Audit quality - The role of directors and audit committees

This information sheet (INFO 196) explains:

It is relevant to audit committee members and to directors, whether or not they are members of a company’s audit committee.

Why is audit quality important?

Auditors play a critical role in ensuring that Australian investors can be confident and informed when making 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 relates to matters that affect the auditor's ability to achieve an audit's fundamental objective: to obtain reasonable assurance that the financial report as a whole is free of material misstatement. Auditors must ensure any deficiencies detected are addressed or communicated through the audit report.

Note: This view is consistent with the objective of the audit, as outlined in 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.

Audit quality can be influenced by such factors as:

  • an audit firm's culture and focus on audit quality, professional scepticism and consultation
  • the auditor's 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)
  • how effectively audit engagements are supervised and reviewed (including audit firm quality reviews)
  • the audit firm's system of accountability of engagement partners and others in the firm for audit quality (e.g. impact on remuneration for poor internal quality review findings).

What are the auditor's responsibilities?

Under the Corporations Act 2001 (Corporations Act), the auditor must:

  • 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).

What are the roles of directors and audit committees?

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 when forming their own opinion on the financial report, as this would undermine the objective of an audit, which is to provide 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.

See also Regulatory Guide 260 Communicating findings from audit files to directors, audit committees or senior managers (RG 260). This guide explains which financial reporting and audit quality findings identified from our reviews of audit files we will generally communicate to directors, audit committees or senior managers. It also explains the process we will follow and the timing of our communication.

What are the directors' responsibilities for auditor independence?

The independence of the auditor is important for 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 the requirements in the Corporations Act that the directors’ report 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 the 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 when recommending the appointment of auditors and on an ongoing basis.

Who should manage the appointment of auditors?

The members of a public company appoint the auditor at an annual general meeting (AGM): section 327B. If a vacancy occurs in the office of auditor, the directors must appoint an auditor to fill it, but the ongoing appointment 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 focus 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 determining their remuneration.

What should be considered when setting audit fees?

A company is required to pay the auditor's reasonable fees and expenses: 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.

When companies are under financial pressure, audit fees can be affected in the pursuit of general cost reductions. However, audit fees are usually a small proportion of costs, and reducing them does not generally 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 increase 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 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 for a lower fee, audit committees and directors should be aware 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. 

How can directors and audit committees promote audit quality?

To ensure audit quality, directors and audit committees may consider certain good practice matters when:

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.

Recommending the appointment of an auditor

Matter

Considerations

Any audit tender or other selection process
  • Is any audit tender or other selection process being conducted independently of company management (i.e. using a panel of non-executive directors)?
  • Are the audit tender or selection criteria focused on audit quality?
  • Are reduced fees likely to compromise audit quality (e.g. by inadequate resourcing or insufficient work being performed)?
  • Have separate tender documents relating to audit quality and to fees been obtained, and the document relating to quality been considered before reviewing the proposed fees?
  • Does the process ensure that potential auditors are not asked for their views on contentious judgements or accounting treatments before their selection (also known as ‘opinion shopping’)?
Commitment to audit quality
  • Has the auditor (including any incumbent auditor) demonstrated a commitment to audit quality and is there a culture within their firm that promotes audit quality?
  • Has any information relevant to audit quality in the audit firm’s annual audit transparency report been reviewed?
  • How is the auditor addressing any general overall findings reported publicly by ASIC from audit firm inspections or from the firm’s own internal quality reviews?

See also Assessing potential and continuing auditors for other matters that may be relevant.

Assessing potential and continuing auditors

Matter

Considerations

Resources devoted to the audit
  • For a continuing auditor, have they prepared a high-level plan for the audit for review by directors and the audit committee?
  • What level of resources will the auditor devote to the audit?
  • Does the auditor demonstrate a sufficient understanding of the business, operations and risk areas relevant to the financial report, and do they plan to respond appropriately to assessed risks? (In a tender process, sufficient access would normally be provided to management.)
  • Do the auditor’s engagement partner, review partner and audit team members have sufficient experience and expertise, given the size and complexity of the company and its operations? (This includes relevant industry expertise, and valuation expertise appropriate for the types of assets, liabilities and exposures of the company.)
  • Will the senior audit team members (particularly the engagement partner) be sufficiently involved in the audit?
  • Are the firm’s arrangements for supervising and reviewing the audit, and internal firm quality reviews and controls, adequate?
Reliance on experts and other auditors
  • Will the auditor directly engage their own firm or external experts to supplement the audit team’s experience and expertise in specialist areas (e.g. for complex asset and financial instrument valuations, or using specialists such as geologists or actuaries, or information technology (IT) system experts) to obtain an independent view on the work of company management and any external specialists engaged by the company?
  • Will the auditor review and rely on systems and controls in performing the audit, particularly where there are large numbers of systematically processed transactions? If so, are matters such as the auditor’s system rotation plan, proposed reviews of IT controls adequate and appropriate?
  • Will the auditor use the work of other auditors and coverage of components within a group (e.g. local or foreign branches, and subsidiaries)? If so, how will they satisfy themselves on the work of other auditors?
  • Will the auditor rely on internal auditors to perform external audit work? (External auditors may rely on internal audit as part of internal controls and to identify risks. However, independence is essential to investor and market confidence in the external audit, and internal auditors may not be seen as fully independent as they are employed by the company.)
Accountability
  • Are the auditor’s engagement partner, review partner, specialists and audit team members appropriately accountable for audit quality?

