AFRC Inspection Process on Non-PIE Auditors (Formerly known as “HKICPA Practice Reviews”)

On 1 October 2022, the AFRC has taken up the responsibility of regulatory oversight over Non-Public Interest Entity Auditors (“Non-PIE Auditors”), and now refers to practice reviews as Inspectors. Practice Reviewers are now referred to as CPA Inspectors., whom are employees of the AFRC and designated as the case managers with the consent of the Financial Secretary.

A detailed outline of the current Inspection Process on Non-PIE Auditors has been published on the website of AFRC. Non-PIE Auditors include the following forms of CPA Practices:

• Part-time & Full-time CPA (practising) who practices accountancy on the accountant’s own name, or under a firm name, e.g. Jack Chan Siu Ming, or Jack Chan & Co.,
• A CPA Firm that practices accountancy under partnerships
• A limited corporate CPA practice may fall within any one of the above two forms of CPA practices.

The process is largely the same as the previous practice reviews conducted by the former Quality Assurance Department of the HKICPA. We have summarized the Inspection process below and included our EQC insight into what you may prepare in advance for each stage of the Inspection process

Stage 1. Assessment

When considering which CPA Practice to conduct inspections on, the following key factors are considered:

1. Internal risk assessment on the CPA Practice, including how well had the Practice performed in previous Inspections or Practice Reviews, Investigations and Disciplinary sanctions
2. Size of the CPA Practice, taking into account the number of clients, and number of Practising Directors
3. The complexity of the practice and of the audit engagements of the CPA Practice
4. the Period of time since the CPA Practice was last inspected by the AFRC, and
5. the available resources conducting AFRC Inspections

EQC Insight on Stage 1. Assessment

1. Internal risk assessments are based on regular health checklists and online questionnaires, and whether significant deficiencies were identified in previous inspections and practice reviews. Significant deficiencies can be identified on three levels, including on the system controls of the CPA Practice, on audit engagement files, and on AML / KYC procedures. To reduce the frequency of Inspections, it is of utmost importance to reduce significant deficiencies and perform better on your first Inspection, as the result of the Inspection will have impact on frequencies of the Practice’s subsequent inspections.
2. The size of CPA Practice includes two factors, i) the number of total clients, and / revenue of the CPA Practice, and the number of engagements that each Practising Director is involved in, and ii) the number of Practising Directors. CPA Practices, that have over 250 audit engagements per calendar year per practising director, or have many high-revenue audit engagements, (usually indicative of the underlying complexity of financial reporting framework and operations), may expect that Inspection will be frequent, and should always be ready for Inspections.
3. The complexity of the CPA Practice refers more to the system controls of the Practice. Some examples may include whether most clients are referred from a single source, its independence from non-assurance service providers, the number of practising directors, the number of network / affiliated firms and offices including office outside of Hong Kong, sub-contracting arrangements, and / regular payments & receipts from affiliated offices that are not controlled by common shareholders / directors, and not part of network firms. CPA Practices with these complex characteristics may expect more frequent inspections.
4. The period since last inspection is straight forward. If your last Practice review was at least 4.5 years ago, you should start preparing for your next AFRC Inspection immediately.
5. Based on sources familiar with the matter, over 95% of the staff previously employed by the Quality Assurance Department of the HKICPA have been re-employed by the AFRC, and we have noticed additional headcounts added to the AFRC Inspection department. We expect that there are about 20 staff employed in the Inspection Department of the AFRC, and each on-site review take 3 business days, and each desktop review takes 2 business days to complete. A reasonableness test informs us that the AFRC has abundant resources to cover many Non-PIE CPA Practices in a year.

Stage 2. Inspection Notification

The appointed CPA Inspector will notify your Practice approximately 6 weeks prior to the Onsite-Inspection / Desktop Inspection of the CPA Practice. Often the Inspector will ask for basic information from the CPA Practice in the six weeks leading up to the actual Inspection date, including a client / engagement list, audit personnel and the Practice’s AML Procedures and Controls on Audit Quality Management, which also include external monitoring review reports. The inspection make take the form of an onsite review or a desktop review.

