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Michael Jurnak

Why Audit Quality Matters

What it means • Why it matters • How to get it

They say a rose is a rose is a rose.

But what about an external audit of your business? Unlike sugar, wheat, or coffee beans, audits are not a commodity — and they’re not created equal. They can differ in their quality.

When people think about quality, they usually think first of tangible products, like a Rolex watch or a Craftsman wrench. For items like these, quality refers to the caliber of the design, materials, performance, and so forth. Yet, in reality, much the same criteria hold true — or should hold true — for intangible services like financial audits of your business. They’re simply not all the same.

In recent years, the turbulent events of the global financial crisis have dramatically highlighted the importance of credible, high-quality financial reporting and auditing. And the issue of audit quality has been emerging rapidly across America and elsewhere in the developed world, as constant changes from regulatory and standards-setting bodies to improve audit quality have become the norm.


What is a high-quality audit?

There are no universally agreed upon definitions of high or low quality in audits, no settled measures or benchmarks, and no agreement about the drivers of such quality. It is difficult for prospective clients and other stakeholders outside a company to “look under the hood” and judge audit quality for themselves, because an audit’s elements are often complex and hard to measure. Much of an audit relies on the process of the audit, and the process can be all but invisible to the client and even more so to financial statement users. Indeed, the only outwardly visible signs of a potentially poor-quality audit are financial statement restatements or re-issuances and investigations. But these can take years to surface and might, by then, bear little relation to the audit’s original quality issues. 

A high-quality audit is essentially an audit that accomplishes its classic goal — namely to be a systematic and objective assessment of your business’s accounts. It should be performed by a qualified, independent organization in compliance with current auditing standards. And it should determine whether your financial statements give a true and fair view of your accounts, business, and present circumstances.

When a complex, modern company — regardless of size — engages an accounting firm that is insufficiently staffed to handle the engagement, lacks experience in the company’s industry, or proposes an inordinately low fee for the job, the resulting audit probably will not include the processes and experience that create an audit of the highest possible quality. Why? Because something’s wrong. Low fees, in particular, can signal the possibility that the firm is not realistically attuned to the complexities of the client company’s business or industry. Although pricing an audit is both art and science, low fees might indicate either great efficiency (good) or insufficient time taken to address the complexities of the industry or business issues (bad).

Remember, if it’s too good to be true….it’s probably not true.

Finally, looking a little more deeply, it should also be clear that audit quality isn’t just about reaching an objectively correct opinion, but how the opinion was reached. Auditing is a process, after all — a verb more than a noun, in a sense — with profound issues of thought and integrity standing behind the final formal audit report.


Why does audit quality matter?

The principal purpose of an audit is to enhance the degree of confidence felt by users of your company’s financial statements. The users can include creditors, shareholders, other stakeholders, and newcomers who might be considering establishing a business relationship with your company. If your accounts are in good order, then a high-quality audit can be one of the best ways to demonstrate your true financial position, qualify for a major loan, or attract partners in other new ventures.

It is also important to note that an audit is a disruption of your company’s normal workflow. This means that in addition to the literal cost of the fees paid to the auditing firm, there are costs to be borne by the organization under audit in the form of lost productivity, including the time spent in preparing for the audit — preparing schedules, pulling documentation, being interviewed, etc. One of the risks of working with overmatched auditing firms is that their personnel can inadvertently multiply these costs, because they don’t have the familiarity with enough complex organizations or the industry expertise to know how to streamline audit workflow and minimize disruptions.

Audit quality also matters in relation to its byproducts. Your company’s ability to have frank, ongoing dialogue with a deep technical resource such as a strong auditing firm leveraging its industry experience can be a powerful ally as you manage your internal controls and engage in other business dealings and associations. Under-qualified auditing firms can’t keep you up to date on the latest financial matters relating to the company and its industry — not because of negligence or ill will but simply because they lack the experience, mechanisms and/or staff to keep up with many industry and business trends. 

 

How to get a high-quality audit

Unlike a gold statue in a museum, the exact nature of high-quality auditing is intrinsically changing over time — an activity that evolves as the day’s business environment, financial reporting standards, regulations, and technology evolve. This means that the pursuit of audit quality never ends: It is not a fixed goal with a definitive outcome.

Continual improvements in various audit elements will result in continual improvements in audit quality as a whole in relation to the dynamic business environment in which audits are performed.

The best way to attain high-quality audits is simply to ally your company with a high-quality auditing firm, one that keeps itself deeply immersed — for your company’s benefit and its own — in the ever-changing world of your industry and today’s audit quality.

A high-quality audit can come from any size firm. It is not necessarily true that a larger firm provides a higher-quality audit. Much more is involved than just firm size.


To have and to hold

Finding a high-quality auditing firm, however, and building a successful long-term relationship with it is, not surprisingly, much like getting married — and demands comparably prudent attention and forethought. I will grant that the relationship is rarely as much fun as marriage, but it still requires good research before sealing the deal. At BerryDunn, we offer prospective clients the following 6-point checklist before they take the plunge and ally themselves — or not — with a new accounting firm.


[1] Is there vision at the helm?     

When selecting an accounting firm for external audits and related financial services for your business, spend a little time with senior management or ask for their information in the proposal for your work. Go ahead: Invite yourself. Remember, culture comes from the top. Ask yourself whether the people you meet evince principled vision and human passion. Do they know what their firm stands for and where it’s going? Can you even get to meet or have a conference call with them? Will you remain important to them after the courtship is over?

