Ch-1 Intro to Auditing

SQC-1 & SA 220 “Quality Control for an Audit of Financial Statements”

Elements of a System of Quality Control

Firm’s system of quality control should include policies and procedures addressing each of following
elements:
(a) Leadership responsibilities for quality within the firm.
(b) Ethical requirements.
(c) Acceptance and continuance of client relationships and specific engg.
(d) Human resources.
(e) Engagement performance.
(f) Monitoring.

Leadership Responsibilities for Quality on Audits

Engagement partner (EP) shall take responsibility for overall quality on each audit engg to which that
partner is assigned.

Actions of EP and appropriate msgs to other members of engg team, in taking responsibility for overall
quality on each audit engagement, emphasise:
(a) The importance to audit quality of:
i) Performing work that complies with Professional stds, Regulatory and Legal requirements (PRL)
ii) Complying with firm’s quality control policies and procedures as applicable
iii) Issuing auditor’s reports that are appropriate in the circumstances and
iv) The engagement team’s ability to raise concerns without fear of reprisals and
(b) Fact that quality is essential in performing audit engg.

Engagement partner (EP) refers to partner or other person in firm who is responsible for audit
engagement and its performance, and for auditor’s report that is issued on behalf of firm, and has
appropriate authority from a professional, legal or regulatory body.

Ethical Requirements
Fundamental principles of professional ethics
(a) Integrity
Ø Requires auditor to be straight forward and honest in all professional & business relationships.
Ø Implies fair dealing and truthfulness.
Ø It effectively means that he shall not be associated with reports, returns, communications or
other info which he believes contains a
• materially false or misleading statement
• contains statements or info. provided recklessly or

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• omits required info. where such omission could be misleading.

(b) Objectivity
Requires auditor not to compromise professional judgment because of bias, conflict of interest or undue
influence of others.

(c) Professional competence and due care

Requires auditor to attain and maintain professional knowledge and skill at the level required to render
competent professional service and also to act diligently and as per technical & professional standards.

(d) Confidentiality: Requires auditor to respect confidentiality of info. acquired as result of

professional or business relationships.

(e) Professional behaviour

It requires an auditor to comply with relevant laws and regulations and avoid any conduct that he knows
or should know might discredit the profession.

Auditor should be Independent of the entity subject to Audit.

Independence comprise of both: Independence of Mind & Independence in Appearance.

1. Independence of mind – state of mind that permits provision of opinion without being affected by
influences allowing individual to act with integrity, exercise objectivity and professional skepticism
2. Independence in appearance –avoidance of facts and circumstances that are so significant that a
3rd party would reasonably conclude an auditor’s integrity, objectivity or professional skepticism
had been compromised.
It enhances auditor’s ability to act with integrity, be objective and maintain attitude of professional
skepticism.

Types of Threats to Independence

5 types of threats:

1. Self-interest threats, which occur when an auditing firm, its partner or associate could benefit from
a financial interest in an audit client.

Examples include:
i) direct financial interest or materially significant indirect financial interest in a client,
ii) loan or guarantee to or from the concerned client,
iii) undue dependence on a client’s fees and, hence, concerns about losing engg,
iv) close business relationship with an audit client,
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v) potential employment with the client, and
vi) contingent fees for audit engagement.

Direct financial interest

Loan or Dependence Contingent Business Potential

guarantee on fees fees Relation Employment

2. Self-review threats, which occur when during a review of judgement or conclusion reached in a
previous audit or non-audit engg or when audit team member was previously director or senior employee
of client.

(Non-audit services include any professional services provided, other than audit or
review of FS. These include mgt services, internal audit, investment advisory service,
design and implementation of IT systems etc.),

Instances where such threats come into play are:

i) when an auditor having recently been a director or senior officer of company, and
ii) when auditors perform services that are subject matters of audit.

3. Advocacy threats, which occur when auditor promotes, or is perceived to promote, a client’s opinion
to a point where people may believe that objectivity is getting compromised.
Examples:

Auditor dealing in shares Auditor becomes advocate in

or securities of Co. litigation or 3rd party disputes

4. Familiarity threats occur when auditors form relationships with client end up being too sympathetic
to client’s interests.

This can occur in many ways:

i) close relative of audit team working in a senior position in client company
ii) former partner of audit firm being a director/senior employee of client
iii) long association b/w auditors and client counterparts and
iv) acceptance of significant gifts or hospitality from client, its directors or employees.

5. Intimidation threats, which occur when auditors are deterred from acting objectively with an
adequate degree of professional skepticism.
Basically, these could happen because of
o threat of replacement over disagreements with application of a/c principles or
o pressure to disproportionately reduce work in response to reduced audit fees or
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o being threatened with litigation.

Safeguards to Independence
Following are the guiding principles in this regard: -
1. For public to have confidence in quality of audit, essential that auditors should always be and
appears to be independent of entities they are auditing.
2. In case of audit, key fundamental principles are integrity, objectivity and professional skepticism,
which require auditor to be independent.
3. Before taking any work, auditor must consider whether it involves threats to his independence.
4. When threats exist, auditor should desist from task or put in place safeguards that eliminate them.
5. If auditor unable to implement safeguards, must not accept the work.

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Independence
Policies and procedures should enable firm to: -
(a) Communicate its independence requirements to its personnel
(b) Identify and evaluate
Þ circumstances and relationships that create threats to independence,
Þ Obtain info on identified breaches, if any, of firm’s P&P, check if they create threat and
Þ to take appropriate action
ü to eliminate those threats or
ü reduce them to an acceptable level by applying safeguards, or,
ü if considered appropriate, to withdraw from the engagement.

EPs provide firm with relevant info about client and personnel of firm promptly notify firm of
circumstances and relationships that create a threat to independence.

All breaches of independence should be promptly notified to firm for appropriate action.

Its objective is to ensure that independence requirements are satisfied.

At least annually, firm should obtain written confirmation of compliance with P&P on independence from
all firm personnel required to be independent in terms of requirements of the Code.

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Acceptance and Continuance of Client Relationships and Audit Engagements [MTP Nov-21]
EP shall be satisfied that appropriate procedures regarding acceptance and continuance of client
relationships and audit engagements have been followed.

Information such as following assists EP in determining whether decisions regarding acceptance and
continuance of audit engagements are appropriate:
• Integrity of principal owners, key management and TCWG of entity
• Whether engg. team is competent to perform audit and has necessary capabilities, including time
and resources
• Whether firm & engg. team can comply with relevant ethical requirements &
• Significant matters that have arisen during current or previous audit engg, and their implications
for continuing the relationship

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Evaluating the Integrity of Client

With regard to integrity of a client, matters that firm considers include, for example:
ü Identity and business reputation of client’s principal owners, key mgt, related parties and TCWG.
ü Nature of client’s operations, including business practices.
ü Info. concerning attitude of client’s principal owners, key mgt and TCWG towards matters such
as aggressive interpretation of a/c stds and internal control environment.
ü Whether client is aggressively concerned with maintaining firm’s fees as low as possible.
ü Indications of inappropriate limitation in scope of work.
ü Indications that client might be involved in money laundering or other criminal activities.
ü Reasons for proposed appointment of firm and non-reappointment of previous firm.

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