TABLE OF CONTENTSUMMARYCHAPTER 1 : INTRODUCTION1.1 Background 11.2 Research Problem 21.3 Research Objectives 21.4 Contribution of the Study 2-3CHAPTER 2 : LITERATURE REVIEW2.1 The Search for Audit Quality 4-62.2 International Standard on Quality Control 1 (ISQC 1) 7-8CHAPTER 3 : METHODOLOGY3.1 Development of ISQC 1 Self-Assessment Checklist 9-103.2 Initial Implementation Process: AQuR System Portal 11CHAPTER 4 : ANALYSIS4.1 Development of ISQC 1 Checklist 11-124.2 Development of AQuR System 12-17CHAPTER 5 : CONCLUSION5.1 Discussion 185.2 Practical Implications 195.3 Limitation and Future Studies 19-20REFERENCE 21APPENDIX 1 22-23APPENDIX 2 24-25ii

SUMMARYIn July 2006, the Malaysian Institute of Accountant (MIA) has adopted the InternationalStandards on Quality Control 1 (ISQC 1) as part of the approved standard of auditing inMalaysia. In assisting the implementation of ISQC 1 among audit firms, a guideline on theISQC 1 requirement is essential. A checklist, which is aimed to guide audit firms incomplying with ISQC 1, was developed based on ISQC1 requirements, ISQC 1 manualand MIA By-Laws. The checklist has incorporated seven elements of ISQC 1: leadershipresponsibilities for quality within the firm, ethical requirements, acceptance andcontinuance of client relationships and specific engagements, human resource, engagementperformance, monitoring and documentation. It has gone through several corroborationprocesses including validation by selected audit practitioners. A focus group interview hasbeen conducted to gain the perceptions of the practitioners on the implementation of ISQC1 in their firms. Results showed that most of them are lack of exposure and knowledge onthe ISQC 1 requirements. Therefore, due to this matter, most of the practitioners havepessimistic perceptions regarding the implementation of ISQC 1. Various constructivefeedbacks from audit practitioners were then incorporated in enhancing the checklist. Uponcompleting the validation process, the checklist was then converted into a portal whichprovides an on-line quality assessment for the audit firms with an integrative result. Thisportal, which is named “AQuR System” is hoped to emulate as a self review portal thatwould assist audit firms in improving and enhancing their governance on audit servicequality.iii

CHAPTER 1: INTRODUCTION1.1 BackgroundAudit quality is viewed as one of the important factors that affect the credibility offinancial statements (Arrunada, 2004). Users are more likely to demonstrate high level ofconfidence on the information presented in the financial statements if the audit of thefinancial statements is perceived to be of high quality. Assessment on audit quality of auditfirms ensures that an audit firm’s processes are systematic and effective (Brinkley, 2006).Auditing the auditors through external evaluations is becoming a driving force ofcontinuous improvement for the profession (Brinkley, 2006). To compete successfully inthis environment, audit firms must continually strive to improve audit quality and hence,maximize client satisfaction.Recent development concerning audit quality control by International Federation ofAccountant (IFAC) has required audit firms to comply with the International Standards onQuality Control (ISQC 1). Malaysian Institute of Accountant (MIA) has, in July 2006,adopted ISQC 1 as part of the approved standard of auditing in Malaysia. In essence, ISQC1 focuses on the quality of audit performed by the audit firms and they are expected tocomply with the standard. Nevertheless, evidence showed that the implementation to ofISQC 1 is rather limited in Malaysian small and medium audit firms (Omar & Johari,2007). Small and medium audit firms tend to operate based on non-standard operatingprocedures, which essentially does not reflect total compliance with ISQC 1.1