Is there a clearly stated Code of Conduct? If so, ask to see it. Really. Check for evidence of a focused, well-articulated strategy that incorporates quality in the firm’s audits — and indeed in all engagements. Does the firm’s governance structure have clear lines of responsibility, leading to the presence of skilled experts in the right positions to drive the quality agenda?


[2] Are they vetting you carefully too?

High-quality accounting firms are selective about their clientele — because they know that, just like a person, their reputation is affected by the company they keep. And vice versa. They need to make sure they have the skills and personnel with the right experience to do the job well.

When selecting an accounting firm for your business, find out if there are rigorous, established client acceptance and continuance policies, including annual reviews. Is a partner in the firm asking to evaluate your company’s “principals and principles” to see how risky a client you’d make? This sounds shocking at first. But done right, assessing potential clients for risk — which combines robust technical knowledge with an analytical and inquiring mind — is a very good sign for you, both for the quality of the firm and for the quality of the services you’ll receive. You should be asked about your company’s financial strength, reputation, accounting policies and practices, management character, and business model as well as your products or services, competitors, and industry.

When it comes to providing audit services in particular, the firm should evaluate you again, this time to make sure of its independence. (Conflicts of interest can arise, for example, if a family member of an audit firm employee is a shareholder or executive in your organization.) You should be asked about your financial and other relationships, investments, loans, and ownership structure.

Finally, ask for a few examples of cases in which the firm has declined to provide a service to a given client, or even resigned the client as a whole, and why. If you get a blank look, you’ll know what to do. Leave.


[3] Are the firm’s standards, tools, and technologies kept well honed?

High-quality accounting firms have high, clearly stated standards and equip themselves with robust audit tools and technologies to make sure their standards are met.

Ask a partner: Which people in the firm are responsible for meeting standards for professional practice, risk management, and quality control. The right answer? Everyone.

Do the firm’s personnel confirm their compliance with these policies annually and in writing? They should.

Does the firm set its requirements well above those of the industry’s professional standards? (We do at BerryDunn. We think it’s a good idea.) Ask for the firm’s most recent peer review report and see what it says.

High-quality firms also dedicate significant resources to keeping their arsenal of audit tools and technologies complete and up to date, reflecting current industry best practice. Why? Because they know that well-honed tools and technologies promote robust documentation, reduce the risk of human error, and contribute to consistent implementation of the audit process — and hence are key drivers of audit quality.


[4] Are the right people on the job?

High-quality accounting firms make sure the partners and staff assigned to a company likes yours are in fact the appropriate ones for your business and industry. Do they have sufficient bench strength to be able to change some of the engagement team members (if you and a team member had a personality conflict or a team member were to leave the firm)?

This calls for personnel who are ethically sound, good communicators, critical thinkers, and problem solvers and also have continually improving technical skills in their field and specialty. 

Ask a partner: How many years of experience does the average partner have with the firm. The right answer? Upwards of 15 is an answer that should help you gain comfort with what they can bring to your engagement based on the wisdom in the firm.

Does the firm promote opportunities and access to courses for its people to continually enhance their core competencies, personal effectiveness, leadership, and professional skills? Does the firm set agreed-upon goals and conduct formal, documented evaluations of these skills on a regular basis in order to assess performance and progress — and to hold its people accountable for them?


[5] Is the firm committed to technical excellence and quality service?

A high-quality accounting firm goes beyond statutory training, accreditation, and licensing requirements. It develops its people’s excellence and delivery of superior-quality service through additional technical training, promoting business understanding and industry knowledge, investing in technical support, developing specialist networks, and instituting effective consultation processes.

Ask a partner: How does the firm enhance its people’s skills? The right answer? Continuously. The firm’s methods should include self-study courses, classroom courses at national and regional levels, web-based seminars, and industry-specific training programs — not to mention staying up to date with relevant periodicals, bulletins, and other technical literature. Technical courses covering independence, financial reporting, and auditing topics should be mandatory at all levels of the firm.

More broadly, does the firm take steps to ensure that its people build their overall business acumen, leadership and personal skills, and knowledge of your industry? It should.

It’s also a good sign when the firm’s partners and personnel are recognized thought leaders and play influential roles in their community and region, including key positions with regulators, standard setters, industry associations, and other professional bodies.


[6] Are the firm’s audits efficient and effective?

How an audit is conducted is as important as the final result. When selecting an accounting firm for your company’s audit, be sure to ask questions about the nuts and bolts of the job.

Early in the audit, will there be significant involvement and leadership from the audit engagement partner in order to maximize the impact of his or her experience and skill, and to direct the scope and tone of the audit? There should be.

How will the auditing team use its professional judgment and skepticism to assess the audit evidence and reach a conclusion as to whether your company’s financial report is in compliance with accounting standards, not materially misstated, and presented fairly?

How will the team be supervised during the audit? Good supervision should reflect individual team members’ capabilities, identify matters for broader consultation with other experts in the firm, and include timely reviews of the audit as it progresses.

At the end of the audit, will the final reporting lead to insightful, open, and honest two-way communication (without surprises)? You bet it should! — because this, after all, is the broader, long-term goal of audit quality, a goal that extends beyond even the audit itself: When you have allied your business with a high-quality accounting firm, your ability to enjoy deep, rewarding business discussion with the firm’s array of experts and advisors will benefit your company in countless ways for years to come.