Understanding the PCAOB’s Latest Inspection Results: Five Guiding Principles for Audit Committees

We often hear that our U.S. capital markets are the envy of the world. Our markets are fueled by investors who have confidence in our markets. I believe much of this investor confidence can be attributed to the system of “checks and balances” that deliver reliable information to investors. One of the many “checks” in our system, and perhaps one of the most valuable “checks” on audit quality, is the PCAOB’s inspection process. The PCAOB recently released its 2022 inspection reports for the U.S. global network firms. These reports contain the PCAOB’s findings from inspections they conducted in 2022 of 2021 audits.

Another of the valuable “checks” in our system is the audit committee’s oversight role of the external auditor, a role that directly contributes to audit quality.  With this in mind, I wanted to share five key principles I consider when reviewing the PCAOB’s inspection reports. If you’re an audit committee member, consider using these principles as context when engaging in dialogue with your external auditors about the PCAOB’s inspection reports.  

1. The PCAOB’s inspection process continues to drive improvement in audit quality

The PCAOB’s inspections are one part of a strong reporting and oversight ecosystem and have a two-fold purpose: To help public company auditors improve the quality of their audits and to protect investors. Therefore, these reports are invaluable to public company audit firms and individual audit teams, who use the information the inspections provide to identify the root cause of audit issues and continuously improve audit quality.

While being part of an audit team that has been selected for an inspection can be stressful (you can read more about my personal experience in my opinion for Bloomberg), auditors understand and embrace the inspection process as a valuable tool that improves performance and drives audit quality, along with investments in technology, processes, and people by the firms.

2. Inspection findings are not the sole measure of audit quality, nor are they a report card

While PCAOB inspection reports provide us with important information about the engagements selected for inspection and any findings, they are not the sole measure of audit quality, nor are they intended to be. I sometimes hear the analogy that the PCAOB’s inspection findings are a report card for audit firms. And while it’s a decent analogy, I don’t think it’s the right one.

The PCAOB’s inspections, largely risk-based, are designed to look at the most complex audits and audit areas – areas that typically require the auditor to exercise the most significant judgments regarding risks, design of procedures, and evaluation of audit evidence. For context, approximately 2% of all audits performed by annually inspected U.S. firms are selected for inspection. Of the audits where a deficiency is identified, the majority remediate with no change to the auditor’s conclusion (more on this later).

Engagements selected for inspection are a small percentage of the firm’s overall audit practice and therefore cannot be considered an overall reflection of the firm’s work, like a report card might be. They are not a tool to rate the firm, nor are they a conclusion about a firm’s overall audit quality.

3. Inspection findings rarely lead to a restatement

We know based on our conversations with investors that they are generally not concerned with deficiencies if there are no restatements. Thus, I think it is important for investors to know that inspection findings do not necessarily mean that the issuer’s financial statements are materially misstated.

From 2009-2021, only 0.8% of inspections resulted in a restatement. From 2017 to 2021, that number fell to 0.5%. In 2020 and 2021, there was not a single restatement as a result of inspections for annually inspected U.S. firms.

4. Inspection findings have narrowed

In the early years of PCAOB inspections, you may have seen an audit deficiency where the firm failed to perform any procedures to test aspects of an account balance or assumption. Whereas today it is more common that the firm performed procedures to test that account, but there were additional procedures that should have been performed.

The PCAOB’s inspection staff have gained experience, which has allowed them to go deeper during inspections. As a result, firms have gotten better and the job of the inspector has gotten harder.

This is a good thing. The result is inspection findings that, as Board member Tony Thompson put it, show “improvements in a number of ways – including declines in the volume and types of findings; narrowing of inspection findings; and/or improvement in issues around tone at the top and responsiveness to implement significant remedial actions.”

5. Audit quality depends on people

Auditing requires people. It requires people with experience, integrity, independence, and strong professional judgment, and application of those skills to the unique business and strategy of the company being audited. Board member Christina Ho said in a speech, “There will be no audit quality without competent auditors.” I know this to be true from my prior experience working with teams to execute audits and my current experience working with hundreds of partners from firms of all sizes who are all dedicated to providing their people with the tools they need to promote audit quality. As I read this latest round of inspection reports, I’ll be thinking about the countless number of auditors out there who are dedicated to continuously learning, improving, and perfecting their skills to ultimately protect investors.

I think audit quality will always be a journey, not a destination. There’s always more work to do and I know audit firms will use their learnings from this year’s reports to continuously raise the bar on audit quality.  Audit committees can contribute to audit quality by asking their auditors what the inspection results mean in the context of their company’s audit. I remain grateful for the important work of the PCAOB in the inspections process, which continues to contribute to our strong reporting and oversight ecosystem that protects investors.

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