EQC Insight on Stage 2. Inspection Notification

From our past experience in Practice review consultancy, approximately 8 weeks were given to CPA Practice prior to the actual review date. The shortening notification period from 8 weeks to 6 weeks may be seen as a preventative measure on CPA Practices performing last-minute preparations. The basic information leading up to an inspection can be prepared ahead of time. Relevant EQC services include Mock AFRC Inspection, External Monitoring Review, and Preparation for Inspection.

Stage 3. Draft Inspection Report

The CPA Inspector must give reasonable opportunity for the CPA Practice to be heard in all matters to be included in the Draft Inspection Report before the report is circulated to the CPA Practice for a formal written response. This opportunity to be heard usually falls immediate after the Inspection dates, when the CPA Inspector discusses the Inspection findings with the CPA Practitioner(s). The CPA Practice may “make representations” regarding the findings.

Once the draft inspection report is sent to the CPA Practice, it will be given 21 calendar days to respond to the report in writing.

EQC Insight on Stage 3. Draft Inspection Report

The opportunity to respond to Inspection findings is given to the CPA Practice to perform one of the following:

• Explain auditor’s judgement in performing selected audit procedures, or decisions made to accept a new client. These explanations should be audit risk-based, rather than commercial explanations. Explanations on selected audit responses that were performed should not be due to a limitation of scope or a lack of client information and controls, unless the circumstances warrant such explanations, such as a modified opinion issued on such matters. However, verbal explanations may not justify the removal of such findings from the Draft Inspection Report, if they were not adequately documented in the working papers.
• Direct the CPA Inspector’s attention to where the relevant audit work has been performed in the circumstances that the Inspector overlooked during the review. However, it is important to note that this is not an opportunity to bring forth new evidence that were previously excluded in the working paper files, as the initial submission of working paper files should have been complete. This step is only when the CPA Practice is certain that the relevant audit work has been well-documented but were missed due to the Inspector’s oversight / unfamiliarity with the Practice’s working papers.
• Express disagreement with inspection findings if the findings do not reflect the factual circumstances, and provide evidence supporting the Practice’s disagreement. However, any disagreements without third-party sourced supporting evidence may not substantiate the Practice’s claims.

EQC acting as your Inspection Consultant may help to perform all of the above in a timely manner, such as that findings can be corrected / reduced in number and seriousness before the circulation of the Draft Inspection Report. The CPA Practice may also request for a meeting in person with the CPA Inspector and team, to clarify any judgement and rationale, however, written responses should also be submitted following a meeting to document all matters discussed for the Committee’s future consideration.

If the findings are proved to be correct and factual, the CPA Practice is recommended to take swift remedial actions to address the findings to give the right impression that the Practice is cooperative and willing to make necessary corrective actions.

The CPA Practice will be given 21 calendar days to provide written submissions to the Draft Inspection Report, based on the date of the report, and not on the date it was received.

All remedial actions should be supported with evidence, such as training attendance certificates, revised controls, policies and procedures on a Practice-wide basis, new working paper templates and illustrative working papers in similar audit engagements.

For more details on our services responding to Inspection findings, please visit here. For examples of remedial actions that the CPA Practice may take, please see our services on Remediating AFRC Inspections here.

Stage 4. Submission of Report and Follow-up Actions

The CPA Inspector will finalize the Inspection Report and submit the final report to the AFRC. The finalized report will be sent to the CPA Practice, and any follow-up actions, or the need for escalation to investigations or disciplinary panel will be determined at this stage.

EQC Insight on Stage 4. Submission of Report and Follow-up Actions

The primary objective of any CPA Practice should be to directly close the Inspection without any further follow-up actions, especially to avoid the need to perform a follow-up Inspection 6+ months from the completion of the first Inspection, or handle further extension of inspection scope, investigations or even complaints against the CPA Practice that may lead to potential reprimands and disciplinary sanctions and financial penalties.

The costs and time required to respond to and handle such follow-up actions would be significantly higher than just preparing for an initial Inspection. Preparation in advance is the key.

In the unfortunate circumstances where further follow-up actions are required, please learn more on our Mitigation services by visiting here.