GAAP Chats: 2021 PCAOB Inspection Reports
GAAP Chats: 2021 PCAOB Inspection Reports

GAAP Chats: 2021 PCAOB Inspection Reports

Mike: They are the independent audit watchdog who are responsible for overseeing the audits of public companies and SEC-registered brokers and dealers. I’m talking about the P-C-A-O-B. Their inspections and associated inspection reports bring angst to audit engagement teams everywhere. And they should! Because those inspection reports, which are public knowledge, lay bare for the world to see the shortcomings of their audits. And I love reviewing them! Perhaps it’s a bit of schadenfreude, but I truly believe it is a worthwhile exercise to review them so I can help others from making the same mistakes. I’m a giver, what can I say! In this episode of GAAP Chats, we talk about our insights from our review of the 2021 PCAOB inspection reports for the annually inspected firms. 

Welcome to GAAP Chats, the podcast dedicated to all things accounting, brought to you by GAAP Dynamics. I’m your host, Mike Walworth and with me, as always, is my faithful partner, Chris Brundrett. We hope you’ll join us on our journey today as we share our passion for accounting and help change the way you train.  

Mike: [evil laugh]

Chris: What’s with the evil laugh? Oh, I know. You’re reading SEC enforcement actions again.

Mike: Close. PCAOB inspection reports.

Chris: Why are you doing that?

Mike: Well, I realized that a few people downloaded our PCAOB eBook from our website last month and it is woefully out of date. And I felt really, really bad, so I decided to update it.

Chris: How out of date was it?

Mike: Well, the most recent edition was released in 2019, but, because of delays in the release of certain firms’ inspection reports, the data in the book was based on 2017 inspection reports.

Chris: Whoa! That’s pretty stale. I’m glad you’re updating it. When will the revised eBook be released?

Mike: Me too! We’re shooting for release sometime in mid-April. And, luckily, the PCAOB has helped us out by releasing the 2021 inspection reports for ALL the annually inspected firms in November 2022. These inspections covered audits of issuers with fiscal years generally ending in 2020. 

Chris: For those in the audience who may not know, the Public Company Accounting Oversight Board, or PCAOB, inspects registered audit firms to assess each firm’s compliance with PCAOB standards and rules as well as other applicable regulatory and professional requirements. 

Mike: In general, the PCAOB inspects each firm either annually or triennially (that’s once every three years) depending on how many issuers they audit. If a firm provides audit opinions for more than 100 issuers, the PCAOB inspects them annually. If a firm provides audit opinions for 100 or fewer issuers, the PCAOB, in general, inspects them at least triennially.

Chris: I know for our training materials we only look at the inspection reports for the annually inspected firms. Obviously the Big 4 make the list, but what other firms does the PCAOB inspect annually?

Mike: Beside the Big 4 ( Deloitte, PwC, EY, and KPMG), for the 2021 inspection cycle the other annually inspected firms were:

  • RSM US (5)
  • BDO USA (6)
  • Grant Thornton (7)
  • Crowe (12)
  • Moss Adams (13)
  • Marcum (16)
  • WithumSmith+Brown (22)
  • Cohen & Co. (51)

Chris: Wow! That’s quite a few firms. Definitely some new additions since our last eBook.

Mike: Yep. Cohen & Co. actually joined the party in 2017, but since then, the PCAOB has added Moss Adams, in 2019, and WithumSmith+Brown, in 2021.

Chris: Any idea if this list will be the same next year?

Mike: According to the PCAOB website, for the 2022 inspection cycle they are adding two more, Baker Tilly Virchow Krause (#10) and BF Borgers CPA will join the party! 

Chris: I'm very familiar with Baker Tilly Virchow Krause. They have been growing over the years. But who is BF Borgers? I’ve never heard of them!

Mike: Neither have I so I did a little research. BF Borgers CPA PC is based in Lakewood, Colorado and is registered as a PCAOB listed firm. According to their website:

BF Borgers currently performs 10-K audits and 10-Q quarterly reviews according to PCAOB standards for over 80 publicly traded companies around the world. These companies range from start-up and development stage to successful mid-market companies.

Mike: And check out this headline from a March 25, 2022 article from Accounting Today:

BF Borgers dominates 2021 SEC client rankings

Mike: The article states that the firm added 39 new SEC clients during 2021, more than any other firm.

Chris: That’s pretty impressive. How big are they?

Mike: Well, they don’t even show up on Inside Public Accounting’s list of the top 500 U.S.-based accounting firms.

Chris: That’s strange! They audit 80+ issuers and they’re not even in the top 500. I mean, a lot of the firms in the 400s of that list are pretty small. What else did you find out?

Mike: Well, the firm’s LinkedIn company page lists the company size at 2-10 employees.

