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PwC to Require More Robust Review and Supervision of Auditors, Although “Minimum Supervision” Still Has Its Place (in Court)

Last month, the PCAOB released its 2011 inspection report for PwC. With a 41% deficiency rate for the 60 audits inspected, it's safe to assume that the firm wishes it could have put up a better number.

As we noted at the time, Papa Whiskey Charlie encouraged the PCAOB to step up its game a little so that firm can quit sucking so much (aka improve audit quality). But in the meantime, they outlined a number of steps it has taken to, yes, quit sucking so much (aka improve audit quality).

Here are the first items listed in the letter signed by Bob Moritz and Tim Ryan:

  • Investing significant amounts of time and attention of Firm leadership in understanding, evaluating and implementing actions designed to support achievement of our quality initiatives
  • Establishing 140 incremental partner and manager roles in our new Assurance Quality and Transformation Organization, a quality-focused organization which encompasses all of our quality support functions – providing for experienced leadership, coordination, oversight and monitoring of all of our audit quality initiatives
  • Utilizing experienced partners from the Assurance Quality and Transformation Organization to provide on-the-ground support to engagement teams and reinforce the implementation of new audit methodology guidance focused on areas of more frequent inspection observations

Sounds great, right? Well, a couple of months ago, we received a message from a PwC auditor who informed us that the firm had recently communicated an upcoming change to its policy of supervision and review for public company audits.

Here's the text of the new policy with some bolding to make it easy on you:

