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August 1991

Internal inspections: often misunderstood, but ever so important. (Quality Review) (column)

by Mancuso, Anthony J.

    Abstract- The American Institute of Certified Public Accountants (AICPA) specifies standards to be followed with regard to internal quality control inspection of member accounting firms. Statement on Quality Control Standards (SQCS) 1 states that procedures for inspection be developed internally consistent with AICPA policies. Three interpretations of SQCS 1 have been issued by the AICPA Quality Control Standards Committee regarding the relationship between monitoring and inspection, inspection implementation in member firms and the documentation of compliance with a quality control system.

Statement on Quality Control Standards (SQCS) 1 prescribes the following requirements that must be documented in regard to an annual inspection:

"Policies and procedures for inspection should be established to provide the firm with reasonable assurance that the procedures relating to other elements of quality control are being effectively applied. Procedures for inspection may be developed and performed by individuals acting on behalf of the firm's management. The type of inspection procedures used depend on the controls established by the firm and the assignment of responsibilities within the firm to implement its quality control policies and procedures."

The AICPA Quality Control Standards Committee issued three interpretations of SQCS 1 which deal with inspection.

The Relationship Between Inspection and Monitoring. There is a distinction between the objectives of inspection and monitoring. The objective of monitoring is to determine on a timely basis that quality control policies and procedures are appropriate. The objective of inspection is to determine compliance with quality control policies and procedures in effect during a given period. Inspection and monitoring are separate activities; however, inspection procedures contribute to the monitoring function.

Implementation of Inspection in CPA Firms. An inspection should be performed each year with respect to each element of the quality control system. Administrative and personnel files as well as engagement working papers, files, and reports, should be reviewed to determine whether there is reasonable assurance that the firm's quality control policies and procedures and professional standards were complied with.

Inspection applies to all CPA firms, including sole practitioners with or without professional staff. In performing inspection procedures, the practitioner may utilize checklists developed by the AICPA, or other relevant materials. Alternatively, sole practitioners may engage a qualified individual or firm to perform inspection procedures. Two firms, including sole practitioners, may provide inspection procedures for each other.

Documentation of Compliance with a System of Quality Control. The emphasis on form and extent of documentation of compliance varieties depending on firm size, degree of operating autonomy allowed personnel and practice offices, the nature of the practice, and appropriate cost- benefit considerations. The interpretation states that "documentation of compliance with each quality control element should be sufficient to enable those conducting an inspection to ascertain the extent of a firm's compliance with its system of quality control, including its compliance with inspection policies and procedures."

What Does All This Mean?

One of the most common deficiencies revealed in recent quality reviews has been the failure of firms to perform annual inspections. Firms do not seem to realize that inspections have been an element of quality control since the original issuance of SQCS 1 more than 10 years ago.

As stated in the interpretation discussed earlier, a firm is not required to perform an inspection in the period under review for a peer or quality review. However, during each of the two intervening years, an inspection of the quality control system is required to make sure the quality control system is working properly.

To satisfy the inspection element, a firm should perform the inspection appropriately, document the inspection properly, and take whatever corrective action the inspection indicates is necessary.

However, if an inspection has been performed in the year of the review, the reviewer is permitted to use the results of the inspection, if properly performed and documented, and with appropriate results, to reduce the scope of the quality or peer review.

The inspection itself does not have to be a full-fledge quality or peer review and can be performed when your client workloads are light. This allows the team to focus on the inspection and complete it more efficiently. However, your firm should follow some basic quality or peer review guidelines.

The inspection should be assigned to a responsible person who is qualified to perform the annual inspection, or, alternatively, the firm can hire an outside consultant. Using appropriate members of the firm's professional staff to perform portions of the inspection is a beneficial way to teach them about quality control and professional standards.

There is no prohibition from a firm performing its own inspection. However, someone too close to the process may lack proper perspective. Inspection of specific engagements should be assigned to someone independent of the engagement.

The scope of the inspection process should include a selection of at least one engagement of each of the following: 1) accounting and auditing practice partners; 2) industries of high public interest or high exposure; 3) the firm's areas of specialization; 4) audit covered by Government Auditing Standards; and 5) an initial engagement.

A review of all of the applicable quality review elements should be made and not just a review of engagement workpapers.

The inspection team should prepare a written report on the scope of the inspection and its findings. The AICPA publishes inspection materials that you can adapt to serve this function. See Exhibit 1 for the AICPA's suggested Quality Control Policies and Procedures related to inspection. In addition, the Quality Review Executive Committee is developing a guide that would be similar to the present PCPS Guide for Performing Inspections.

The Bottom Line

Most important are the actions taken to correct any deficiencies that the inspection team finds. The quality or peer reviewer, in establishing the scope of his or her review, will look at the firm's inspection reports and pay particular attention to corrective actions taken. The reviewer will also look at whether the firm followed through on promised corrective actions in subsequent engagements.

In quality reviews of firms with 10 or fewer professionals, the reviewer is not required to review the specifics of the inspection program. The reviewer will, at a minimum, inquire as to whether you have an inspection program. In quality reviews of firms with more than 10 professionals, the reviewer will review documentation to see that the firm has complied with quality control standards for inspections and see that the results of the inspection are consistent with his or her independent findings.

The importance of performing an annual inspection of the firm's quality control system cannot be overemphasized. With all of the time and effort spent in establishing a quality control system, it would seem plausible that a firm should make the additional effort of ensuring that they are complying with their quality control standards.

By Anthony J. Mancuso, CPA, Weber Lipshie & Co. (Excerpted from "Quality Control Manual For CPA firms," Panel Publishers, Inc., New York, N.Y., Copyright 1990)

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