As we discussed in a previous post, four out of ten audits inspected in 2014 did not have sufficient evidence to support the audit opinion. Our analysis of PCAOB inspection reports over the past six years has shown that the combined audit deficiency rate of the annually inspected firms has more than doubled since 2009!

Which begs the question, “Are audits getting worse?”

We do not believe this to be the case. Considering the complexity of accounting standards and the ever-increasing documentation requirements, we feel that the auditing profession does an exceptional job. However, we do believe that auditors, at times, may forgo using professional judgment in lieu of checklists and audit programs.

Jay Hanson, PCAOB Board Member, articulated this theory in a speech at the 11^th Annual Life Sciences Accounting & Reporting Congress on March 17, 2015:

“I would caution auditors at all levels, however, about the danger of training in their judgment and experience for compliance with documentation and check-list requirements. Checklists, practice aids, audit guidance and similar documents can be helpful tools for auditors to work through complex issues and avoid missing important steps, but they should not replace the judgment that is crucial to the performance of an effective and efficient audit. This is an issue that we at the PCAOB will be mindful of, as we move forward with our 2015 inspections and remediation discussions with firms, as well as in the context of our standard setting activities.”

Chapter 11 of AS 1015 Due Professional Care in the Performance of Workstates auditor judgment is required in:

• Selecting the areas to be tested,
• Determining the nature, timing, and extent of tests performed,
• Interpreting the results of audit testing,
• Assessing the reasonableness of accounting estimates, and
• Evaluating audit evidence.

However, we believe there is another factor leading to the increase in audit deficiency rates.

The largest source of funding for the PCAOB comes from the companies whose financial statements must be audited by PCAOB-registered firms. Section 109 of the Sarbanes-Oxley Act, as amended by the Dodd-Frank Act, requires funds to cover the PCAOB's annual budget, less registration and annual fees, to be collected from "issuers," and from brokers and dealers registered with the Securities and Exchange Commission (SEC). The amount due from issuers, brokers, and dealers is referred to as the Board's "accounting support fee".

As shown in the graph above, the accounting support fee has grown from $151.8 million in 2009 to over $252 million in 2014 – an increase of 66%! Furthermore, the amount of money allocated to inspections from the accounting support fee has nearly DOUBLED since 2009!

We believe that the increase in audit deficiency rates is at least partly attributable to the increase in PCAOB resources allocated to inspections. The PCAOB has obviously ramped up the resources dedicated to inspections, and like any organization, it wants show a return on its investment.

In 2015, although the total accounting support fee was reduced, the percentage allocated to inspections (54.9%) actually increased over 2014. In their 2016 budget, the PCAOB has allocated $125.1 million to inspections. Unfortunately for auditors, this means continued increased scrutiny of their audit documentation to ensure it is in compliance with PCAOB auditing standards, especially in the areas of recurring audit deficiencies.

GAAP Dynamics has helped our largest client, a Big 4 firm, deal head-on with PCAOB inspection comments. We've helped regional firms prepare for their first-ever PCAOB inspection. We can help your firm too!

Our one-day course, Preparing for PCAOB Audits and Inspections, helps accounting firms of all sizes steer clear of PCAOB inspection findings. Want to learn more? Take a peek at the course here.

Want more information on the results of our analysis of PCAOB inspection reports? You’re in luck! We’re set to release our first ever eBook in the coming weeks. Stay tuned!