Audit quality - The role of directors and audit committees
This information sheet (INFO 196)provides guidance to assist directors and audit committees in their role in ensuring the quality of the external audit of a financial report. It explains:
- why audit quality is important
- the responsibilities of the auditor
- the roles of directors and audit committees
- the responsibilities of directors for auditor independence
- who should manage the appointment of auditors
- what matters should be considered in setting audit fees, and
- what directors and audit committees can do to promote audit quality.
This information sheet is relevant to audit committee members and to directors, whether or not they are members of a company’s audit committee.
Download this information sheet as a printable PDF (112 KB)
Auditors have a critical role in ensuring that Australian investors can be confident and informed in making their investment decisions. High-quality audits support the quality of financial reports and enable investors to rely on the auditor’s independent assessment of financial reports.
Audit quality concerns matters that contribute to the likelihood of the auditor achieving the fundamental objective of obtaining reasonable assurance that the financial report as a whole is free of material misstatement, and that the auditor ensures any deficiencies detected are addressed or communicated through the audit report.
This view is consistent with the objective of the audit, as outlined in the auditing standards: see paragraph 11 of Auditing Standard ASA 200 Overall objectives of the independent auditor and the conduct of an audit in accordance with Australian auditing standards, and is consistent with the Financial Reporting Council (FRC) definition of audit quality.
Note: See the FRC submission on the International Auditing and Assurance Standards Board (IAASB) consultation paper, A framework for audit quality (PDF from FRC website, 119 KB), May 2013.
Audit quality can be influenced by a range of factors, including:
- an audit firm culture focused on audit quality and professional scepticism
- a culture of consultation
- an understanding of the business and the risks affecting the financial report
- the internal and external experience and expertise applied in audits (including recruitment and training, the use of experts, and specialist industry knowledge)
- the supervision and review of audit engagements (including audit firm quality reviews)
- audit firm quality controls, and
- the accountability of engagement partners and others in the firm for audit quality (e.g. through impacts on remuneration for poor internal quality review findings).
Under the Corporations Act 2001 (Corporations Act), the auditor is required to:
- form an opinion about whether the financial report complies with the accounting standards and gives a true and fair view, as well as about certain other matters (section 307) and report to members (section 309)
- conduct their audit in accordance with the auditing standards (section 307A)
- meet independence requirements (including professional standards) and give the directors an auditor’s independence declaration (section 307C), and
- report certain suspected contraventions of the Corporations Act to ASIC (section 311).
An audit committee is a committee of the board of directors that focuses on issues relevant to the integrity of the company’s financial reporting. The ASX Listing Rules require certain listed entities to have audit committees. Other companies may choose to have an audit committee.
While the existence of an audit committee does not alter the need for directors to take responsibility for financial reports, audit committees can play an important role in the financial reporting process and in supporting and promoting audit quality.
The auditor gives an independent opinion that follows after the directors’ opinion on a financial report. A company must have its own systems, processes and controls, as well as appropriate resources, to produce high-quality financial reports. Directors must not rely on the auditor in forming their own opinion on the financial report, as this would undermine the objective of an audit in providing independent assurance to members on the financial report. See also Information Sheet 183 Directors and financial reporting (INFO 183).
Audit committees should consider raising any audit quality concerns that are not satisfactorily resolved with the auditor with the board of directors. Directors and audit committees may seek advice where appropriate, and may raise concerns with ASIC if needed.
The independence of the auditor is important in promoting market confidence in the auditor’s report on the financial report. Actual and perceived independence from directors and company management, as well as the objectivity of the auditor, underpins audit quality.
The directors’ role in ensuring the independence of the auditor is illustrated by requirements in the Corporations Act for the directors’ report to include:
- the auditor’s independence declaration, and
- for a listed company, a statement about whether the provision of non-audit services by the auditor during a financial year is compatible with the general standard of auditor independence in the Corporations Act, and whether that statement is consistent with the advice of the audit committee (section 300(11B–11E)).
It is important for directors and audit committees to consider the independence of the auditor both in recommending the appointment of auditors and on an ongoing basis.
The members of a public company appoint the auditor at an annual general meeting (AGM): section 327B. The directors must appoint an auditor to fill a vacancy in the office of auditor, but the ongoing appointment of an auditor occurs at the next AGM: section 327A and 327C.
Because it is generally not practical for members of larger listed companies to be involved in a detailed assessment of auditors and the determination of audit fees, the audit committee and directors can play an important role in recommending the appointment of an auditor.