1.2 Research ProblemBased on the guidelines stated in ISQC 1, compliance with the standard is perceived ashigh audit quality. Although large audit firms have been argued and associated with highaudit quality (DeAngelo, 1981), very limited studies have measured audit quality using anobjective measure (Krishnan & Schauer, 2000). Past studies have indirectly inferred thatlarge audit firms as a proxy for high audit quality (DeAngelo, 1981; Carcello et al., 1992;Krishnan & Schauer, 2000). However, stakeholders want to know the variation of auditquality among all audit firms.1.3 Research ObjectivesThis study has two main objectives. The first objective is to develop self-review checklistto assist the audit practices assessing their own audit quality control.By using thechecklist, the audit firms are expected to gauge on their own the level of quality for theiraudit work. The second objective is to set-up a system for this assessment through an onlineweb-portal. The portal provides a convenient and an interactive system to audit firms.This institutional self review portal will indirectly motivate and persuade audit firms tomonitor and improve their audit quality.1.4 Contribution of the StudyThis study is hoped to contribute to the improvement in the quality control of auditpractices in Malaysia. This study is not aimed to strengthen the proposition that largeraudit firms deliver higher audit quality compare to the smaller ones, but to provide a moreobjective appraisal of audit quality in audit firms. The self-assessment checklist extends2

previous studies in the development of an objective measure. The checklist would enableaudit firms to self-assess their service and to recognize any deficiency that could havecompromised audit quality.3

CHAPTER 2: LITERATURE REVIEW2.1 The Search for Audit QualityThe demand for auditing services arises from a need to facilitate dealings between theparties involved in business relationships-shareholders, creditors, public authorities,employees and customers, etc (Arrunada, 2000). The accounting profession has facedincreasing pressure from external parties to monitor and improve the quality of the auditprocess (Sutton, 1993). There are numerous of previous research done on studying multiaspectsof audit quality. The strong interest in examining audit quality is partly due to theconcern of issues such corporate collapse, expectation gaps and corporate governance.One of the main areas in audit quality literature is the association between audit qualitywith audit firm size. As suggested by DeAngelo (1981), larger firms provide higherqualityaudits because larger firms have fewer incentives to compromise their standards toensure retention of clients in comparison with smaller firms. Audits performed by largeaudit firms are perceived to be of higher expected quality than audits by small firms. Also,Palmrose (1988) finds that large auditors have lower litigation rates than small auditors.Similarly, Dupoch and Simunic (1982) also found that audit quality is a function of thenumber and extent of audit procedures performed by the auditor and that larger firms havemore resources with which to conduct tests. In addition, Moore and Scott (1989)demonstrate analytically that audit firm size and the extent of audit work undertaken arepositively related.4

Although past studies have supported that high audit quality is related to firm size, theextent of audit quality for each firm requires a more objective measurement of auditquality. For example, Carcello et al. (1992) assessed audit quality based on the perceptionsof auditors, prepares and users. Using twelve components of audit quality, Carcello et al.(1992) suggested that four components to be most important in determining audit quality.The components include audit team and firm experience with the client, industry expertise(especially within the audit team), responsiveness to client needs, and compliance with thegeneral standards (competence, independence, and due care) of generally accepted auditingstandards (GAAS).Sutton (1993) argued that there is a need for accounting researchers to developed objectivemeasure in evaluating process quality. Sutton (1993) has attempted to develop a set offactors for influencing various stages of the audit process. The selection of the factors isdone by the auditors of large audit firms.An audit quality factor is defined to theparticipants as any variable affecting the audit team’s ability to achieve the level of auditquality desired. He identified four stages of audit process: engagement planning, interimfieldwork, year-end fieldwork and final administration. The study also develops themonitoring process or performance indicators for each quality factors included in therespective stages (Sutton, 1993). His results support that there exists a consensus amongexperienced auditors on a set of key audit quality factors which have a significant impacton overall audit quality.5

Krishnan and Schauer (2000) examined the association between auditor size and auditquality for a sample of non-profit organizations. Using the compliance score analysis oneight GAAP reporting requirements to assess audit quality, they found that audit reportingwas inconsistent among the non-profit organizations. Of the eight reporting requirementsexamined, noncompliance is highest for those that pertain specifically to non-profitorganizations such as disclosures about pledges and donated materials. Results also showthat the extent of noncompliance decreases as one moves from the small non-Big 6 (nowknown as Big 4) to the large non-Big 6 and from large non-Big 6 to the then Big 6.The development of objective audit quality has been further extended to cover firm levelrather than engagement level only. For example, a guideline has been presented by expertrepresentatives from State Auditors Institution (SAI) concerning audit quality for publicauditors. After a series of discussion and meetings, the committee finalize that there arethree different audit quality attributes that should be taken care of (Mazur et al., 2005).First, it involves the quality control system. Second, the study also includes one importantattributes of audit quality which is quality assurance. Last, the audit quality control systemincludes the institutional management such as managing human resources, institutional riskand external relations. This guideline is proposed for all SAIs to apply in both courts andoffices, and to all audits, both regularity and performance.6