Chris: You mean GAAP Dynamics is larger than this firm that audits over 100 issuers?

Mike: Yep. And the firm’s website shows only ONE Managing Partner and ONE Audit Director. That’s it. Oh, and the Audit Director must be new because the old one has been barred by the PCAOB from being associated with a registered public accounting firm.

Chris: What?!

Mike: Here’s the headline from the PCAOB press release dated May 24, 2022:

PCAOB Sanctions Former BF Borgers Audit Director for Violating PCAOB Rules and Standards in Four Audits of Three Public Companies

Chris: Oh boy! What’s your prediction for the results of their 2022 PCAOB inspection report considering the new Audit Director came in about mid-way through. 

Mike: What did Clubber Lang predict in Rocky III? PAIN!

Chris: I would like to be a fly on the wall during that inspection! Well, enough about them. What interesting stuff do you have for us based on your review of the 2021 PCAOB inspection reports for the annually inspected firms?

Mike: Well, before we dive into our insights, let’s first do a bit of a level set. Within the reports, the inspection observations are divided into two parts: Part I and Part II.

Chris: What’s the difference?

Mike: Well, Part I is all about inspection observations related to deficiencies noted during the inspection and this part of the report is also divided into two parts:

  • Part I.A: 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 ICFR.
  • Part I.B: Deficiencies that do not relate directly to the sufficiency or appropriateness of evidence the firm obtained to support its opinion(s) but nevertheless relate to instances of non-compliance with PCAOB standards or rules.

Part II – Observations Related to Quality Control: Criticisms of, or potential defects in, the firm’s system of quality control. Part II deficiencies are not publicly disclosed when the report is first issued. What’s interesting is that they give the firm 12 months to correct it and if they do it never sees the light of day. If they don’t then they are out from 1 to 12 months and they make the report public. 

Chris: And we focus on Part I.A deficiencies, correct?

Mike: That’s right. Mainly because the deficiencies noted in Part I.B are mostly procedural in nature. Things like communications with audit committees, management representation letters, and the like. But the big reason is that the PCAOB doesn’t summarize and report them like they do the Part 1.A deficiencies. And as for the Part II deficiencies related to quality control, the PCAOB only makes them public if the firm fails to rectify them within a year, so most never see the light of day.

Chris: Got it. Let’s get to insights. Whatcha got?

Mike: First, the overall audit deficiency rate for the annually inspected firms was 26%. This means that a quarter of all the audits inspected had deficiencies that were of such significance that the PCAOB believed the firm had not obtained sufficient appropriate audit evidence to support its opinions on either the financial statements and/or internal controls over financial reports.

Chris: That sounds bad, but, based on my recollection, the audit deficiency rate used to be somewhere in the mid-40’s.

Mike: You’re right. I mean, we’ve been looking at these things going back 10+ years. Back in 2012/2013 the audit deficiency rate for the annually inspected firms was 42% and it declined to a low of 20% in 2020. But then, this year, it spiked up again to 26%.

Chris: Is there a big disparity of the deficiency rates among the firms that are being inspected? And be general. In other words, don’t name names. We usually don’t name names, the example earlier was just because of the disparity. Ultimately, we want these firms to be clients.

Mike: Got it! Well, the average deficiency rate of the Big 4 firms was 16%, while the average deficiency rate for the non-Big 4 firms was 39%.

Chris: That’s quite a gap. I thought the gap between these two groups was narrowing?

Mike: It was. Back in 2012 the gap was quite large, but by the 2017 and 2018 inspection cycles the gap was gone. However, the gap between the deficiency rates of the Big 4 and non-Big 4 firms has been growing since that time.

Chris: What’s causing the gap?

Mike: Math.

Chris: What do you mean?

Mike: Well, let's look at the averages. The 16% average deficiency rate of the Big 4 firms is helped considerably by the fact that one of these firms, PwC, had a deficiency rate of only 4%.

Chris: I said no names!

Mike: I’m sorry, but I have to call out excellence.

Chris: That is an exceptionally low deficiency rate.

Mike: Yeah, Deloitte’s was that low in 2020 and during that year PwC had a 2% rate. You get where I’m going. Two of the Big 4 firms have had exceptionally low deficiency rates over the past couple of inspection cycles.

Chris: What about the other firms?

Mike: Well, again it kind of is a math problem. Of the other 8 firms, 3 of them had audit deficiency rates above 50%, with one at 76%!

Chris: That’s not good.

Mike: Nope. And it brings down some of these other firms that are doing a really good job, like Cohen & Co. who over the past 5 inspection cycles has had deficiency rates of 11%, 0%, 0%, 0%, and 13%.

Chris: Wow! Those deficiency rates are really good! Any idea what is causing the high deficiency rates of those other 3 firms.

