The Standards on Quality Management are guidelines issued by the ICAI on 14th October 2024, for all the firms performing audits or reviews of financial statements or other assurance or related services engagements. SQM-1 outlines the framework for designing, implementing and operating a system of quality management and SQM-2 deals with the quality reviews at engagement level. In this blog, we shall delve into the scope and structure of these standards along with the way forward in adopting these standards effectively.
Background and the Need
The term quality is paramount in ensuring and enhancing reliability and credibility. Also, the public interest can be served by the consistent performance of quality engagements. Guidelines protecting these interests are quality standards. Although the Standard on Quality Control (SQC-1) has been in place since April 2009, significant changes in regulatory frameworks, the expanding global needs, and the rapid advancement of technology across all sectors of the economy have reshaped the landscape. These demand the need to evolve in the approach of performing audits and assurance engagements. While the existing SQC-1 focused on quality control, SQMs emphasize quality management shifting from reactive to pro-active quality checks with the risk-based approach.
Standard on Quality Management 1 (SQM-1)
SQM-1 provides a structured approach outlining a firm’s responsibilities to design, implement and operate a system of quality management for audits or reviews of financial statements, or other assurance or related services engagements. It aims at establishing a system of quality management enabling consistent performance by firms upholding quality, ethics and compliance with regulatory frameworks. Effective dates of applicability of SQM-1 are as below:
- Recommendatory: System of quality management in compliance with this SQM to be implemented by April 1, 2025, with evaluation of the system to be performed within 1 year from April 1,2025
- Mandatory: System of quality management in compliance with this SQM to be implemented by April 1, 2026, with evaluation of the system to be performed within 1 year from April 1,2026
While a system of quality management works on an iterative basis considering the nature and circumstances of a firm and its engagements, it operates covering key components set out by the SQM-1. Let us explore these key elements in detail, offering insights into how firms can implement quality management systems to achieve sustainable excellence.
1. The Firm’s Risk Assessment Process
The firm needs to develop a robust and organized risk assessment structure as part of its quality management system. It provides a basis for establishing quality objectives and ensures early detection of evolving risk factors that might adversely impact the quality management system. While designing such a process, the firm should take into consideration the nature and complexity of its operations, its resources, the regulatory framework under which the firm operates and of its engagements.
2. Governance and Leadership
This component is critical for fostering an environment that supports quality management. Governance and Leadership should demonstrate a commitment to quality through a culture that exists throughout the firm reinforcing professional ethics, values and behaviors
3. Relevant Ethical Requirements
The firm is duty-bound to ensure that its system of quality management fulfills the relevant ethical requirements. The Code of Ethics outlines the principles to ensure professional conduct, with the fundamental principles being integrity, objectivity, professional competence and due care, confidentiality and professional behavior. The firm should ensure that the firm itself, along with its personnel, network, and external service providers involved in its engagements, adheres to such compliance
4. Acceptance and Continuance of Client Relationships and Specific Engagements
The firm’s quality management system should include procedures for the acceptance and continuance of clients and engagements. It must ensure that such decisions are made considering the engagement’s nature, the client’s adherence to integrity and ethical values and the firm’s ability to perform engagements fulfilling professional standards and applicable regulatory frameworks. It must also ensure that the firm’s financial and operational priorities do not compromise these objectives or lead to inappropriate judgements.
5. Engagement Performance
The firm should have a proper mechanism for direction, supervision and review at appropriate levels in performing engagements, to ensure effective management of their quality parameters. It must also ensure that the engagements are carried out by exercising professional judgements, proper consultations to resolve differences, and adhering to documentation and compliance standards.
6. Resources
The firm must ensure that utilization of resources, whether human (internal and external) or technological, is managed in a way that enables the effective implementation of quality assurance to meet quality objectives. Hiring and retaining competent personnel, establishing accountability through evaluations, incentives and promotions, and utilizing appropriate technology and intellectual resources are a few actions that can align firm’s actions with quality objectives.
7. Information and Communication
The firm shall establish a culture of open communication ensuring an effective flow of information. Also, it should have communication mechanisms to handle responses, share necessary details with external parties when required, reassess client relationships and confirm staff independence.
