use of technology in planning, performing, documenting and archiving audits electronically, the way of looking at the concept of a permanent audit files needs to change from an evaluation perspective. So long as the information is electronically available in the audit file, even in an earlier year, and there is evidence of review of the same in the current year, the same should meet the criteria of having been maintained in a permanent audit file.

5. Contents of the current audit file

The IG states that the Audit firm should document the Audit queries raised and explanations received thereto in the current audit file. Such documentation is impractical since many queries and explanations are received and closed verbally and it is not possible to track every verbal query and explanation received and for that matter even the written queries and explanation are difficult to track at times since not all queries are resolved or closed at one go and there will be several follow-ups and responses and each query gets closed at its own time so tracking those for documentation purpose

becomes difficult. Further, such documentation expectation will also be counter productive to achieve audit quality since engagement teams may hesitate to seek queries and responses in writing for the fear of having them recorded and being subject to inspections, which may be performed with hindsight, which the auditor did not have when performing the audit, thereby exposing the auditor to inspection risk.

6. Availability of standard checklists

The evaluation criteria based on availability and use of standard checklists is a welcome measure. To enhance the relevance of such checklists, CA firms should prepare checklists which require the auditor to provide answers in a descriptive manner for topics that are principle based rather than just a yes / no answer (For e.g. the standards on auditing (SA) a principle based and therefore a checklist which seeks a description from the audit as to how the SA was complied with will certainy enhance the relevance of such a checklist).

With regard to checklists on accounting, ideally they should be completed by the management of the audit client and reviewed by the auditor. The auditor should also ensure that the matters included in the accounting checklist are also duly considered by the audit client in their risk – control matrices to demonstrate their internal financial controls over financial reporting.

7. Analysis of budget vs actual time

The IG states that all significant deviations from budgeted time, cost, or staff requirements should be fully described in files. A root cause analysis of the deviations may indicate audit client inefficiencies in providing the relevant and correct information. In such a scenario, the auditor will need to assess the impact of such inefficiencies on the opinion on internal financial controls over financial reporting and also assess if such acts were a result of a fraudulent behaviour requiring reporting under section 143(12) of the Companies Act, 2013 and under CARO.

8. Quality control of engagements

One of the evaluation criteria in the AQMM on quality control of engagements is “Total engagements having concluded to be satisfactory as per quality review vs No. of engagements quality reviewed.” This evaluation criteria appears misleading and contrary to the principles of audit quality. The CA firms policies should state that no audit report is issued until the engagement performance is remediated and made satisfactory. If the CA firm policy on quality control does not state so, then it is a material weakness in the audit quality policies of the CA firm since the policy in itself has been drafted inadequately / inappropriately. Under such fundamental circumstance, this evaluation criteria appears inappropriate.

9. No. of engagements without findings

One of the evaluation criteria is considering the number of engagements without findings in external inspections. There are a few issues that require clarification. The first is that the CA firm may not agree with the finding. In such circumstance when should the issue of finding in an engagement Page 5 of 2 be determine – when reported as a finding or when ultimately concluded after representations by the CA firm. The second is, there may be observations which are points for consideration by the CA firm in future audits – should they be considered as a finding? Thirdly, the inspection may make an observation that the auditor is advised to follow a particular matter in letter and spirit – should they be considered as a finding?

10. Benchmarking of service delivery

The AQMM requires evaluation of number of client disputes (other than fees disputes) and how they are addressed. In this context, guidance is required as to when a matter is considered as a dispute – when a claim is made or when the claim is settled with an adverse outcome of the firm or any of its partners. Also clarity is required as to how long the matter should be reported – during the pendency of the dispute or during the pendency of any penal action on the audit firm (say an audit firm is restricted from performing certain engagements for a few years)

11. Human Resource (HR) Management:

Considering the scope of the evaluation criteria and the depth of coverage on this important enabler aspect for audit quality, CA firms should seriously evaluate the need for a HR person who can be delegated the responsibility to oversee the HR function in the firm. Without such dedicated and focussed effort CA firms will find it hard to satisfy the evaluation criteria for this topic.

12. Employee training

The IG when specifying some of the training requirements has suggested training on AI, blockchain and data analytic tools, when the evaluation criteria only specifies at data analytic tools. This requirement in the IG relating to training in AI and blockchain should be read in the context of relevance and therefore the training on these topics would need to be provided only if the circumstances arise which need such expertise.

13. Empanelment with RBI / C&AG:

There is a positive recognition in the scoring for such empanelment. However, there may be firms which may not want to be so empanelled since they are aware that they do not possess the necessary skill set for perform an audit of a financial institution (this is also a factor for consideration in the SQC when accepting a client or engagement) or may even be for commercial and business reasons. By including this scoring in the denominator for such CA firms who chose not to be empanelled for genuine and strategic reasons, theses CA firms are negatively impacted when determining the % score. It may be clarified that in such cases, the denominator should also be suitably reduced so as not to impact the % score of the CA firm.

The AQMM should be read in the context of laying down certain principles (not all) on audit quality. In a way they specify the minimum expectations for an audit quality foundation. CA firms are certainly encouraged to go beyond and exceed the expectation set out in the AQMM. For example, CA firms may develop Page 6 of 2 their own audit quality indicators to enhance their audit quality. It is important that CA firms retain artifacts / evidences to support their competency assessment in the AQMM since these will be subject to subsequent review by the peer reviewer / AQMM reviewer. It needs to be noted that eventually, the scores in the AQMM will be considered by Boards and Audit Committees when evaluating CA firms for appointment as auditors. Audit Quality is a journey and not a destination. As audits will continue to being performed, one needs to travel continuously carrying audit quality. The AQMM too will go through revisions based on feedback received by the CAQ from the CA firms and also when ISQM 1 is adopted in India.