In a previous post we introduced you to the new quality management standards (ISQM 1 / SQMS 1 and ISQM 2 / SQMS 2) issued by the International Auditing and Assurance Board (IAASB) and the Auditing Standards Board (ASB) which were developed largely due to concerns about audit quality, as highlighted by inspection findings by regulators. These standards apply to all firms performing audits or reviews of financial statements, or other assurance or related services engagements in accordance with the standards published by the IAASB and ASB. In this post we’ll take a deeper dive into ISQM 2 and SQMS 2 Engagement Quality Reviews dealing with the requirement within ISQM 1 to establish policies or procedures addressing engagement quality (EQ) reviews. In last week’s post we looked at ISQM 1 and SQMS 1 dealing with a firm’s responsibility for having a system of quality management (SOQM).
It should be noted that the ASB has a strategic objective to converge with the standards of IAASB and, as a result, the SQMSs were developed using the ISQMs as the base starting point. As such, there are only minor differences between the two sets of standards.
What is an engagement quality (EQ) review?
According to the former PCAOB Chairman Mark Olson, an EQ review “increases the likelihood of identifying and correcting deficiencies in the audit prior to the issuance of the auditor’s report.” The requirement for EQ reviews is not new. In fact, the PCAOB already has a requirement for EQ reviews for audits of public companies in the United States (AS 1220 Engagement Quality Review). However, standard setters and audit oversight bodies identified concerns that existing requirements published by the IAASB and ASB were not sufficiently robust. As a result, the IAASB issued ISQM 2 in December 2020 and the ASB followed suit in June 2022 with SQMS 2.
ISQM 2 defines an EQ review as an objective evaluation of the significant judgments made by the engagement team and the conclusions reached thereon, performed by the EQ reviewer, and completed on or before the date of the engagement report. The EQ review is an important part of the audit review process. It’s one of the ways audit firms ensure they are delivering quality audits. Think of it like having a second set of eyes to evaluate the performance of the engagement team, including the engagement partner.
According to ISA 220 (Revised), significant judgments include matters related to the overall audit strategy and audit plan for undertaking the engagement, the execution of the engagement, and the overall conclusions reached by the engagement team. Some examples include:
- Matters related to planning the engagement, such as matters related to determining materiality.
- The engagement team’s risk assessment process, including situations where consideration of inherent risk factors and the assessment of inherent risk requires significant judgment by the engagement team.
- Results of the procedures performed by the engagement team on significant areas of the engagement, for example, conclusions in respect of certain accounting estimates, accounting policies, or going concern considerations.
- The engagement team’s evaluation of the work performed by experts and conclusions drawn therefrom.
- The significance and disposition of corrected and uncorrected misstatements identified during the engagement.
- The proposed audit opinion and matters to be communicated in the auditor’s report, for example, key audit matters.
ISQM 2 Engagement Quality Reviews addresses:
- The appointment and eligibility of the EQ reviewer; and
- The EQ reviewer’s responsibilities relating to the performance and documentation of an EQ review.
Appointment and eligibility of EQ reviewers
An EQ reviewer is a partner, other individual in the firm, or an external individual, appointed by the firm to perform the EQ review. The EQ reviewer is NOT a member of the engagement team. Furthermore, both the EQ reviewer and individuals that assist them should:
- Have the competence and capabilities, including sufficient time, and the appropriate authority to perform the EQ review;
- Comply with relevant ethical requirements, including in relation to threats to objectivity and independence of the EQ reviewer; and
- Comply with provisions of law and regulation, if any, that are relevant to the eligibility of the EQ reviewer.
It is important to note that ISQM 2 requires a “cooling-off” period of two years, or longer if required by relevant ethical requirements, before an engagement partner can assume the role of the EQ reviewer. This requirement applies to all engagements subject to an EQ review, as determined in accordance with ISQM 1.
If the EQ reviewer becomes aware of circumstances that would impair the eligibility, the EQ reviewer shall notify the appropriate individual(s) in the firm and decline the appointment to perform the EQ review. If EQ review has already commenced, then they should discontinue the performance of the EQ review.
Performance of the EQ review
The performance of an EQ review does not change the responsibilities of the engagement partner for managing and achieving quality on the engagement, or for the direction and supervision of the members of the engagement team and the review of their work.