8. The Monitoring and Remediation Process
It is crucial for the firm to adopt a constant monitoring mechanism to assess the operation of the quality management system and take corrective actions in response to identified deficiencies. Various steps, including inspection of completed engagements, ensuring sufficient time and competencies for monitoring personnel, root cause analysis of the deficiencies and irregularities, and implementing appropriate remedial processes should be employed to ensure smooth quality management and avoid other compliance issues.
Standard on Quality Management 2 (SQM-2)
SQM-2 outlines the policy framework that a firm must establish for appointing an Engagement Quality Reviewer, and responsibilities of such reviewer relating to performance and documentation of reviews. It aims to support the evaluation process in achieving the quality objectives outlined in SQM-1. The role of an engagement quality reviewer is to conduct an objective evaluation of significant judgements and conclusions made by the engagement team. This SQM is effective for:
- Recommendatory: Audits and reviews of financial statements or other assurance and related services engagements for periods beginning on or after April 1,2025
- Mandatory: Audits and reviews of financial statements or other assurance and related services engagements for periods beginning on or after April 1,2026
Let us look at the scope and coverage of this SQM in the following paragraphs:
1. Appointment & Eligibility of an Engagement Quality Reviewer
The firm’s policies and procedures should require an individual outside the engagement team to appoint the reviewer. However, in smaller organizations, this may not be practical, and a member of the engagement team might need to appoint an engagement quality reviewer. While appointing the reviewer (including the assistants to such reviewer), the firm needs to take several criteria into consideration including competence, authority, and independence. The reviewer and assistants must not be members of the engagement team. However, if smaller firms do not have internal members for review, they may engage external reviewers. In any case, an engagement quality reviewer must be a member of the Institute of Chartered Accountants of India, and the appointment must also comply with cooling off requirements as outlined in the Code of Ethics.
2. Engagement Quality Review – Key aspects
This SQM gives comprehensive guidelines for the Engagement Quality Review. It requires the firm’s policies and procedures to specify such scope emphasizing the need for professional judgement in performing the review. Key aspects include:
- The timing of the review depends on the complexity of the engagement. However, early involvement ensures timely resolution of issues.
- The nature of the entity, complexity of the engagement and quality risks impact the extent of reviewer’s procedures
- In the case of group audits, coordination would be required with group engagement reviewers and component level reviewers to ensure consistency in audit judgements
- Continuous information flow with the engagement team and review of audit documentation helps the reviewer assess risks, evaluate professional judgements made and evaluate exercise of professional skepticism in relation to such judgements.
- Assessment of whether the engagement partner was sufficiently involved in key decisions throughout the engagement as required by SA 220 (Quality Management for an Audit of Financial Statements)
- Assessment of financial statements and disclosures, and their alignment with audit conclusions and professional judgements
Escalation of unresolved concerns to specified individuals in the firm as outlined in the firm’s policies and procedures which might further require consultation within or outside the firm by such individuals
3. Documentation
The extent and nature of documentation depend on complexity, entity characteristics and matters under review. The documentation may be maintained electronically, through memorandums or via engagement team meeting minutes. Further, the documentation requirement under this SQM must align with those specified in SQM-1 which outlines the procedures covering key aspects like safe custody, integrity, accessibility and retrievability of data along with retention periods.
4. Engagement Partner responsibility in engagement quality reviews
This SQM requires the engagement partner to sign the engagement report only after the completion of the engagement quality review and resolution of all the issues raised by the reviewer. Further SA 220 also mandates that, in audit engagements, the engagement partner must not date the auditor’s report until the engagement quality review is completed.
Conclusion
Firms must now take steps to implement the new SQMs. The immediate focus would be to redraft policies and procedures aligning with the new requirements and dedicate a team to implement and monitor compliance requirements. SQMs provide a structured framework to ensure that assurance engagements maintain ethical, professional, and operational standards. These standards aim at promoting a culture of quality, accountability, and transparency in assurance engagements, ensuring firms adhere to regulatory requirements and maintain professional integrity.
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