FAQs - Inspection

An inspection includes, but is not limited to, where applicable, the evaluation of the following:

• the effectiveness of the remedial actions proposed by the auditor following the last inspection;
• the compliance of the auditor’s system of quality management with the Hong Kong Standards on Quality Management;
• the Firm’s compliance with the anti-money laundering and counter-terrorist financing requirements set out in the Guidelines on Anti-Money Laundering and Counter-Terrorist Financing for Professional Accountants (AML Guidelines) issued by the Hong Kong Institute of Certified Public Accountants.  The AML Guidelines form part of the Code of Ethics for Professional Accountants (HKCoE); and
• the compliance of completed PIE engagement(s) and completed engagements other than a PIE engagement with the applicable auditing and assurance standards and the HKCoE.

The AFRC adopts a risk-based and proportionate approach to inspections of auditors for determining the priority and frequency of inspections.  PIE auditors that audit more than 100 PIEs will be inspected annually.

The AFRC will notify the auditor about the engagements which have been selected for inspection before the scheduled inspection visit. The auditor will be required to provide all audit documentation regarding the selected engagements within one week of the notification.

The number of engagements selected for inspection for each auditor is proportionate to the number and the risk profile of its audit clients and past inspection results of the auditor. The AFRC may select one to several individual engagements for inspection in each inspection year.

In selecting individual engagements for inspection, the AFRC generally takes a risk-based approach.  The inspectors will select engagements for inspection having considered and assessed various risk factors.  Such risk factors include but are not limited to, where applicable,  the following:

• the nature or principal activities of the entity
• whether the entity has significant operations in certain emerging businesses or markets
• those industries that were severely impacted by the current economic conditions
• areas that present audit challenges and/or significant audit risks
• whether the engagement partners or engagement quality control reviewers are subject to investigation or sanction
• that the auditor’s report was issued shortly after the appointment
• the level of public interest, such as audits of listed entities with larger market capitalisation and capital market transaction engagements such as initial public offerings
• the incoming auditor accepted a substantial reduction in the audit fee

Depending on the size of the auditor and the number and complexity of individual engagements selected for inspection, the inspection visit could last for a few weeks to several months or more. An inspection may also be conducted in phases. The notification letter relating to each phase will specify each inspection visit date and anticipated duration of the inspection visit.

Depending on the size of the auditor and the number and complexity of individual engagements selected for inspection, the number of inspectors being assigned can range from two to six or more.

Yes.  The audit working papers of Hong Kong audit firms located in Chinese Mainland are subject to the AFRC’s inspection.

On 22 May 2019, the AFRC and the Supervision and Evaluation Bureau (SEB) of the Ministry of Finance of the People’s Republic of China signed a Memorandum of Understanding (MOU) on cooperation in respect of audit regulation.  

Pursuant to the MOU, the SEB and the AFRC will provide assistance to each other in respect of their audit regulatory responsibilities in relation to inspection, investigation and discipline in order to enhance regulatory efficiency. Therefore, the AFRC can make a request for assistance to the SEB in gaining access to audit working papers of Hong Kong audit firms located in the Chinese Mainland.

The information required to be provided to the AFRC in advance of the inspection visit includes, but is not limited to, where applicable, the following:

• background information of the auditor
• organisation chart of the auditor
• quality management manual and other relevant documentation in relation to the auditor’s system of quality management
• latest internal review or monitoring report(s)
• a list of engagements completed during the period specified in the AFRC’s notification letter and related information. Such information includes but is not limited to, where applicable, the full name of the entity, type of engagement, type of audit opinion, engagement team information including the use of components and audit fee information.
• any other information relating to the auditor as required by the AFRC

The list of information required for the inspection can be found here Information required for inspection | AFRC for reference purposes only.

We inspect the auditor’s system of quality management (SoQM) and anti-money laundering and counter-terrorist financing (AML/CTF) policies and procedures through discussions with the auditor’s leadership and management, reviews of related documentation, and testing of key policies and procedures.

For a completed engagement inspection, we review a portion of the audit and interview the engagement team regarding audit areas selected for review. It should be noted that an inspection does not cover every aspect of the Firm’s SoQM, AML/CTF policies and procedures, nor was it designed to identify every weakness or deficiency in the Firm’s SoQM, AML/CTF policies and procedures.  

An engagement inspection does not involve the review of all the audit working papers of the selected engagement, nor is it designed to identify every weakness and/or deficiency of the selected engagement. We generally focus our attention on audit areas we believe to be of greater complexity and areas of greater significance or with a heightened risk of material misstatement to the financial statements. An inspector focuses on the appropriateness of key judgements made in reaching the conclusion and the sufficiency and appropriateness of the evidence obtained.

