21.2 Philippine Standards on Quality Management

Philippine Standards on Quality Management

Quality management is fundamental to the integrity and credibility of the accounting profession. To address corporate governance failures, complex commercial structures, and evolving stakeholder expectations, the international and Philippine standard-setting bodies replaced the legacy quality control framework with a comprehensive, risk-based quality management architecture. For CPALE candidates, mastering Philippine Standard on Quality Management 1 (PSQM 1) and Philippine Standard on Quality Management 2 (PSQM 2) is vital for answering both theoretical and regulatory audit questions.

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1. Evolution from PSQC 1 to PSQM 1 and PSQM 2

The Shift from Quality Control to Quality Management

Historically, audit firms operated under Philippine Standard on Quality Control 1 (PSQC 1), Quality Control for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements. While PSQC 1 established essential quality policies, it suffered from inherent structural weaknesses:

• It encouraged a linear, check-the-box compliance mindset, where firms implemented standardized policies without assessing whether those policies mitigated their specific operational risks.
• It operated reactively rather than proactively, focusing on inspecting engagements long after audits were finalized rather than managing quality in real time.
• It was insufficiently scalable for sole practitioners and medium-sized accounting practices.

To overcome these limitations, the Auditing and Assurance Standards Council (AASC) adopted the IAASB's revolutionary Quality Management suite, effective December 15, 2022:

1. PSQM 1: Quality Management for Firms that Perform Audits or Reviews of Financial Statements, or Other Assurance or Related Services Engagements (replaces PSQC 1).
2. PSQM 2: Engagement Quality Reviews (a new, dedicated standalone standard governing EQR appointment, eligibility, and performance).
3. PSA 220 (Revised): Quality Management for an Audit of Financial Statements (clarifies the engagement partner's leadership role and responsibility for managing quality at the engagement level).

Comparative Matrix: PSQC 1 vs. PSQM 1 Key Structural Enhancements

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2. The Eight Components of PSQM 1

Under PSQM 1, every professional accounting firm in the Philippines must design, implement, and operate a System of Quality Management (SOQM) tailored to its specific practice. The SOQM comprises eight interrelated components:

                               The Eight Components of PSQM 1
                                               │
      ┌────────────────────┬───────────────────┼────────────────────┬────────────────────┐
      ▼                    ▼                   ▼                    ▼                    ▼
1. Firm's Risk        2. Governance        3. Relevant          4. Acceptance &      5. Engagement
   Assessment            & Leadership         Ethical              Continuance          Performance
   Process               (Tone at Top)        Requirements         of Clients           (Supervision)
      │
      ├────────────────────────────────────────┼─────────────────────────────────────────┐
      ▼                                        ▼                                         ▼
6. Resources                             7. Information &                         8. Monitoring &
   (Human, Tech, Intellectual,              Communication                            Remediation
    Service Providers)                      (Two-Way Flow)                           (RCA & Annual Review)

1. The Firm's Risk Assessment Process

The firm's risk assessment process functions as the driving engine of the SOQM. It is a continuous, three-step risk-based methodology:

1. Establish Quality Objectives: The firm establishes the quality objectives mandated by PSQM 1, alongside any additional objectives necessitated by the firm's specialized services.
2. Identify and Assess Quality Risks: The firm identifies and assesses conditions, events, or circumstances that have a reasonable possibility of occurring and adversely affecting the achievement of a quality objective.
3. Design and Implement Responses: The firm designs and puts into operation specific policies and procedures directly addressing the assessed quality risks.

2. Governance and Leadership

Governance and leadership establishes the internal environment and tone at the top:

• Ultimate Responsibility: The firm's Chief Executive Officer (CEO) or Managing Partner assumes ultimate responsibility and accountability for the firm's SOQM.
• Operational Responsibility: Operational responsibility for the SOQM, or specific aspects thereof, may be assigned to qualified partners possessing appropriate authority, experience, and time.
• Culture of Quality: Firm leadership must demonstrate a consistent commitment to quality that transcends commercial interests (such as fee generation, cost cutting, or partner profits).
• Performance Evaluations: Professional advancement, compensation, and partner distributions must be linked to quality performance rather than purely financial billing metrics.