The following policy changes are effective for audits of periods ending after December 15, 2012:
For public company audits […], a manager or partner is also required to perform a detailed review of work where the first level of review was performed by a senior associate.  This requirement also applies to non-public company audits, except in lower risk audit areas identified by the engagement leader and evidenced in the approved Assigned Workflow Report.
On public company audits […], the engagement leader should review documentation supporting our understanding of the "end-to-end" flow of transactions in business processes and our identification of likely sources of potential misstatement (LSPM), which is expected to be included in Gather Evidence view in multiple instances of the EGA entitled "Identify risks and understand controls in the business process – [business process or FSLI name]".  The engagement leader should review, at a minimum, the flow of transactions documentation and completed LSPM templates for business processes related to revenue, inventory, business combinations, and impairments, and for those business processes that impact financial statement accounts that present elevated or significant risks of material misstatement.
Okay, so you're an audit firm dealing with pressure from an ambitious regulator and you want to increase the level of review to minimize the "fail" in your inspections. It sure sounds like something that a firm's leadership might put into action "to support achievement of our quality initiatives" or something that a "Assurance Quality and Transformation Organization" would be responsible for monitoring, doesn't it? 
Here's what our tipster speculated to us at the time, "This guidance is likely due to pressure from the PCAOB but that has not been confirmed by anyone here. All of our changes are derived from the pressure from the PCAOB." When asked to elaborate, our tipster made a few points:
1 – Does this new guidance requiring at least manager-level review on every workpaper improve audit quality? — No.  If a senior first reviews a workpaper knowing that a manager is going to come behind them and review it again, their review is likely going to be lighter as a result while the manager reviews knowing that the senior has already reviewed it. This is also known as groupthink.
2 – Are they [Ed. note: presumably, firm leadership] pushing for PwC to promote earlier? — The more managers we have to review these workpapers, the better, right? So why not promote people earlier so we can have more people that are eligible to review? This new guidance may drive title inflation more than anything.
3 – If ever become a partner, I don't want to be reviewing the flowcharts and other templates that a first year put together. Last year, these weren't requirements. Now all of the sudden, it requires partner sign off? Seems like a typical knee jerk reaction from our firm.
Some reactions:
1 – Yeah, sounds about right.
2 – If the firm were to actually accelerate promotions to manager it would undoubtedly expose the firm to more risk. Most first-year and second-year managers are just glorified senior associates. Rushing more SAs into manager roles will result in more less experienced people running engagements, with the possibility of more audit deficiencies, more material misstatements missed, more lawsuits, so on and so forth.
3 – Seriously, since when do partners have to work?
Maybe these are knee-jerk reactions to the PCAOB inspection, but there's something else interesting to consider – perhaps an unintended consequence from these changes to the supervision and review policy. 
Remember those wage and hour lawsuits that the Big 4 are tangled up in? For those needing a refresher, these are suits that were brought by non-CPA associates against various accounting firms who believe they were misclassified as exempt professionals and are owed overtime and other benefits due because they should be treated as non-exempt employees. One of the most noteworthy cases is Campbell v. PricewaterhouseCoopersOne of key arguments that PwC has made in Campbell is that these non-licensed associates are integral to the audit process — they regularly exercise judgment, are only subject to "general supervision," make decisions on what testwork is performed, etc. etc. In other words, they are extremely capable employees who can be trusted with applying audit methods and procedures and only require someone to come around every so often to make sure things are moving along.
In a perfect auditing world that might be the case, but Francine McKenna wrote a more apt description of what it's actually like to be an entry-level opiner, back in June 2011:
The firms have created a Hobson’s choice for the entry-level auditor. Their immediate superiors may ask them to do robotic, routine, data entry into pre-programmed audit software, scan hundreds of documents, or to ask questions of a senior client employee while using discretion and judgment in deciding if they’ve heard true and complete information. Either way, their choice is only to do what they’re told. During busy season they have been known to follow orders for 60-80 hours per week. 
Sounds awful, right? Here's where it gets interesting:
[W]hen audit firms expect entry-level professionals to, “exercise discretion and independent judgment with respect to matters of significance,” they are perpetuating performance requirements that contradict PCAOB Auditing Standards in service to avoiding overtime pay. More likely, the firms’ first objective is to perpetuate artificial status and value in the eyes of both college graduates and audit clients so the firms can continue to attract bright-eyed graduates and justify higher than necessary fees for work that is performed by the least experienced, but least costly, resources under general, or less than general, supervision by partners.
So all that new supervision and review policy stuff our tipster shared with us means there is no more "general supervision" it's more like "super supervision." There's very little room for exercising discretion or independent judgment for associates when every facet of an audit will require a detailed review by, at minimum, a manager. This means the myth of associates having any kind of meaningful effect on the audit will actually become a part of the firm's supervision and review policy because the monitoring of these employees will be – supposedly – more significant. This would go against the very argument that PwC has been making in the Campbell case.
Take a look at the comparison Francine makes between a PCAOB disciplinary order1 from last year and PwC's description of unlicensed auditors' duties: 
And while that's quite good, this is far more telling:
To make matters even more interesting, PwC is one of the few firms that requires auditors to have their CPA license* prior to being to be promoted to senior associate. That means no auditor that requires "super supervision" would be in a position to “exercise discretion and independent judgment with respect to matters of significance.” 
But the problem, again, is that isn't what the firm is arguing in its wage and hours disputes.2 
So what we have here is a new policy from a firm, the seeds of which were probably sown when some of these supervisory and review issues came up with a regulator behind closed doors. These issues didn't see the light of day because of nice things like clout and sharply dressed lawyers who know a thing or two about legally being in compliance with auditing standards. Meanwhile, the two-year-old standard has been enforced against many firms that don't have those nice things.

PCAOB spokeswoman Colleen Brennan declined to comment. PwC had no comment.

What now? Well, it'd be interesting to know if PwC's attorneys Campbell were aware of this new supervision and review policy. It'd also be interesting to know if the framers of this new policy were aware of what the lawyers in California were saying. And it'd also be interesting to know what the PCAOB thinks of the PwC's new policy and what they think of the arguments that PwC's attorneys are making in Campbell. We probably won't get direct answers to any of these questions, but it certainly reiterates the impunity and hubris of the large accounting firms and the PCAOB's inability to consistently enforce its standards. We're all getting used to it. 

1 Please also refer to Auditing Standard No. 10, if you are so inclined.
2 Head. Spinning.
* A little correction here — The license doesn't have to be in hand or framed on the wall or anything. Generally speaking, all four of the exam sections have to be passed.