2.2 International Standard on Quality Control 1 (ISQC 1)In 2004 the International Auditing and Assurance Board (IAASB), of the InternationalFederation of Accountants (IFAC) has approved the International Standard on QualityControl (ISQC 1) concerning the quality control for firms that perform audits and reviewsof historical financial information and other assurance and related services engagements.In line with the requirement by IFAC, Malaysian Institute of Accountants (MIA) hasimposed that all registered accountants and auditors (practitioners) in Malaysia to complywith the new quality control standards by 30 June 2006. The standards introduce severalnew concepts and requirements in respect of quality control within auditing firms. As aresult, practitioners face with additional responsibilities in respect of implementing newquality control safeguards and procedures.ISQC 1 is different from ISA 220 “Quality Control for audits of Historical FinancialInformation” which sets out the quality control standards to be applied to individual auditengagements. On the other hand, ISQC 1 deals with firm wide quality control whichprovides reasonable assurance that firms and its personnel comply with professionalstandards and regulatory and legal requirements; and reports issued by the firm orengagement partners are appropriate in the circumstances (Holt, 2006, p.14). ISQC 1 setsout six quality control elements that must be rigorously and comprehensively addressed. Itcovers (1) leadership responsibilities for quality within the firm; (2) Ethical requirements;(3) Acceptance and continuance of client relationships and specific engagements; (4)Human resource; (5) Engagement performance; and (6) Monitoring. The standard requires7

audit firms to document evidence of the operation of each of the six elements of its qualitycontrol system and retain that documentation for an appropriate period.8

CHAPTER 3: METHODOLOGY3.1 Development of ISQC 1 Self-Assessment ChecklistThe development of the checklist involved three different stages. First, the researchersformed common themes of ISQC 1 dimensions based on several sources. This study refersto the ISQC1 requirements (MASA 2007), ISQC 1 manuals issued by MIA, MIA PracticeReview Questionnaires, MIA By-Laws, Australia Questionnaires on Quality Control forFirms and Pakistan’s ISQC 1 Review Self-assessment Questionnaire.A series ofbrainstorming sessions has been conducted to identify the critical factors for each elementof ISQC 1.Second, a review with two representatives from the MIA was conducted.Therepresentatives were the manager of technical development and the manager of practicereview. MIA requires a practice review for all audit firms which includes compliance onthe ISQC 1 and ISA 220. Both of the representatives have thoroughly checked the format,design and questions of the checklist. The checklist was further revised according to theircomments.Third, this study also uses a focus group interview with ten audit practitioners to evaluateeach item of the checklist. This method has been applied previously in Sutton (1993). Inthis session, the practitioners provided their inputs and discussed in detail the relevancyand usefulness of each question.Among the feedbacks given are that some of therequirements in the ISQC 1 are not suitable to be implemented in a small and medium9

audit firms. Lack of awareness on the requirements of ISQC 1 is another feedback thatgained strong support from majority of the practitioners. Besides feedback on the questionsin the checklist, participants were also required to provide their feedback on the overallformat of the checklist. The conclusion of this session was marked by group consensus.3.2 Initial Implementation Process: AQuR System PortalOnce the checklist has been considered satisfactory after various amendments were madebased on the feedbacks given, it is then converted into a web-based checklist named as“AQuR System”. A series of discussion and trial run sessions were done to finalize theportal. At this stage, input from MIA and Malaysia Accounting Research and EducationFund (MAREF) were also considered. Audit firms will be notified by MIA to access thewebsite and voluntarily self-assess their audit quality. They are encouraged to fill up thechecklist prior to the practice review, where representatives from MIA will physically visitselected samples of audit firms.10