3. Relevant Ethical Requirements

The firm must design responses to ensure that the firm and its personnel understand and comply with relevant ethical requirements, including the Philippine Code of Ethics:

• Mechanisms to identify, evaluate, and address threats to compliance with the fundamental principles.
• Rigorous monitoring of independence requirements, including the mandatory collection of annual written confirmations of compliance with independence from all personnel required to be independent.
• Policies for identifying and resolving potential conflicts of interest before accepting client assignments.

4. Acceptance and Continuance of Client Relationships and Specific Engagements

Before accepting a new client or continuing an ongoing professional relationship, the firm must assess:

1. Integrity and Ethical Values of the Client: Reviewing the background of the client's principal owners, key management personnel, and those charged with governance.
2. Firm Capability and Competence: Ensuring the firm has sufficient personnel with the required competence, specialized industry knowledge, time, and resources.
3. Compliance with Ethical Standards: Confirming that the firm and engagement team can comply with relevant ethical requirements, including independence.
4. Financial Health: Assessing whether commercial pressures or client insolvency could create undue management bias or fee recovery disputes.

5. Engagement Performance

Engagement performance governs the execution of professional engagements in accordance with professional standards and applicable regulatory requirements:

• Direction, Supervision, and Review: Ensuring engagement partners actively direct and supervise engagement teams and perform comprehensive, timely reviews of audit work.
• Consultation Protocols: Establishing policies for consulting on difficult or contentious matters (e.g., emerging accounting treatments, unusual legal issues) with designated internal technical specialists or external experts. Agreed consultation conclusions must be documented and implemented.
• Resolution of Differences of Opinion: Establishing clear procedures for resolving differences of opinion within the engagement team, with the EQR, or with consultation providers. The audit report shall not be dated or issued until all differences of opinion are formally resolved.
• Assembly of Engagement Documentation: Final assembly of audit files must be completed on a timely basis, not more than 60 calendar days after the date of the auditor's report (PSA 230 / PSQM 1).
• Retention of Engagement Documentation: Audit files must be retained for a period sufficient to meet the needs of the firm and applicable law or regulation. For audit engagements, the retention period is ordinarily no shorter than five (5) years from the date of the auditor's report, or, if later, the date of the group auditor's report. Laws or regulations may require a longer period.

6. Resources

The firm must obtain, allocate, and maintain the resources necessary to operate its SOQM and execute engagements:

• Human Resources: Hiring, development, training, performance evaluation, and assignment of qualified personnel to engagement teams.
• Technological Resources: Deploying and maintaining secure audit software, automated working paper platforms, data analytics applications, and IT security safeguards.
• Intellectual Resources: Standardized audit methodologies, industry accounting guides, specialized audit programs, and technical checklists.
• Service Providers: Vetting and monitoring external third-party resources, such as external valuation specialists, IT audit service bureaus, and cloud storage providers.

7. Information and Communication

Information and communication ensures the continuous, relevant flow of data throughout the organization:

• Internal Communication: Transparent communication of quality objectives, SOQM policies, and operational responsibilities across all engagement teams and office locations.
• External Communication: Accurate and timely communication with clients, Those Charged with Governance (TCWG), regulatory agencies (PRC, BOA, SEC, BSP), and external stakeholders.

