The Public Company Accounting Oversight Board (PCAOB) on April 30, 2024, published a staff report about how a root cause analysis (RCA) can lead to improved audit quality.
The 9-page report covers general considerations, other observations about root cause analysis from audit inspections, and key questions for firms to consider.
An audit firm’s understanding of the underlying reasons behind a deficiency can result in incremental improvements to a firm’s system of quality system, which in turn would improve audit quality, the report notes.
This comes as inspection results have shown high audit deficiency rates. (See PCAOB Chair Williams: Rising Audit Deficiency Rates are ‘Unacceptable’ in the July 26, 2023, edition of Accounting & Compliance Alert.)
RCA is a multifaceted approach, not a single well-defined process or methodology, and firms should consider what makes sense for their facts and circumstances. And RCA does not mean that only one factor is the cause of an issue.
“Selecting from a list of potential causes, opting for prepopulated fields, or even using the five whys technique, although helpful, appears to be too linear and limiting for complex problems, and these methods will not likely show the many intricate interrelationships between each cause and associated effect,” the report explains.
The term “five-whys” refers to a strategy of asking “why” five times, drilling down to the root cause.
Illustrative Example
The report provides an example, illustrating how RCA could be beneficial when a firm is trying to fix insufficient testing of management review controls in a business combination.
The audit firm concluded that one cause was insufficient supervision and review by a partner who appeared to rely too much on a senior manager who was new to the engagement team and did not have enough experience or knowledge of the company being audited.
Moreover, the firm identified other causes, such as lack of training or insufficient knowledge by engagement team members.
“Performing a thorough RCA and identifying these root causes helped the firm design and implement appropriate corrective actions into its QCS to address each of the causal factors that contributed to the deficiency,” the report states.
Good Root Cause Analysis Process
The staff report provides the following characteristics and practices of a well-designed RCA process:
- dedicated team;
- guidance and training;
- data gathering and tools;
- scope;
- level of analysis;
- prioritization;
- conclusions;
- monitoring remedial actions; and
- reporting.
The staff found that large audit firms have formal RCA processes at varying stages of design and implementation.
Smaller firms have a process tailored for their structure and size. But inspectors also found that many small firms either had limited or no RCA procedures.
“The PCAOB strongly encourages firms to assess the underlying root causes of a deficiency so that the deficiency can be effectively addressed and ultimately remediated and eliminated,” the board states. “RCA is an important procedure that many audit firms use to evaluate the adequacy of and compliance with their quality control system.”
The staff also saw that certain firms have metrics such as milestones, distribution of hours during the year, partner workload, partner industry experience, and use of specialists, among others.
In addition, the report highlights challenges at certain firms, including persistent criticisms and delayed causal analysis.
This article originally appeared in the May 1, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
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