Yet More PCAOB Inspection Hints

We have fresh intel on how the PCAOB may change its approach to inspecting audit firms, and what those changes might mean for the audit committees and internal audit executives who deal with the firms.

All five PCAOB members appeared Monday at the AICPA’s annual public company accounting conference in Washington, and inspections were Issue No. 1 on attendees’ minds. PCAOB chairman William Duhnke said the board is conducting a far-reaching review that will consider how inspections are done, what gets inspected at an audit firm, and how the PCAOB’s findings are disclosed.

“From our perspective, nothing is off the table,” he said. “We’re considering all ideas.”

Good to hear, but that far-reaching review of inspections won’t be done until well into next year. Here and now, the PCAOB also just published a bulletin of its priorities for audit firm inspections that will start happening in early 2019. That bulletin dwelled much more on how audit firms manage themselves, such as quality control; and much less on specific economic issues such as Brexit, interest rates, or M&A activity. So what does all this talk of inspection reform mean for audit firms and audit committees in the short term?

PCAOB board member Duane DesParte said the short term will be “a greater emphasis on prevention” of audit deficiencies — hence the focus on subjects such as quality control. Pushing firms now to have strong quality control and control environments should, he said, lead to fewer deficiencies of all kinds later.

The PCAOB also has a project on the books to revisit its audit standards for quality control. The focus on quality control this spring will help to inform that standard-setting project too, as well as other work the PCAOB wants to do with “AQIs” — audit quality indicators.

Um, great stuff, but what about everyone on the corporate side? No worries, DesParte said. Another PCAOB priority in 2019 will be outreach to audit committees.

Most notably, DesParte said the PCAOB will reach out to all audit committee chairs for issuers whose audits get inspected. That’s new. The PCAOB had kinda sorta tried to communicate with audit committees of inspected issuers in prior years, but hadn’t been as disciplined about it as what DesParte outlined.

The PCAOB will reach out to all audit committee chairs for issuers whose audits get inspected. That’s new.

Audit committee members, CFOs, and internal audit executives are likely to be delighted with this news. First, they never relished the idea that their audits might be inspected while they weren’t aware of that fact. More broadly, a common suspicion is that audit firms gear their audits to pass PCAOB inspection, rather than than to assess the client’s actual risk. So as the PCAOB works more closely with audit committees, the committees can keep closer watch to make sure their audit firms don’t try that nonsense with them.

Striving for More Useful Inspections

Indeed, that fear of “auditing toward the inspection” is partly why the PCAOB is stepping up its attention to firm management issues such as quality control, DesParte said.

“We’re not trying to be ‘gotcha!’ in the number of deficiencies we find,” he continued. “Our overall objective is similar with audit committees: to raise the bar on audit quality. Our goal is to be giving counsel to the firms and giving them observations on how to improve quality control.”

Sure, DesParte said, PCAOB inspectors will still ding firms for specific deficiencies when those deficiencies are found. “But certainly we appreciate the perception that’s out there, and that is something we’re considering.”  

Hmmm. You can see DesParte’s point, and he’s not wrong to raise it. Then again, specific risk issues and gotcha moments are what audit committees understand. As much as they want high-quality audits, they worry about specific issues: fair value measurement, accounting estimates, revenue recognition, operating leases.

So the PCAOB has a delicate tightrope to walk here, between its two constituencies of audit firms and audit committees. Let’s see how this new crop of PCAOB board members keeps their balance.

The PCAOB also wants to overhaul what its inspection reports actually say, and get them into the hands of investors and audit committees more quickly. Right now, inspection reports are text-heavy tomes crammed with technical lingo. They can also be based on underlying corporate activity might be two years old — hardly much help if an audit committee reads the inspection report for its audit firm, and finds that their company has had the same risks for 18 to 24 months.

To that end, DesParte said, the new inspection reports might (it’s all still tentative right now) might rely more on executive summaries and charts, less on dense narratives in 12-point type.

“We are working hard to figure out how to streamline our internal practices, to get our reports out in a more timely fashion,” he said. As to the reports themselves: “We want the findings to be more than inspectors talking to auditors, but make our findings more accessible for all stakeholders.”

That could also include bulletins from the PCAOB that offer best practices found by the inspections, rather than litanies of deficiencies found.