8. Monitoring and Remediation Process

The monitoring and remediation component provides objective evaluation of the SOQM's design and operation:

• Ongoing Monitoring Activities: Continuously evaluating the design and implementation of quality management policies.
• Periodic Inspections of Completed Engagements: Selecting at least one completed engagement for each engagement partner for inspection on a cyclical basis determined by the firm, considering the firm's quality risks and the nature of its engagements.
• Root Cause Analysis (RCA): Investigating identified quality deficiencies to determine their true root causes (e.g., workload compression, inadequate training, or unclear methodology) rather than treating superficial symptoms.
• Remedial Actions: Implementing concrete corrective measures, such as revising audit templates, mandatory staff retraining, reallocating client workloads, or imposing internal disciplinary measures.
• Annual Evaluation of the SOQM: The firm's leadership (CEO / Managing Partner) must evaluate the SOQM at least annually and conclude whether the system provides the firm with reasonable assurance that its quality objectives are being met.

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3. PSQM 2: Engagement Quality Reviews

Scope and Purpose of PSQM 2

Philippine Standard on Quality Management 2 (PSQM 2) governs the appointment and eligibility of the Engagement Quality Reviewer (EQR) and the performance and documentation of the review. The engagement quality review is an objective evaluation of the significant judgments made by the engagement team and the conclusions reached thereon, performed before the audit report is issued.

Mandatory Engagement Quality Review Criteria

Under PSQM 1, the firm's policies must require an EQR for:

1. All audits of financial statements of listed entities;
2. Audits or other engagements for which an EQR is required by law or regulation; and
3. Any other engagements for which the firm determines that an EQR is an appropriate response to assessed quality risks (e.g., high-profile public entities, complex IPO transactions, or entities facing severe going concern uncertainties).

Eligibility and Objectivity of the Reviewer

The firm must establish policies to ensure the EQR possesses the requisite competence, capabilities, and authority:

• Professional Qualifications: The EQR may be an internal partner of the firm or an external qualified professional possessing extensive audit experience and technical expertise in the relevant industry.
• Independence and Objectivity: The EQR cannot be a member of the engagement team, cannot be selected by the engagement partner, and must not participate in making operational audit decisions for the engagement.
• Mandatory Cooling-Off Period: An individual who served as the engagement partner cannot be appointed as the EQR for that engagement until a cooling-off period of two (2) years has elapsed, or longer if relevant ethical requirements demand it. This cooling-off requirement prevents the self-review threat and safeguards the reviewer's objectivity.

                               EQR Eligibility & Process Flow
                                             │
                   ┌─────────────────────────┴─────────────────────────┐
                   ▼                                                   ▼
            Eligibility Check                                    Scope of Review
• Experienced partner or external expert              • Discussion of significant matters with
• Independent of the engagement team                    engagement partner
• Mandatory 2-year cooling-off if former             • Review of financial statements and audit report
  engagement partner                                  • Review of documentation relating to significant
• Objective & technically competent                     judgments (estimates, fraud risks, going concern)
                                                      • Evaluation of team independence & consultations
                                                                       │
                                                                       ▼
                                                             Report Dating & Sign-Off
                                                      • EQR must complete review and sign off
                                                        BEFORE the audit report is dated and released!
                                                      • Absolute prohibition on premature report release.

Performance and Timing of the Review

1. Concurrent Performance: The EQR must perform the review at appropriate stages during the engagement, rather than solely at the conclusion, so that significant matters can be addressed and resolved promptly.
2. Review of Significant Judgments: The EQR reviews audit documentation relating to significant matters, evaluates the engagement team's assessment of independence, reviews consultations on contentious matters, and evaluates whether the proposed audit report is appropriate in the circumstances.
3. Sign-Off Requirement: The engagement partner shall not date or release the auditor's report until notification has been received from the EQR that the engagement quality review is complete. If differences of opinion exist between the engagement partner and the EQR, the firm's formal dispute resolution mechanism must be followed, and the report cannot be released until the dispute is resolved.

Documentation Requirements under PSQM 2

The EQR must document that:

• The review procedures required by PSQM 2 have been performed;
• The review was completed on or before the date of the auditor's report; and
• The reviewer is not aware of any unresolved matters that would cause the reviewer to believe that the significant judgments made by the engagement team and the conclusions reached were not appropriate.