Understanding of Standard on Quality Management SQC 1

Ninad Mankar , Last updated: 13 December 2023
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SQC 1 deals with the firm's responsibility for having a system of quality management. The SQC is the mechanism that creates an environment that enables and supports engagement teams in performing quality engagements. It helps the firm in achieving consistent engagement quality because it is focused on how the firm manages the quality of engagements performed.

Objectives of the standard

The firm is to establish and maintain a system of quality control
That quality control system provides reasonable assurance that e firm and its personnel comply with professional standards and applicable legal and regulatory requirements
Reports issued by the firm or engagement partners are appropriate in the circumstances

Components of SQC-1

Leadership responsibilities for quality within the firm
Ethical requirements
Acceptance and continuance of client relationships and specific engagements
Human resources
Engagement performance
Monitoring

We will cover first 4 components in this post. Let's understand each component in detail.

Understanding of Standard on Quality Management SQC 1

1. Leadership responsibilities for quality within the firm

Performing quality work begins with strong leadership within the firm and engagement partners committed to the highest ethical standards.

The provision of quality audits and related services is vital to:

Safeguarding the public interest;
Maintaining client satisfaction;
Delivering value for money;
Ensuring compliance with professional standards; and
Establishing and maintaining a professional reputation.

Delivery of high-quality and cost-effective services is the principal driver of success for professional audit firms. Quality service is also vital in relation to the public-interest responsibilities of professional accountants.

The provision of quality services should always be a key objective in the firm's business strategy; that objective needs to be communicated to all personnel on a regular basis, and the results monitored. This requires leadership and accountability for promised actions.

Poor quality control can lead to inappropriate opinions, poor client service, lawsuits, and loss of reputation. Below are some of the points that limit/ resist the quality of the service provided:

Limitation						Description
Poor Attitudes						A poor attitude is at the heart of most hindrances to quality. It includes such attitudes (but not necessarily this extreme) as the following: Firm continually operates in a crisis mode; Poorly planned engagements and activities are the norm; Poor commitment to quality or compliance with the highest ethical standards; Not caring about the expectations of quality by the public and other stakeholders; The belief that there is no risk to the firm in small audits, so work performed should be minimal; Audit work tailored to the fee received — not the risk involved; Clients are considered totally trustworthy by the controlling partner; Minimizing or avoiding the need for 'engagement quality control reviews'; The belief that, because the clients pay the bill, they must get what they want; Partners keeping (or accepting) an audit client (for the fees generated) even though it is (would be) highly risky for the firm; Unwillingness to adopt standard firm policies on quality control. Asking staff to follow the firm's policies, but not complying personally (i.e., "do what I say, not what I do").
Unwillingness Development	to	Invest	in	Training	or	Conducting a quality audit is dependent on attracting and retaining qualified and competent people to perform the work. This requires ongoing professional development and performance appraisals for all partners and professional staff (every period). Lack of investment in staff also leads to staff turnover.
Lack of Discipline						A failure to discipline partners or staff when the firm's policies are wilfully contravened sends a very clear message to personnel that written policies are really not that important. This undermines compliance with all of the firm's policies and increases the risk to the firm

A strong tone at top can be set by firm's management and engagement partners through the following:

Setting tone at top	Description
Establish the Firm's Objectives, Priorities, and Values	This could include: An unwavering commitment to quality and high ethical standards; Investment in staff's learning, training, and skills development; Investment in the required technological, human, and financial resources; Policies to ensure sound engagement and fiscal management
Communicate Regularly	Reinforce the firm's values and commitments by communicating regularly (verbally and in writing) with staff. Communications would address the need for integrity, objectivity, independence, professional skepticism, staff development, and accountability to the public. Communications could be made through the Performance-appraisal system, partner updates, emails, office meetings, and internal newsletters.
Update the Quality Control Manual	Each period, update the firm's quality control policies and procedures to address weaknesses and any new requirements
Hold People Accountable	Assign clear responsibilities and accountabilities for quality-control functions (such as independence issues, consultation, file review, etc.).
Develop Staff Competence and Reward Quality Work	Develop staff through: Clear job descriptions and documented annual performance appraisals that make the quality of work a priority; Providing incentives/rewards for delivering quality work; and Taking disciplinary action when the firm's policies are wilfully contravened
Continually Improve	Take prompt action to correct deficiencies when identified, such as through the firm's engagement file monitoring, including the cyclical inspection of completed engagement files.
Set an Example	Provide staff with a role model in the positive example set by partners in their day-to-day behaviour. For example, if a policy emphasizes the need for quality work, a staff member should then not be criticized for legitimately going over the budgeted time

