November 15, 2016

AQIs - An Opportunity for Audit Committees

By Cindy Fornelli and Paula Loop

In recent years, stakeholders in both the private and public sectors have shown a growing interest in quantitative metrics regarding audits (commonly referred to as “audit quality indicators” or “AQIs”). In essence, the driving idea behind AQIs is to establish a clear set of criteria that can help inform audit committees about key matters that may contribute to the quality of, or provide additional transparency into, an audit. After all, a well-informed audit committee is one that is better equipped to carry out its responsibilities of overseeing its company's financial reporting and audit processes.

Yet despite the interest in AQIs, recent research shows that a significant number of audit committees are not fully—or formally—using AQIs. As the data below shows, over 40 percent of audit committees do not formally use AQIs. Using AQIs could be an opportunity for those audit committees to further inform themselves. Doing so will require careful application of what we've learned to date about the complex issue of AQIs.

By the Numbers

Last month, PwC published its Annual Corporate Directors Survey. Conducted over the summer, the 2016 survey polled 884 public company directors, of which 71 percent serve on the boards of companies with more than $1 billion in annual revenue. Participants hailed from nearly two dozen industries, with leading sectors represented including banking, retail and industrial products.

In a first for this survey, PwC queried directors on their use of AQIs. The findings should interest anyone who has tracked this issue. For example, the most popular AQI metric used by survey respondents was the industry experience of the audit engagement team. The chart shows the most frequently used AQIs.

Perhaps the survey's most striking finding, however, was the 42 percent of respondents who indicated that they did not formally use AQIs. Among companies with annual revenue greater than $10 billion, that percentage jumped even higher, with 61 percent of directors from those companies indicating that they did not formally use AQIs. Smaller companies (i.e., those with less than $1 billion in sales) appear to be in the vanguard here, with 63 percent reporting that they used AQIs formally.

Key Considerations

Judging by PwC's research, the opportunity for audit committees to formally use AQIs remains ripe. However, as has been revealed over the years, the formal use of AQIs is complex, with many variables and points of view.

Fortunately, the body of knowledge around AQIs has grown along with interest in the subject. The Center for Audit Quality (CAQ), for example, has extensively explored AQIs in consultation with public company auditing firms, audit committee members, regulators, investors, and a range of other stakeholders. In 2014, the CAQ developed an approach to AQIs, then pilot tested that approach on 30 audit engagements. Last year, the CAQ discussed what it had learned with audit committees at a series of roundtables held in the United States, the United Kingdom, and Asia.

From this work, there are several key considerations to help audit committees address the possible use of AQIs. These considerations should be salient for board members considering using AQIs. The considerations are:

  • One size does not fit all. Audit committees have expressed a desire for the approach to AQIs to be flexible. Audit committees, working with the external auditor, should tailor or customize the selection and portfolio of AQIs that best suit their specific information needs.
  • Quantitative metrics are not the end of the story. In addition to quantitative metrics (such as those pilot tested by the CAQ, audit committee members have expressed a desire for information that can assist them in their assessment of the more qualitative aspects of the audit. Examples of the types of qualitative information audit committee members use include whether the engagement team has the right communications and project management skills, as well as the appropriate mindset to bring forth professional skepticism and auditor judgment.
  • Context matters. It has become clear that AQIs alone, without context, cannot adequately communicate factors relevant to any particular audit engagement or audit firm.
  • Working with AQIs is an iterative process. Audit committee members have stressed that the process of identifying and evaluating AQIs needs to be audit committee-driven and iterative. This process will require continuous assessment and refinement in order to meet the changing information needs of audit committees.

Learning More

Whatever the complexities, the development of the use of AQIs continues to hold great promise. Namely, AQIs can strengthen the conversation around audit quality in a way that benefits boards, companies, investors, and, ultimately, the capital market system.

For those interested in learning more, consider the following resources.

A securities lawyer, Cindy Fornelli has served as the Executive Director of the Center for Audit Quality since its establishment in 2007.

A Certified Public Accountant, Paula Loop is the leader for PwC’s Governance Insights Center, which aims to strengthen investor confidence and provide resources for directors and investors addressing new and traditional challenges.