Facilitating the audit process

Matter

Considerations

Supporting the audit
  • Is audit quality likely to be compromised by reduced audit fees that might result in the audit being inadequately resourced or insufficient work being performed?
  • Have financial reporting processes and audit processes been planned to ensure that an effective quality audit can be conducted within the financial reporting deadlines?
  • Have any concerns or risks highlighted by the auditor, including concerns about systems, processes or policies that could materially affect future financial reports, been considered and addressed?
Company management and staff
  • Is there appropriate accountability and incentives for company management and staff to focus on the quality of financial reporting, timely reporting and facilitation of the audit process?
  • Has company management given the auditor all information and explanations that may be relevant to the financial report and audit in a timely manner?
  • Do company management and staff have a positive and helpful approach to the audit process?

Communicating with the auditor


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 the processes that support 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.

Matter

Considerations

Addressing any risk areas or areas of concern
  • Is the auditor informed in a timely manner of any areas of risk or concern that are relevant to the financial report and audit?
  • Is the auditor informed about any concerns with accounting treatments, accounting estimates, accounting records, and financial reporting systems and processes so that any concerns may be properly considered and addressed?
  • Does the auditor provide written reports on key issues and concerns?
  • Do directors and the audit committee challenge the auditor, including on professional scepticism applied in judgement areas such as accounting estimates and accounting policies?
Ensuring access to directors and audit committee
  • Is the auditor invited to attend all audit committee meetings, except when the audit committee is discussing the auditor’s performance?
  • Is there an open dialogue between the auditor and the directors and audit committee on matters affecting the financial report, the audit and audit quality?
  • Does the auditor meet with the directors and the audit committee, without company management present and without any minutes of the discussions being shared with management?
  • Does the auditor have open access to the audit committee chair without company management present, outside of the formal audit committee meetings?

Maintaining auditor independence

Matter

Considerations

Independence and objectivity
  • Is there a policy on the auditor's independence?
  • If the auditor performed any non-audit services, were these reviewed and approved before the auditor was engaged, to ensure their independence is not compromised?
  • Have audit team members avoided becoming too close to company management, which can affect independence and objectivity?
  • Have the directors and audit committee members formed their own views on complex accounting policy choices or estimates, including seeking independent third-party advice, rather than relying on the views of the auditor?
  • Have any other matters that may affect the independence and objectivity of the auditor been considered?
  • Has the auditor explained the basis for their independence declaration?

Assessing audit quality


Directors and audit committees are well-placed to evaluate an auditor's performance, and can help to ensure that members receive a valuable independent audit opinion on the financial reports. This promotes market confidence in the company’s financial reports.

Matter

Considerations

Quality and standards
  • Has the auditor demonstrated a commitment to audit quality, and the application of high ethical standards?
The audit process
  • Did the auditor demonstrate a sufficient understanding of the business, operations and risk areas relevant to the financial report, and have they responded appropriately to assessed risks?
  • Did the auditor exhibit sufficient professional scepticism in challenging, rather than rationalising, estimates and accounting policy choices (e.g. complex or subjective asset valuations, including cases where the reported net assets exceed the market capitalisation of the company)?
  • Has the auditor addressed risks or concerns identified by the directors and audit committee?
Communication of issues
  • Did the auditor raise key issues affecting the financial report in a timely manner?
  • Did the auditor raise relevant and useful comments in their management letters?
Other information
  • Has information relevant to audit quality in an audit firm’s annual audit transparency report been reviewed?
  • Has any other information on audit quality been reviewed (e.g. internal company staff observations or assessments of audit quality)?
  • Can the auditor take any actions to improve audit quality? If so, are measures and timetables in place to track progress of these actions?
Findings from ASIC’s audit inspections and surveillances
  • If ASIC (or other regulators) selected the company’s audit for review, have the directors and audit committee considered the review’s scope and results?
  • Have any overall findings from ASIC’s inspections or surveillances been addressed (even if not directly related to the company’s audit)?
  • If the auditor indicated these findings were not significant (e.g. mere documentation matters), have the directors and audit committee challenged this, as we do not report insignificant findings?

Where can I get more information?

Important notice

Please note that this information sheet is a summary giving you basic information about a particular topic. It does not cover the whole of the relevant law regarding that topic, and it is not a substitute for professional advice.

You should also note that because this information sheet avoids legal language wherever possible, it might include some generalisations about the application of the law. Some provisions of the law referred to have exceptions or important qualifications. In most cases your particular circumstances must be taken into account when determining how the law applies to you.

This is Information Sheet 196 (INFO 196), reissued on 23 June 2017. Information sheets provide concise guidance on a specific process or compliance issue or an overview of detailed guidance.

What's new

Review of 31 December 2016 financial reports

ASIC has announced the results from a review of the 31 December 2016 financial reports of 90 listed and other public interest entities. 17-219MR, 30 June

Inspection of audits for 2015–16

ASIC has released the results of its audit firm inspections for the 18 months to 31 December 2016, as well as three information sheets related to improving audit quality and our inspection process. 17-214MR, 29 June

Communicating ASIC’s findings from audit files,

This new regulatory guide provides transparency on our criteria and process for communicating financial reporting and audit findings. 17-200MR, 23 June

More releases on financial reporting and audit

Last updated: 20/10/2014 12:00