CHAPTER 4: ANALYSIS4.1 Development of ISQC 1 ChecklistThere are seven dimensions of the quality control in ISQC 1 (refer to Figure 1). Details ofthe definition for each dimension are shown in Appendix 1.EthicalRequirementISQC 1DimensionsClientRelationshipsLeadershipDocumentationMonitoringEngagementPerformanceHumanResourcesFigure 1: Dimensions of ISQC1 Audit Quality Control DimensionsThe structure of the checklist consists of two parts (refer to Figure 2). The first partpresents questions on the policy and procedures and the second part presents questionsregarding the practices.PartPolicy andProceduresPracticesExplanationThe part presents the questions on the policy and procedures on eachelements of ISQC 1. The questions shall be answered using “YES” or“NO” option.The part comprises of questions on the practices of each elements of ISQC1. Each indicator shall be answered using four-scale options.Figure 2: ISQC1 Self-assessment Checklist - Format11

Questions on the practices shall be answered using four different indicators. The scaleenables the audit firm to assess the degree to which practices and/or processes are in placethat indicate adherence to the indicators. The audit firm may choose if the practices and/orprocesses are highly functional, operational, emerging or not evident (refer to Figure 3).The firm should use the scale as an opportunity to ask itself challenging questions and torespond with accurate answers geared toward self-improvement.IndicatorNot evidentEmergingOperationalHighlyfunctionalExplanationNo evidence/ documentation existsEvidence indicates early or preliminary stages of implementationEvidence indicates practices and procedures are actively implementedEvidence indicates practices and procedures are effectively andconsistently implementedFigure 3: Self-assessment Checklist - Definitions of ScaleBased on the discussion with the practitioners, the finalized questions for each dimensionwere agreed consensusly. Details of the question items are shown in Appendix 2.4.2 Development of AQuR SystemThe second stage of this study is to develop the portal known as AQuR System for theinstitutional self review on the quality of audit firm. All the information in the checklistprepared in the first stage is transferred to the portal. The portal is developed based on thedimension in ISQC 1, of which each dimension is categorized into “Policies andProcedures” and “Practices”. There are different windows for different dimension of whichusers of the portal can access to any window integratively. The cover page of the portal isshown in Figure 4 where audit firms may access the portal by registering to the database..12

Figure 4: Log-in Page of the AQuR System Portal13

Figure 5: Background of the AQuR System PortalOnce the users have accessed the portal, the background page will be displayed menutoolbars as shown in Figure 5.Figure 6a and 6b demonstrate the sample of one element of ISQC 1 checklist. Thequestions are all presented in a single page. Users can choose the option given in the page.They can make changes in the option of the answers and save their work accordingly.Users are also allowed to go to other elements without following the order of the menu list.Once they have completed each element, users can see the result of the section by clickingthe ‘result’ menu button.14

Figure 6a: Sample Content of the On-line Questions from AQuR System Portal15

Figure 6b: Sample Content of the On-line Questions from AQuR System PortalThe result section demonstrates the score for each element as well as the overall score.The score assessment would be weighted according to the importance of each dimension aswell as the type of questions (either policies and procedures or practices). Audit firms mayreceive scores for each dimension as shown in Figure 7.16

CHAPTER 5: CONCLUSION_______________________________________________________________________5.1 DiscussionVery limited studies have examined the issue of audit quality directly in audit firms. Mostof previous researches have used size of audit firm as the proxy of audit quality. Thisstudy, however, shows a direct proxy measure for audit quality. This study develops aself-review checklist of audit quality control based on the requirements in ISQC 1 as wellas input from other standards. Using a focus group interview, it is hoped that the feedbackgathered from the audit practitioners may contribute towards enhancing understanding ofaudit quality as well assisting in the improvement of the checklist itself.Auditpractitioners are encouraged to assess their own audit quality by leveraging on the AQuRSystem portal.Preliminary findings on the implementation of ISQC 1 could assist the auditing professionin monitoring the quality of the audit process as well as the audit firms. This approach ishoped to help the audit practitioners to assess their efficiency and effectiveness of theiraudit firms based on standards and benchmark information given in the ISQC 1. In doingso, MIA has fully supported this project and closely worked with the model provided inother countries such as Australia and Pakistan. Audit quality is an increasingly importantissue and should be a useful area of exchange of national experiences (Mazur et al., 2005).18

