Public Company Accounting Oversight Board (PCAOB) Chair Erica Williams urged accounting firms to do a better job of auditing public company financial statements, citing continued year-over-year increases in audit deficiencies. The deficiency rate for the 2022 inspection cycle is expected to be 40 percent, up from 34 percent in 2021 and 29 percent in 2020, according to a staff report that provides a preview of 2022 inspection observations, published on July 25, 2023.
“These findings are absolutely unacceptable, and audit firms must make changes to turn things around and live up to their responsibility to investors,” Williams said. “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.”
The PCAOB inspected 157 accounting firms, reviewing portions of 710 audits of operating public companies. For comparison, the PCAOB inspected 141 audit firms for the 2021 cycle, reviewing portions of 690 audits.
The 40 percent rate is for Part I.A of an inspection report, which describes deficiencies “that were of such significance that we believe the firm, at the time it issued its audit report(s), had not obtained sufficient appropriate audit evidence to support its opinion(s) on the issuer’s financial statements and/or internal control over financial reporting (ICFR).”
The staff found that many of the problems identified were recurring ones, indicating that audit firms may not be doing their best to up their game and improve audit quality.
The PCAOB does not review all audits but selects them largely based on a risk assessment of areas that are likely to be more challenging, among other things. The board also uses random selection, but the percentage is lower and tends to be for larger firms. The random selection is to introduce an element of unpredictability and is intended to gauge a more correct level of deficiency rate.
The latest report said that the most significant increase in deficiencies was within the global network firms (GNF), which include both U.S. and foreign GNFs.
The deficiency rate for U.S. GNF was 16 percent in 2020, 21 percent in 2021 and 30 percent in 2022 inspection. For non-U.S. GNF, the deficiency rate was 34 percent in 2020, which was cut in half to 17 percent in 2021, but went back up to 31 percent in 2022.
Inspectors also found continued increase in deficiency rates among firms that are inspected yearly but are not part of GNFs. These are firms that audit more than 100 public companies. In 2020, the deficiency rate was 35 percent, going up to 40 percent in 2021 and 51 percent in 2022.
PCAOB inspection reports also have Part I.B, which describes instances of noncompliance with board standards or rules other than deficiencies related to performance of audit to get sufficient audit evidence to support audit opinions. And the findings for this are also grim. The PCAOB staff expects that about 46 percent of the audits reviewed will have one or more deficiencies in Part I.B, which is up from 40 percent in 2021 and 26 percent in 2020.
The PCAOB stated that some audits have both Part I.A and Part I.B deficiencies, and the staff expects that about 61 percent of the 710 audits the board reviewed in 2021 will have one or more Part I.A and/or Part I.B deficiencies, which is an increase from 55 percent in 2021 and 44 percent in 2020.
It is unclear what the exact causes are for the deficiencies to have gone up.
There have been many special purpose acquisition company (SPAC) initial public offerings, and some auditors experienced challenges during the SPAC boom.
While random selection has increased compared to 2020, this does not necessarily explain the rise in the deficiency rate. In 2022, PCAOB inspections found that 48 percent of the randomly selected audits resulted in at least one deficiency, and the staff expects about 26 percent of those randomly selected engagements will be included in Part I.A.
By contrast, 64 percent of the risk-based selections resulted in at least one deficiency, and the staff expects about 42 percent of those risk-based selections will be included in Part I.
“Although we do not perform analyses to determine the root causes of the deficiencies our inspectors identify, many firms do,” the report notes. “Certain firms have indicated that this deterioration of audit quality may in part be attributable to higher-than-normal staff turnover, use of less experienced staff in general, and the ongoing impact of COVID-19 and related remote work.”
In response to a question by Thomson Reuters during a media briefing, Chair Williams said that the reason behind the increase varies from firm to firm.
“There really is no one-size-fits-all explanation,” she said.
“I will say that some firms have said the ongoing impacts of COVID-19 and the Great Resignation, the war on talent could be contributing factors, but we are three years out from the start of the pandemic,” she added. “And these challenges are no longer new, and firms really do have a responsibility to meet the challenges head on. So, at the same time, you know, a 40 percent deficiency rate simply cannot be explained away by the pandemic and many of the deficiencies that the PCAOB inspectors have identified have been recurring for years well before COVID-19.”
In the meantime, some investor advocates had previously criticized that the PCAOB under the leadership of Williams’s predecessor, William Duhnke, has been lax in supervising firms. Such criticism led SEC Chair Gary Gensler to remove Duhnke in June 2021. Williams became chair of the PCAOB in January 2022.
This article originally appeared in the July 26, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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