Public Company Accounting Oversight Board (PCAOB) Chair Erica Williams disputed arguments that the number of financial restatements is a good audit quality indicator, which has been relatively low in contrast to high audit deficiency rates identified during inspections in recent years.
“For instance, some have suggested that audit quality can be best measured by the number of issuer restatements. Specifically, some argue that a relatively low number of restatements translates to high audit quality. I believe that view is too simplistic,” Williams said on October 29, 2024, during the 16th International Institute on Audit Regulation in Washington that audit regulators around the world attend.
While she did not specifically address who have made such claims, PCAOB member Christina Ho for instance in late September gave a speech making that very suggestion.
In particular, Ho accused the PCAOB of “painting a dire picture of the state of audit quality,” questioning whether the inspection and enforcement numbers that were emphasized to the public tell the entire story about the state of audit quality today.
In 2023, board inspectors found 46% of audits reviewed had at least one deficiency, an increase from 40% in 2022, 34% in 2021, and 29% in 2020.
In Ho’s view, an audit deficiency rate does not provide the only indicator of audit quality. Instead, the number of financial restatements, “suggests a more positive and hopeful reality,” she said, citing a study by the Center for Audit Quality which found that the number of financial restatements decreased by more than 50% over a 10-year period with 402 financial restatements in 2022, which is down from 858 in 2013.
The deficiency rate for audits with incorrect opinions in the 2023 inspection reports is less than 5%, she said.
Moreover, she said that the deficiency rates should be examined more closely. (See Board Member Ho Criticizes PCAOB for ‘Painting a Dire Picture’ of Audit Quality.)
Chair Williams’ Response
However, Williams, in her remarks, said that a proper audit should identify errors before restatements become necessary.
“At the same time, a poorly performed audit does not always mean that the financial statements are erroneous,” the PCAOB chair said. “Management’s processes and controls may very well have resulted in financial statements that are materially correct, despite the auditor’s lack of diligence. It is worth noting that issuers changing audit firms tends to correlate with increased restatements.”
In addition, she said poor audits might miss errors that might never come to light unless there is a change in the audit firm and the new firm identifies the errors.
“If errors are not uncovered, there is no restatement,” Williams said. “That is the risk to investors.”
She said that measuring audit quality is not simple. Thus, the PCAOB has been focused on Part I.A deficiencies and other information to help various stakeholders in evaluating audit firms’ work. Part I.A is the first section of an inspection report that provides any findings in a firm’s audit work.
For example, some in the industry, such as Tom Quaadman of the U.S. Chamber of Commerce, also question the severity of inspection findings.
“First off, what is an audit deficiency? It can be as simple as the auditor and the inspector having a difference in opinion. That doesn’t necessarily mean something’s wrong,” Quaadman told Thomson Reuters recently. “They’re just looking at something differently.”
But Williams said Part I.A findings are serious because the audit firm did not obtain sufficient appropriate evidence to support its opinion, “and audit opinions were signed without completing the audit work required to verify the accuracy of the financial statements.”
She explained that such deficiencies include a failure to perform procedures to test revenue or the costs of inventory. Inspectors also observed instances of auditors not identifying and testing any controls over long-lived assets and depreciation expense.
“Simply put, these deficiencies are not just serious, but they go to the heart of the audit,” she said. “These Part I.A deficiencies are relevant when assessing the quality of work done by an audit firm. But audit quality is complex, and it escapes simplistic proxies or measures.”
This article originally appeared in the November 1, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
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