5.2 Practical ImplicationsThe audit quality control assessment provides a practical implication such that this is toenhance the governance of audit quality control among audit firms. A well-recognizedaudit quality of the organization would make customers’ choices easier and lowers theirexpectation of risk. It also builds loyalty, leads to repeat business, and encourages currentclients to refer the organization to others (Brinkley, 2006).AQuR System portal is a developed to measure the quality of audit work performed byaudit firms. The rating system is expected to benchmark audit firms against the industrybest practices. AQuR System will supply independent analysis regarding qualityperformance to the audit firms that will enable audit firms to provide high quality audit tothe clients.5.3 Limitation and Future StudiesThis self review checklist is not meant for a pass-fail test or a competition. It is designedas a diagnostic tool in order to enhance understanding of each firm in comparison to theaspirational practices described in ISQC 1. The score assessment produce via AQuRSystem could assist the management of the audit firms to identify areas for improvement toenhance their audit quality.Nevertheless, the implementation of AQuR System would not be successful withoutcooperation and participation from audit practitioners. Therefore, it is hoped that with the19

joint effort of many parties, such as MIA and the audit firms, the awareness and acceptanceon the importance of having good quality audit will be augmented to a higher level.Pursuant to the development of AQuR System, future research will be based on theacceptance and usage of the portal towards enhancing the quality of audit. Furthermore,due the importance of having good quality audit, more research should explore other areasthat relate to audit quality such as customer service satisfaction, customer loyalty, auditorsswitching and auditors turnover.20

REFERENCESArrunada, B. 2004. Audit failure and the crisis of auditing. European BusinessOrganization Law Review 5: 635-643.Arrunada, B. 2000. Audit quality: attributes, private safeguards and the role of regulation.The European Accounting Review 9 (2): 205-224.Brinkley, M. 2006. Health check for the audit brands. Internal Auditor (June): 79-83.Carcello, J.V., Hermanson, R.H. & McGrath, N.T. 1992. Audit quality attributes: Theperceptions of audit partners, preparers, and financial statement users. Auditing:AJournai of Practice & Theory, 11 (1): 1-15.DeAngelo, L. E. 1981. Auditor size and audit quality. Journal of Accounting andEconomics 3: 183-199.Dupoch, N. & D. Simunic 1982. Competing in Auditing: An assessment. Paper presentedat Syposium on Auditing Research IV. University of Illanois at Urbana-Champaign.Krishnan, J. & Schauer, P.C. 2000. The differentiation of quality among auditors:Evidence from the not-for-profit sector. Auditing 19 (2): 9-25.Malaysian Approved Standards on Auditing (MASA). 2007. Malaysian Institute ofAccountants.Mazur, J., Revesz, J., Vella, B. & Havens, H. 2005. Guidelines on Audit Quality.International Journal of Government Auditing 32 (2): 10-14.Moore, G. and W.R. Scott. 1989. Auditors’ Legal Liability, Collusion with Managementand Investors’ Loss. Contemporary Accounting Research. Spring :754 -774.Omar, N. & Mohd Alwi, M.J. 2007. International standard on Quality Conrol (ISQC 1): Asurvey report for the Malaysian Institute of Accountants (MIA), Working Paper,Universiti Teknologi MARA.Palmrose, Z-V. 1988. An analysis of auditor litigation and audit service quality. TheAccounting Review (January): 55–73.Sutton, S.G. 1993. Toward an understanding of the factors affecting the quality of the auditprocess. Decision Sciences 24 (1): 88-105.21