It is possible that company management may have interests that are not fully aligned with the conduct of quality audits, and so may not be best placed to assess auditors and set audit fees. For example, incentives for management to achieve certain levels of financial performance may lead to setting low audit fees that could place undue pressure on audit quality.
While consideration should be given to any management concerns with audit quality, non-executive directors – who are focused on the need for audit quality and who have direct accountability and fiduciary responsibilities to the company – should ideally manage the process of appointing and replacing auditors and determine the remuneration of the auditors.
A company is required to pay the reasonable fees and expenses of an auditor: section 331. The setting of audit fees is a commercial decision by companies and their auditors. The process should be managed by the directors (who should be responsible for setting the overall fee) and the audit committee. Directors and audit committees should ensure that audit fees are not set at a level that could lead to audit quality being compromised.
Many companies have been under pressure to reduce costs because of difficult economic circumstances or other factors. Audit fees have sometimes been affected in the pursuit of general cost reductions. However, audit fees are usually a small proportion of costs, and reductions generally do not have a significant impact on a company’s profit.
In difficult economic conditions, auditors continue to be faced with more challenging judgements in areas such as assessing whether a company is a going concern, impairments of assets and fair values. This increases the time spent on an audit and might be expected to lead to increases rather than reductions in audit fees. Changes in the company’s business, reporting requirements or the risks affecting financial reports may also warrant increases in fees.
If a company decides to seek tenders for audit services, the primary focus should be on audit quality rather than on reducing fees and saving costs. A quality audit supports the quality of financial reporting.
Some audit firms may offer discounted fees to maintain or increase revenues, contribute to fixed costs, occupy staff during downturns, maintain or build market share, or build a presence in a particular industry. In some cases, an auditor may not have understood the company’s business, reporting requirements and the extent of audit work required.
While there may be instances where an effective but more efficient audit can be obtained, audit committees and directors should be aware of a risk of pressures in some audit firms to limit the impacts of low or reduced fees on margins. Inadequate fees can create a risk that audit quality is compromised and that auditors do not obtain sufficient and appropriate audit evidence to support their opinion. This should be of concern to directors and audit committees.
In ensuring audit quality, directors and audit committees may consider certain good practice matters when:
- recommending the appointment of an auditor to members
- assessing potential and continuing auditors
- facilitating the audit process
- establishing ongoing communications with the auditor
- maintaining auditor independence
- assessing the quality of audits conducted.
The matters that may be considered are listed as questions under each area. They may also be included in some form in the audit committee’s charter.
In recommending the appointment of an auditor to members, directors and audit committees may consider the following matters: see also ‘Assessing potential and continuing auditors’ for other matters that may be relevant.
|Any audit tender or other selection process||
|Commitment to audit quality||
When assessing potential auditors to recommend to members, and when reviewing and promoting the quality of ongoing audits (through review of the continuing auditor’s plans for each reporting period), directors and audit committees may consider the following matters.
|Resources devoted to the audit||
|Reliance on experts and other auditors||
To facilitate the audit process, directors and audit committees may consider the following matters.
|Supporting the audit||
|Company management and staff||
The quality of communications between directors and audit committees and the auditor is important in supporting audit quality. This communication should include concerns and risks affecting processes supporting the information in the financial report, and how these concerns and risks are being addressed by directors and management and responded to in the audit.
Two-way communication between the auditor and directors helps the auditor to obtain information that is relevant to the audit and assists directors in overseeing the financial reporting process. In establishing ongoing communications with the auditor, directors and audit committees may consider the following matters.
|Addressing any risk areas or areas of concern||
|Ensuring access to directors and audit committee||
To maintain auditor independence and objectivity, directors and audit committees may consider the following matters.
|Policies and processes||
|Independence and objectivity||
Directors and audit committees are well-placed to evaluate the performance of an auditor and can help to ensure that members are provided with a valuable independent audit opinion on the financial reports. This promotes market confidence in the company’s financial reports.
In assessing the quality of an audit that has been conducted, directors and audit committees may consider the following matters.
|Quality and standards||
|The audit process||
|Communication of issues||
|Findings from ASIC’s audit inspections and surveillances||
Where can I get more information?
- For copies of auditing standards, go to http://www.auasb.gov.au/Pronouncements/Australian-Auditing-Standards.aspx.
- Read Information Sheet 183 Directors and financial reporting (INFO 183)
- Contact ASIC on 1300 300 630.
This is Information Sheet 196 (INFO 196), issued in March 2014. Information sheets provide concise guidance on a specific process or compliance issue or an overview of detailed guidance.