In performing the EQ review, ISQM 2 requires that the EQ reviewer:
- Read, and obtain an understanding of, information communicated by:
- The engagement team regarding the nature and circumstances of the engagement and the entity; and
- The firm related to the firm’s monitoring and remediation process, in particular identified deficiencies that may relate to, or affect, the areas involving significant judgments made by the engagement team.
- Discuss with the engagement partner and, if applicable, other members of the engagement team, significant matters and significant judgments made in planning, performing, and reporting on the engagement.
- Based on the information obtained in (a) and (b), review selected engagement documentation relating to significant judgments made by the engagement team and evaluate:
- The basis for making those significant judgments, including, when applicable to the type of engagement, the exercise of professional skepticism by the engagement team;
- Whether the engagement documentation supports the conclusions reached; and
- Whether the conclusions reached are appropriate.
- For audits of financial statements, evaluate that the basis for the engagement partner’s determination of the relevant ethical requirements relating to independence have been fulfilled.
- Evaluate whether appropriate consultation has taken place on difficult or contentious matters or matters involving differences of opinion and the conclusions arising from those consultations.
- For audits of financial statements, evaluate the basis for the engagement partner’s determination that the engagement partner’s involvement has been sufficient and appropriate throughout the audit engagement such that the engagement partner has the basis for determining that the significant judgments made, and the conclusions reached are appropriate given the nature and circumstances of the engagement.
In addition, for audits of financial statements, the EQ reviewer shall review the financial statements and the auditor’s report thereon, including, if applicable, the description of key audit matters. There is a similar requirement for reviews of financial statements or financial information, as well as other assurance and related services engagements.
It appears to me that the above requirements should be included in a checklist that is completed, signed, and dated by the EQ reviewer, and included in the engagement documentation.
Documentation of the EQ review is the responsibility of the EQ reviewer and shall be filed with the engagement documentation. Such documentation shall be sufficient to enable an experienced practitioner, having no previous connection with the engagement, to understand the nature, timing, and extent of the procedures performed by the EQ reviewer and their team, and the conclusions reached in performing the review. Sounds a lot like audit documentation requirements where the basic premise is “if it’s not documented, you didn’t do it!”
At minimum, such documentation should include:
- The names of the EQ reviewer and individuals who assisted with the EQ review;
- An identification of the engagement documentation reviewed;
- The basis for the EQ reviewer’s determination that the EQ review requirements have been fulfilled and whether the EQ review is complete;
- Any notifications to the engagement partner by the EQ reviewer of any concerns that the significant judgments made by the engagement team, or the conclusions reached thereon, are not appropriate; and
- The date of completion of the EQ review and notification to the engagement partner that the EQ review is complete.
ISQM 2 is effective for:
- Audits and reviews of financial statements for periods beginning on or after December 15, 2022; and
- Other assurance and related services engagements beginning on or after December 15, 2022.
SQMS 2 is effective for:
- Audits or reviews of financial statements for periods beginning on or after December 15, 2025; and
- Other engagements in the firm’s accounting and auditing practice beginning on or after December 15, 2025.
An engagement in the firm’s accounting or auditing practice begins when an engagement letter or other agreement to perform attest services is signed or when the firm begins to perform the engagement, whichever is earlier.
We hope this post has helped you better understand the requirements of ISQM 2 and SQMS 2 as it relates to EQ reviews. Check out this page on the IAASB website for the standard, as well as a fact sheet and first-time implementation guide.
If you need help getting your audit and accounting training in compliance with the new audit quality standards, let’s talk. We’re currently helping several accounting firms with their compliance, and we’d be happy to help you too!
About GAAP Dynamics
We’re a DIFFERENT type of accounting training firm. We don’t think of training as a “tick the box” exercise, but rather an opportunity to empower your people to help them make the right decisions at the right time. Whether it’s U.S. GAAP training, IFRS training, or audit training, we’ve helped thousands of professionals since 2001. Our clients include some of the largest accounting firms and companies in the world. As lifelong learners, we believe training is important. As CPAs, we believe great training is vital to doing your job well and maintaining the public trust. We want to help you understand complex accounting matters and we believe you deserve the best training in the world, regardless of whether you work for a large, multinational company or a small, regional accounting firm. We passionately create high-quality training that we would want to take. This means it is accurate, relevant, engaging, visually appealing, and fun. That’s our brand promise. Want to learn more about how GAAP Dynamics can help you? Let’s talk!
This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.