PCAOB Blasts Audit Firm Deficiencies

The Public Company Accounting Oversight Board is taking audit firms to task this week, issuing a special report about the most recent round of PCAOB inspections that found an “unsettling trend” of ever-more deficient audits — results that the PCAOB chair blasted as “absolutely unacceptable.” 

“These findings are absolutely unacceptable, and audit firms must make changes to turn things around and live up to their responsibility to investors,” PCAOB chair Erica Williams said in a statement released Tuesday. “The PCAOB will continue demanding firms do better, conducting transparent inspections, and bringing strong enforcement actions where appropriate. We are also asking audit committees to hold firms accountable by posing tough questions to their auditors on behalf of investors.” 

Williams made her fiery statement in conjunction with a report also released Tuesday by the PCAOB declaring that the agency now expects 40 percent of audits reviewed this year to have one or more so-called “Part I-A” deficiencies: serious issues where inspectors believe the audit firm issued its opinion without sufficient evidence to support the auditor’s conclusions. That 40 percent number is up from 34 percent in 2021 and 29 percent in 2020.

The report also predicted a jump in Part I-B deficiencies, where the audit firm isn’t following PCAOB standards but the infraction isn’t directly related to a specific audit. Those deficiencies are expected to hit 46 percent in 2022, compared to 40 percent in 2021 and 26 percent in 2020.

For those of you about to say, “Yes, but the covid pandemic…” or “Yes, but the Great Resignation…” Williams held a press conference Tuesday morning to make clear she isn’t buying those excuses. 

“We’re three years out from the start of the pandemic,” Williams said in a press conference to discuss the report. “These challenges are no longer new. It’s the audit firms’ responsibility to meet the challenges head-on.” Moreover, Williams added, many of the issues flagged by PCAOB inspectors this year have been chronic problems that existed well before covid struck in 2020. 

So What Are These Issues?

They’re all the issues one would typically expect to see from a report on PCAOB audit firm inspections, which is probably a significant part of why Williams is so exasperated with the firms’ performance. For example… 

Deficiencies in auditing internal control over financial reporting. The report faulted auditors for not applying enough scrutiny to management review controls. Specifically, auditors didn’t look closely enough at the review procedures control-owners performed, such as the procedure to identify items for follow-up and procedures to determine whether those items were appropriately addressed.

The report also dinged audit firms for not performing procedures to test the accuracy and completeness of the information produced by the company and used by the auditor as the population for testing user access and change management controls. (That could potentially be a big deal for internal auditors, since you play an important role in producing such information, or at least in assuring that the information is reliable.)

Deficiencies in auditing financial statement areas. This is a big and broad subject for the PCAOB, since corporate financial statements are so complicated. The inspectors raised concerns about business mergers, goodwill, long-lived assets, inventory, accounting estimates, and revenue — any one of which can bring a company lots of grief if the numbers aren’t accurate. 

The specific issues here are too many to list, but phrases like “insufficient testing” or “insufficient evaluation” came up over and over. In other words, the audit firms weren’t skeptical enough about the company’s assertions; inspectors wanted to see more rigor and testing of those assertions. Which, of course, ultimately translates into more demands upon the client and higher audit fees.

Deficiencies in communications to the audit committee. This was really interesting. The audit firm is supposed to be in regular communication with the board’s audit committee, especially when the audit firm finds significant problems. Apparently that’s not happening to the PCAOB’s satisfaction either. 

For example, the PCAOB inspectors found recurring instances of audit firms not discussing significant fraud risks, not reviewing the auditor’s assessment of the company’s ability to continue as a going concern, and not communicating  uncorrected and corrected misstatements identified by the auditor.

That all might sound rather obscure, but look at the larger picture: the PCAOB is worried about the audit firm’s relationship with the audit committee. That relationship is supposed to be crucial for sound corporate governance, and here we have the PCAOB saying too many audit firms aren’t talking with their clients the way those firms are supposed to. 

Enter the Audit Committee

The PCAOB also stressed that board audit committees should seize on this week’s news about audit firm deficiencies, and ask their external auditor four specific questions. 

• Has our audit engagement been inspected, and, if so, would you share the results? Were there any audit areas that required significant discussions with the PCAOB that did not result in a comment form?
• Has the engagement partner been inspected on other engagements? If so, what were the results of that inspection?
• What is the audit firm doing to address overall increased inspection findings?
• Are there any audit procedures that are unnecessarily complicated or not “straightforward” because management is not providing clear, supportable information?

Look, those are worthwhile questions for any audit committee to ask. I’m more interested in why the PCAOB is encouraging audit committees to engage in this deeper level of dialogue. 

My best guess: because the PCAOB is trying to remind everyone that the annual audit is actually supposed to accomplish something, rather than just be an expensive exercise we only undertake because federal securities law requires it.

To that extent, this outburst of exasperation from Williams goes hand-in-hand with other efforts we’ve seen lately either to make auditors do more for investor protection, or to hold auditors accountable after large corporate scandals that left investors burned. Hence we see the PCAOB pondering whether to make auditors responsible for finding compliance violations at their client companies. 

My questions are two. 

First, will audit committees actually follow Williams’ suggestion and start quizzing audit firms more aggressively about the firm’s performance and prior encounters with the PCAOB inspection staff? That is, will they see the audit firm as a resource to be managed and used appropriately, so the audit committee can fulfill its duty of oversight? Or will the committee act in a passive way, reading the auditor’s presentation and then calling it a day? 

Second, how will management and internal audit respond to all this? Because if audit firms keep asking for more evidence or more testing, inevitably that will lead to more griping about audit fees and to more questions about how the company can streamline its financial reporting and internal control processes so the company can keep those fees down. 

Food for thought, which Williams clearly likes to serve hot and spicy.