For details of the AFRC’s inspection process in relation to auditors, please refer to the “Outline of the AFRC’s Inspection Process for PIE Auditors” and “Outline of the AFRC’s Inspection Process for Practice Units that are not PIE Auditors”, which is available on the AFRC’s website Guidance Materials | AFRC.

An inspection finding is a weakness and/or deficiency that should be brought to the attention of the auditor’s leadership because of its significance.  The significance of an inspection finding depends on its nature and extent, as well as the facts and circumstances that gave rise to it.

It is important to recognise that engagement inspection findings do not necessarily indicate that the financial statements are materially misstated, but rather that the quality of the audit has been affected by deficiencies identified in key aspects of the auditor’s work.

During the course of our inspection, we hold frequent meetings with the engagement team and the auditor to discuss our findings. Prior to the conclusion of the inspection, we agree with the auditor factual information on the procedures performed by the auditor during the engagement to address the area of concern relating to each finding, so that the inspector can make an assessment of the severity of the finding and the overall audit quality of the engagement on a fair and accurate basis.
 

The system of quality management of an auditor and completed engagements other than a PIE engagement will not be graded, however, individual PIE engagements subject to our inspection is rated based on the number, nature and severity of its inspection findings.  We use Audit Quality Rating (AQR) to describe our overall assessment of the quality of the audit work we inspected.  There are four categories of AQR, and they are:

1        Good 
2        Limited improvements required
3        Improvements required 
4        Significant improvements required

1 represents the highest score and 4 represents the lowest score.

The quality rating for each engagement and the deficiencies identified in an auditor’s system of quality management are compared and calibrated to inspections conducted at the same and other firms to ensure their consistency. Before being issued, each firm-wide and engagement inspection report is reviewed by the Head of Inspection or, where there is a conflict of interest, by a Deputy Head of Inspection, for quality and the appropriateness of the deficiencies identified and ratings assigned to engagements.

The Inspection Committee provides oversight of the work of the inspection function and, where requested, advises on the evaluation of individual findings, the overall audit quality rating of inspected engagements and on our assessment of deficiencies in systems of quality management.

The Inspection Committee also undertakes an ex post annual review of a sample of completed inspections and reports their findings and recommendations to the Board.

In addition, the Process Review Panel for the Accounting and Financial Reporting Council (PRP) is an independent body appointed by the Chief Executive of the HKSAR to provide an external check and balance with the aim of ensuring fairness in the AFRC’s decision making, due process, and the proper use of its regulatory powers. The panel reviews and advises the AFRC on the adequacy of its internal procedures and operational guidelines governing the actions and decisions made in the performance of its regulatory functions. Reports from the PRP are submitted to the Financial Secretary annually.

Normally, the inspector will send a dated draft inspection report to the auditor within six weeks of the formal exit meeting with the auditor. The inspector will allow a period of 21 days for the Relevant Persons to respond in writing.

On receipt of the written responses from the auditor or expiration of the period allowed for responding, the inspector may modify the report in light of any new information or contention in the responses from the auditor. The inspector will then send a copy of the final inspection report to the auditor.
 

Currently, reports on inspections of an individual engagement and an individual auditor’s system of quality management will only be issued to Relevant Persons and will not be made public unless the inspection report is of public interest. However, PIE auditor should share the information contained in the inspection report with the relevant audit committee of the PIE.

We publish an annual inspection report which summarises the work of the Inspection Department, highlighting key findings, observations and insights from our inspections.
 

All firms inspected are required to develop and execute a plan to remediate the deficiencies identified in our inspections of their systems of quality management and to address the root causes of significant findings and common findings identified in our inspections of the engagements.

For details of the follow-up action that the AFRC may take, please refer to sections 21H and 20ZZE of the AFRCO.
 

The auditor should notify the AFRC immediately if they are not able to provide the support and resources required by the inspectors at the time specified, for example due to the absence of key personnel. The AFRC will try to accommodate a request for a change to the inspection visit date if valid and substantiated reasons have been provided.

To achieve an effective inspection, an auditor may consider the following:

• Set the right tone for an inspection
• Ensure all the relevant information on the procedures performed and audit evidence obtained by the engagement team supporting the audit opinion are provided within the timeframe specified in the notification letter issued by the AFRC before the start of inspection
• Be prepared for questions on the background and significant audit risk areas of the individual engagement selected for inspection
• Ensure individuals responsible for the system of quality management and the individual engagement selected for inspection are available to clarify issues raised by the inspectors
• Seek clarification if the requests or inquiries raised by the inspectors are unclear and be responsive to the comments raised by the inspectors
• Demonstrate commitment to audit quality even if weaknesses and/or deficiencies are identified