2. Ethical requirements

The firm should establish policies and procedures designed to provide it with reasonable assurance that the firm, its personnel and, where applicable, others (such as experts employed/engaged by the firm) subject to independence requirements.

This can be done in following way:

Mode of implementation	Description
Communication	Communicate its independence requirements (through email/ weekly or monthly newsletters)
Identify and evaluate circumstances and relationships that create threats to independence	Establish an Internal communication mechanism to report breaches of independence. E.g. Email communication to the Firm's management. Engagement partners to provide the firm with relevant information about client engagements, including the scope of services, to enable the firm to evaluate the overall impact. E.g. whenever a new client/ engagement is accepted, the same should be communicated to all staff along with the independence requirement applicable and ask staff to report a breach of independence if applicable to them.
Reporting by staff/ partners	Personnel to promptly notify the firm of circumstances and relationships that create a threat to independence so that appropriate action can be taken by the firm.
Maintaining a database of independence	The firm and its personnel can readily determine whether they satisfy independence requirements The firm can maintain and update its records relating to independence The firm can take appropriate action regarding identified threats to independence

The firm should establish a system in such a manner that it is notified of breaches of independence requirements, and to enable it to take appropriate actions to resolve such situations.
All who are subject to independence requirements to promptly notify the firm of independence breaches of which they become aware.
For this, a firm can draft an Independence Policy to cover aspects required by this SQC.
As per Para 23 of SQC-1, "At least annually, the firm should obtain written confirmation of compliance with its policies and procedures on independence from all firm personnel required to be independent in terms of the requirements of the Code". Following is the format given by ICAI in its implementation guide on SQC-1.

The above independence confirmation can be obtained in paper format or electronic format such as over email or Google forms etc. Further, to strengthen the independence process, the firm should obtained it before starting any engagement.

3. Acceptance and continuance of client relationships and specific engagements:

One of the most important decisions that a firm can make is determining what engagements to accept or which client relationships to retain. A poor decision can lead to unbillable time, unpaid fees, additional stress on partners and staff, loss of reputation, and, worst of all, potential lawsuits.

SQC 1 and SA 220 require firms to develop, implement, and document their quality control procedures in regard to their client acceptance and retention policies. Ideally, these policies and procedures should address the level of risk and the client characteristics (such as poor management integrity, a high-risk industry, or a publicly-traded company) that would not be acceptable to the firm.

It is to be noted that as per SA 220 the audit file must contain client/engagement acceptance and/or continuance details.

The following table givens an illustrative list of questionnaire before accepting a new client:

Consider	Line of inquiry
The Firm's Quality Control Requirements	What policies and procedures are in place to provide reasonable assurance that the firm will only undertake or continue relationships where: The firm can comply with the ISA requirements; The engagement risks involved are within the firm's tolerance for risk?
What Work Is Required?	What is the nature and scope of the audit? What accounting framework will be used? How will the auditor's report and financial statements be used? What is the deadline (if any) for completing the audit?
Does the Firm Have the Competence, Resources, and Time Required?	Does the firm have sufficient personnel with the necessary competence and capabilities? Do the selected firm personnel have: - Knowledge of relevant industries or subject matters, - Experience with relevant regulatory or reporting requirements, or - Ability to gain the necessary skills and knowledge effectively? Are experts available, if needed? Where applicable, are there qualified persons available to perform the engagement quality control review? Can the firm and the available staff (in light of timing requirements for other clients) complete the engagement within the reporting deadline?
Is the Firm Independent?	Can the firm and the engagement team comply with ethical and independence requirements?

