Top 5 Observations from Recent PCAOB Inspection Reports
Top 5 Observations from Recent PCAOB Inspection Reports

Top 5 Observations from Recent PCAOB Inspection Reports

Each year about this time we undergo an extensive analysis of the PCAOB inspection reports of the annually inspected firms. Why? Because we want to help you improve audit quality and reduce those pesky audit deficiencies!

Background

If an accounting firm audits a publicly traded company or securities broker-dealer registered with the SEC, it is subject to regular PCAOB inspections. More than 2,000 accounting firms, both in the U.S. and abroad, are registered with the PCAOB. The vast majority of these accounting firms are inspected at least once every three years — so called “triennially inspected firms”. However, if an accounting firm audits more than 100 public companies, it is subject to annual PCAOB inspections.

According to the PCAOB website, there were ten annually inspected firms in 2015 (ranked in order by U.S. revenues):

  1. Deloitte & Touche LLP
  2. PricewaterhouseCoopers LLP
  3. Ernst & Young LLP
  4. KPMG LLP
  5. RSM US LLP
  6. Grant Thornton LLP
  7. BDO USA, LLP
  8. Crowe Horwath LLP
  9. Marcum LLP
  10. MaloneBailey, LLP

Note: This post, originally published on April 11, 2017, has been updated to include the inspection results for all annually inspected firms.

What is an audit deficiency?

Inspections identify whether there are deficiencies in how the accounting firm performed its audit and whether there are weaknesses in its quality controls over public-company auditing. Certain of the deficiencies identified are of such significance that it appears (in the opinion of the PCAOB inspection team) that the audit firm, at the time it issued its audit report, had not obtained sufficient appropriate audit evidence to support its opinion. These are the audit deficiencies that are reported in PCAOB inspection reports of audit firms and made public for all to see.

Here are the top 5 observations based on our review of the 2015 PCAOB inspection reports for the annually inspected firms:

Observation #1 – There was a huge improvement in the overall audit deficiency rate.

As you can see from the chart above, the overall audit deficiency rate for the annually inspected firms had been hovering around 40% for the last three years. As a result, the International Forum of Independent Audit Regulators (IFIAR) and the six largest international audit firm networks entered into a new initiative to reduce audit deficiencies and improve audit quality globally, with particular focus on root cause analysis by the firms and implementation of responsive actions. Based on the 2015 deficiency rate, at least in the U.S., it appears they are on the right track!

Observation #2 – Non-Big 4 firms have made considerable progress narrowing the gap with the Big 4.

Prior to 2015, the combined audit deficiency rate for non-Big 4 firms had been hovering around 50%, much higher than compared to the Big 4 firms. However, this gap appears to have narrowed considerably based on the 2015 inspections. Why? Well, a big reason was that Marcum, a newcomer to the list of annually inspected firms, had a 0% audit deficiency rate. Wow! Also, MaloneBailey decreased its audit deficiency rate by a whopping 40%!

Observation #3 – ICFR reclaims the top spot in the most cited audit deficiency.

While audits of internal control over financial reporting (ICFR) under AS 5 has always been the single most cited auditing standard contributing to audit deficiencies, over the past few years it had lost its top spot to the risk assessment standards (AS 8 through AS 15) when considered as a group. However, during the 2015 inspection cycle, AS 5 reclaimed the top spot. Of all the audits inspected with at least one audit deficiency, 29% related to ICFR, the same percentage as the risk assessment standards. However, the statistics are even more telling when looking at the percentages based on the total number of audit deficiencies. Of all the audit deficiencies noted, a whopping 41% related to AS 5 compared to only 25% for the risk assessment standards. All hail AS 5!

Observation #4 – The types of audit deficiencies noted remains unchanged.

The more things change, the more they stay the same! Although the order switched a bit, the types of audit deficiencies noted remains unchanged. They are (in order of frequency):

  • Testing internal control over financial reporting (AS 5)
  • Assessing and responding to risk (AS 8 through AS 15)
  • Auditing accounting estimates, including fair value measurements (AU 342 and AU 328)
  • Performing audit sampling (AU 350)

The PCAOB takes a risk-based approach in selecting engagements for inspection and you can bet that it will continue to focus on areas it believes to be the highest risk. As such, auditors would be wise to learn from the audit deficiencies noted in these areas, as it appears to be a “hit list” for the PCAOB.

Observation #5 – New information within the inspection reports provides valuable insight into the financial statement areas most prone to audit deficiencies.

The PCAOB is providing additional information within its inspection reports, including the financial statement accounts or auditing areas related to each deficiency. In order of frequency, here are the top financial statement areas where deficiencies were noted for each of the “Big 3” audit standards:

Testing Internal Control over Financial Reporting (AS 5)

  • Revenue, including accounts receivable, deferred revenue, and allowances
  • Inventory and related reserves
  • Business combinations, including contingent consideration
  • Impairment of goodwill and intangible assets

Assessing and Responding to Risk (AS 8 through AS 15)

  • Revenue, including accounts receivable, deferred revenue, and allowances
  • Inventory and related reserves
  • Loans, including allowance for loan losses
  • Investment securities, including derivatives and equity method investments

Auditing Accounting Estimates, including Fair Value Measurements (AU 342 and AU 328)

  • Business combinations, including contingent consideration
  • Revenue, including accounts receivable, deferred revenue, and allowances
  • Impairment of goodwill and intangible assets
  • Loans, including allowance for loan losses

This is good information and firms would be wise to ensure their audit procedures and documentation in these areas are following the rules.

Final Thoughts

We believe it is good practice for all firms, regardless of size, to analyze audit deficiencies detailed in PCAOB inspection reports, make necessary changes to their audit procedures, and improve the quality of their training. This will increase audit quality and reduce audit deficiencies. Best of luck during the 2016 audits’ inspection cycle!

Disclaimer
This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.

PCAOB Inspection
 
PCAOB Inspection

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