Appendix 1: Definition of ISQC 1 ElementsNo. Element Definition1. Leadershipresponsibilities forquality within thefirm2. Ethicalrequirements3. Acceptance andcontinuation ofclientrelationships andspecificengagementsThe firm shall establish policies and proceduresdesigned to promote an internal culture based on therecognition that quality is essential in performingengagements. Such policies and procedures shall requirethe firm’s chief executive officer (or equivalent) or, ifappropriate, the firm’s managing board of partners (orequivalent), to assume ultimate responsibility for thefirm’s system of quality controlThe firm shall establish policies and procedures designedto provide it with reasonable assurance that the firm and itspersonnel comply with relevant ethical requirementsThe firm shall establish policies and procedures for theacceptance and continuance of client relationships andspecific engagements, designed to provide it withreasonable assurance that it will only undertake orcontinue relationships and engagements where it: (a)Has considered the integrity of the client and does nothave information that would lead it to conclude that theclient lacks integrity; (b) Is competent to perform theengagement and has the capabilities, time and resourcesto do so; and (c) Can comply with relevant ethicalrequirements4. Human resources The firm should establish policies and proceduresdesigned to provide it with reasonable assurance that ithas sufficient personnel with the capabilities,competence, and commitment to ethical principlesnecessary to perform its engagements in accordancewith professional standards and regulatory and legalrequirements, and to enable the firm or engagementpartners to issue reports that are appropriate in thecircumstances5. EngagementperformanceThe firm should establish policies and proceduresdesigned to provide it with reasonable assurance thatengagements are performed in accordance withprofessional standards and regulatory and legalrequirements, and that the firm or the engagementpartner issues reports that are appropriate in thecircumstances22

6. Monitoring The firm should establish policies and proceduresdesigned to provide it with reasonable assurance that thepolicies and procedures relating to the system of qualitycontrol are relevant, adequate, operating effectively andcomplied with in practice. Such policies and proceduresshould include an ongoing consideration and evaluationof the firm’s system of quality control, including aperiodic inspection of a selection of completedengagements7. Documentation The firm shall establish policies and procedures for thedocumentation to provide evidence of the operation ofeach element of the system of quality control(Source: MASA 2007)2

Appendix 2: Question Items for Each Element of Quality Control ChecklistLEADERSHIP RESPONSIBILITIES FOR QUALITY WITHIN THE FIRM Allocates sufficient resources Assigns appropriate person Aims in achieving quality in all engagements Emphasizes on firm’s quality control system Exerts quality auditing cultureETHICAL REQUIREMENTS Complies with the fundamental principles of professional ethics Identifies and promptly notify the threats to independence Requires the rotation of the engagement partner and the engagement qualitycontrol reviewer Takes action on non-compliance with relevant ethical requirements Requires partners and staff members to make independence declaration at leastannuallyACCEPTANCE AND CONTINUANCE OF CLIENT RELATIONSHIPS ANDSPECIFIC ENGAGEMENTS Address the element of acceptance and continuance of client relationship andspecific engagements Ensures that the personnel assigned the following matters in acceptance andcontinuance of client relationship and specific engagements Employs an assessment criteria on client’s integrity Discusses with the appropriate level of client management and those charged withgovernance regarding the reasons for withdrawal and the appropriate action to betakenHUMAN RESOURCE Establishes policies and procedures dealing with the personnel issues Communicates the above policies and procedures to the partners and staffmembers Plans future staffing needs Provides continuous training for partners and staff members Communicates the identity and role of the engagement partner to client Ensures the engagement partner(s) has the capabilities, competencies, authoritiesand time to perform their engagements Defines and communicates clearly to the engagement partner of his or herresponsibility Assigns appropriate staff with the necessary capabilities, competency and time toperform engagements Conducts partners and staff members’ appraisals on regular basis Offers appropriate remuneration package3

ENGAGEMENT PERFORMANCE Designs the quality of engagement performance for example through audit manual,standardized documentation, specific guidance materials and software tools Undertakes appropriate consultation with experts within or outside the firm toresolve difficult and contentious matters Resolves differences of opinion by consulting other practitioners, professionalbody or regulatory body Completes the assembly of final engagement files on a timely basis after theengagement reports have been finalized Maintains the confidentiality, safe custody, integrity, accessibility andretrievability of engagement documentation Conducts quality control review in a timely mannerMONITORING Establishes policies and procedures designed to provide reasonable assurance thatthe system of quality control is relevant and adequate Establishes policies and procedures on complaints and allegations relating to thesystem of quality control Ensures inspections of the engagement are conducted regularly Evaluates the effect of deficiencies noted as a result of the monitoring processDOCUMENTATION OF SYSTEM OF QUALITY CONTROL Establishes policies and procedures requiring appropriate documentation toprovide evidence on the operation of the six elements of the quality control system4

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