Where conflicts of interest, lack of independence, or other threats have been identified:
- Has appropriate action been taken to eliminate those threats or reduce them to an acceptable level by applying safeguards, or
- Have steps been taken to withdraw from the engagement?
If the entity being audited is a component of a larger group, the group engagement team may request certain work to be performed on the financial information of the component. In such cases, the group engagement would first obtain an understanding of the following:
- Whether the component auditor understands and will comply with the ethical (including independence) requirements that are relevant to the group audit
- The component auditor's professional competence
- Whether the group engagement team will be able to be involved in the work of the component auditor to the extent necessary to obtain sufficient appropriate audit evidence
- Whether the component auditor operates in a regulatory environment that actively oversees auditors.

Are the Risks Involved Acceptable?

For new engagements, has the firm communicated (as required by SA 300) with the predecessor auditor to determine if there are any reasons for not accepting the engagement?
Has the firm conducted an Internet search and had discussions with firm personnel and other third parties (such as bankers) to identify any reasons why the firm should not accept the engagement?
What are the values ("tone at the top") and future goals of the entity?
How competent are the entity's senior management and staff?

Are there difficult or time- consuming issues to address (accounting policies, estimates, compliance with legislation, etc.)?
What changes have taken place this period that will impact the engagement (business trends and initiatives, personnel changes, financial reporting, IT systems, purchase/sale of assets, regulations, etc.)?
Is there a high level of public scrutiny and media interest?
Is the entity in good financial health and does it have the ability to pay the firm's professional fees?
Will the entity provide help to the firm in obtaining information and preparing schedules, analysis of balances, providing data files, etc.?

Can the Client Be Trusted?

Are there any scope limitations, such as unrealistic deadlines or an inability to obtain the required audit evidence?
Is there any reason (or recent event) that casts doubt on the integrity of the principal owners, senior management, and those charged with governance of the entity? Consider the entity's operations, including business practices, the business' reputation, and history of any ethical or regulatory infringements.
Are there any indications that the entity might be involved in money laundering or other criminal activities?
What is the identity and business reputation of related parties?
Does management have a poor attitude toward internal control and an aggressive attitude toward interpretation of accounting standards?
Consider corporate culture, organizational structure, risk tolerance, complexity of transactions, etc.

In addition to above, ICAI has in its implementation guide on SQC-1 has given illustrative format of Client/ Engagement Acceptance/ Continuance Form which can be access from this link (Microsoft Word - Implementation Guide to SQC 1-INITIAL PAGES.doc (icai.org) on Page No. 50.

4. Human resources:

The firm should establish policies and procedures designed to provide it with reasonable assurance that it has sufficient personnel with the capabilities, competence, and commitment to ethical principles necessary to perform its engagements in accordance with professional standards and regulatory and legal requirements. Such policies includes:

Recruitment
Performance evaluation
Capabilities, including time to perform assignments
Competence
Career development
Promotion
Compensation
The estimation of personnel needs It can be done through following mechanism:

Policy aspects	How it can be implemented
Recruitment	Management establishes/enforces standards for hiring the most qualified individuals. Recruiting practices include employment interviews, background checks, and communication of values, expected behaviours, and management's operating style. Training policies address prospective roles and responsibilities, expected levels of performance, and evolving needs
Performance Evaluation	Ensure Job performance is periodically evaluated, the results reviewed with each employee, and appropriate action taken Setting Key Performance Indicators such as Client wise Profitability, no. of new clients on boarded etc.
Capabilities, including time to perform assignments	Professional education Continuing professional development, including training

	Work experience Coaching by more experienced staff, for example, other members of the engagement team
Competence and Career development	Continuing training for all levels of firm personnel, Provides the necessary training resources and assistance to enable personnel to develop and maintain the required capabilities and competence
Promotion and Compensation	Makes personnel aware of the firms expectations regarding performance and ethical principles Provides personnel with evaluation of, and counselling on, performance, progress and career development Ensure that Promotions is based on merits and benefits accrued to the firm