Mike: I’m sure it is a number of things, and we will get into that in our PCAOB eBook, and various blog posts. But if I had to put one word to the problem, I’d say that word would be “SPACs,” at least for the two firms with the highest deficiency rates.

Chris: What?! That’s my favorite topic!

Mike: I know. And you couldn’t stop talking about it over the past couple of years! You’d drone on and on and on…

Chris: I get it! But honestly, the SPAC market has really slowed down compared to what it was over the last couple of years. It will be interesting if that changes some of these deficiency rates just by the nature of the market shift. 

Mike: Anyway, check out this paragraph from one of those firm’s (one with a high deficiency rate) 2021 inspection report:

Fifteen of the 25 audits we reviewed in 2021 are included in Part I.A of this report due to the significance of the deficiencies identified. The identified deficiencies primarily related to the firm’s testing of controls over and/or substantive testing of equity and equity-related transactions and revenue and related accounts. The firm significantly increased its number of issuer audits in the past two years by accepting a large number of special purpose acquisition companies (SPACs). During the year under inspection, the firm audited 463 SPACs or issuers that were formed by mergers between non-public operating companies and SPACs (“de-SPACs”), and many of these issuers restated their financial statements to correct misstatements related to warrants and/or certain redeemable shares. Ten of the 25 audits we reviewed in 2021 were SPACs or de-SPACs, and all of these audits are included in Part I.A. 

Chris: Guess the Big 4 was right to stay away from auditing SPACs! What else have you got?

Mike: Well, of the 380 audits inspected, 98 of them had at least one audit deficiency. That’s the 26% audit deficiency rate. However, of the 98 with deficiencies, 81 of those had multiple deficiencies, meaning if the audit engagement team screwed up, they usually screwed up multiple times.

Mike: But, on the plus side, of those 380 audits, there were no audits with an incorrect opinion on either the financial statements or the internal controls over financial reporting.

Chris: So, the audits being done are fundamentally sound. That’s comforting. What’s the biggest areas where deficiencies were noted?

Mike: Are you talking about deficiencies related to the PCAOB auditing standards or audit areas?

Chris: Both. Let’s start with the auditing standards. I’d imagine AS 2201 dealing with ICFR and integrated audits tops the list.

Mike: And you’d be right! Based on all the deficiencies noted, 37% relate to just this one standard.

Chris: What other standards do teams screw up?

Mike: In order they are:

  1. AS 2810, Evaluating Audit Results (15%)
  2. AS 2301, The Auditor’s Response to the Risks of Material Misstatement (13%)
  3. AS 1105, Audit Evidence (13%)
  4. AS 2501, Auditing Accounting Estimates, including Fair Value Measurements (8%)

Chris: Interestingly, we’ve seen a lot of focus over the past few years on auditing accounting estimates by the firms that we have worked with. So at least it’s getting towards the bottom of the top 5 list. What about the audit areas with the most deficiencies? I’ll bet I can guess one of the areas, and that’s gotta be Revenue.

Mike: You’re en fuego! The others are, in no particular order:

  • Business combinations,
  • Allowance for credit losses,
  • Inventory, and
  • Equity and equity-related transactions

Chris: The last one makes a lot of sense, and maybe the first one, especially given the SPAC issues that you noted earlier. Allowance for credit losses, that’s a new standard. Inventory is kind of surprising. It will be interesting when we get into the details in our eBook, what might be going on there. Well, enough with that. I think we are running out of time.

Mike: OK, let me just run through the most frequently identified deficiencies related to the financial statement audits because I think you’ll like them! They are, in order of the number of deficiencies:

  1. Did not sufficiently evaluate the appropriateness of the issuer’s accounting method or disclosure for one or more transactions or accounts.

Chris: Stop! That’s a GAAP thing not an auditing standard!

Mike: Yeah, baby! The GAAP is back!! Continuing with the list:

  1. Did not sufficiently evaluate significant assumptions that the issuer used in developing an estimate;
  2. Did not perform sufficient testing of data or reports used in the firm’s substantive testing;
  3. Did not obtain sufficient evidence as a result of overreliance on controls (due to deficiencies in testing controls); and
  4. Did not perform sufficient testing related to an account or a significant portion of an account or to address an identified risk.

Mike: Want to hear about the deficiencies noted related to the audits of ICFR?

Chris: As much as I would love to, not today. You’re giving away too much. Save something for the eBook or at least a blog! I’ll take us out!

That’s all for this episode of GAAP Chats, your source for all things accounting.  Notes and resources from today’s episode are linked in the description and as always you can find us online at, and @gaapdynamics across social media. It’s never too late to become a GAAPologist! Head over to our website and subscribe to our blog so that you’re the first to know what’s new with GAAP Dynamics.

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