Audit Quality Indicators: An Approach to Keep Us Out of the Fog

Here’s something not everyone knows about me. When I worked for Bank of America, I earned my Six Sigma “Green Belt” certification.

Now, you won’t find me touting my Green Belt on my LinkedIn profile page, because frankly, I don’t use it much these days. Still, I’m glad to have done the training, which taught this lawyer a great deal about the benefits—and challenges—of standardized processes, as well as using indicators to measure the effectiveness of those processes.

At a very general level, my Six Sigma training showed me the importance of a precise approach to such measurement. For one, you don’t want the cost of collecting and analyzing metrics to outweigh the benefit. Also, you also want to avoid the danger of information overload. As Daniel Boorstin once put it: “The fog of information can drive out knowledge.”

Lately, my colleagues and I at the Center for Audit Quality (CAQ) have given a great deal of thought to the right approach to metrics. Why? The public company auditing profession, along with regulators that oversee it, has been working hard on how to develop a standard set of indicators that could provide audit committees with a broader understanding of audit quality. We think we’ve found an approach that will get everyone better looped in to audit quality, while keeping audit committees and others out of the fog of information.

Let’s take a closer look.

Background: Desire for Indicators on Audit Quality

Across the globe, there is strong interest in having more indicators available on audit quality, starting with firms that make up the public company auditing profession. The CAQ launched an “audit quality indicators” (AQIs) project in 2012. We convened a variety of critical stakeholders—including investors, audit committees, preparers, audit professionals, and former regulators—to discuss possible AQIs and approaches to communicating them.

Meanwhile, regulators, such as the Public Company Accounting Oversight Board (PCAOB) have also been very active on this topic. In 2013, the PCAOB announced plans to pursue a project to define key elements of audit quality, as did the International Auditing and Assurance Standards Board. The PCAOB plans to issue a concept release in 2014 and is likely to hold a roundtable on the subject later this year.

The Right Approach to AQIs: Tailored

The CAQ is looking forward to adding our perspective at the roundtable and in response to the anticipated concept release. In fact, we’ve developed a paper that sets forth in detail our thoughts on the right approach to AQIs, along with a set of potential AQIs. At the highest level, our approach flows from the common sense notion that information collection and communication must be tailored to be useful and to avoid excessive cost and overload. Here are our guidelines for accomplishing this tailoring.

• Communications of AQIs should be directed at audit committees. The CAQ Approach recognizes the vital role the audit committee plays in providing oversight of the audit. These communications are intended to supplement other communications provided to the audit committee, including the auditor’s required communications under professional standards, as well as, information included in the audit firm’s audit quality and transparency reports.

• Communication of AQIs should be focused largely on engagement-specific indicators. Communication of indicators at the engagement-level could drive actions that might help maintain or increase audit quality on an engagement, and may also assist the audit committee in evaluating the effectiveness of the audit firm. Additionally, AQIs may primarily be quantitative in nature. However, these indicators are more useful when supplemented by contextual qualitative narrative and dialogue between the auditor and the audit committee.

Pilot Testing Is Critical

How will we know whether collection of these indicators will be practical and meaningful? In our view, a critical step will be for audit firms to perform pilot testing of the set of potential AQIs with their audit committees. This testing will help us to identify challenges, to assess whether communicating this information is helpful to audit committees, and to enable audit firms to provide insights to regulators and others.

At the moment, we’re calling on our member firms to undertake an AQI pilot testing program that would begin in the second quarter and run through early next year (the completion of the 2014 audit cycle).

An Important Project

While it might not necessarily lead to me to dust off my Six Sigma Green Belt, the development of a set of potential AQIs is an important and exciting undertaking on many levels.

For public company auditing firms, the initiative exemplifies the profession’s commitment to the continuous cycle of improvement. With the right approach—one that stays out of the fog of information—it will also bolster their interaction with audit committees.

For regulators, AQIs can serve as a tool to help them carry out their oversight mission.

For investors, most importantly, the development of AQIs can provide more reassurance that our system of investor protection continues to strengthen to their benefit.

I’m sure I’ll revisit the topic of AQIs in future Influencer posts. I welcome your thoughts in the comments.

Photo: EM Karuna / shutterstock