Just about every employer in corporate America is singing the blues about talent shortages caused by the Great Reset and the Great Resignation. However, these effects are not being felt uniformly across all businesses. Those employers with a history of mismanaging their human capital, like the largest audit firms, are being hit the hardest.
The public accounting business model has relied excessively on its ability to counter the effects of massive turnover with its ability to hire and train massive numbers of new people every year directly out of college. However, that pipeline of new talent is currently in an alarming state of decline. Enrollments in accounting majors and the quantity of newly minted CPAs are both down.
To stem the exodus of audit professionals, audit firms are paying higher salaries to attract and retain the same level of relatively inexperienced professionals. Of course, this means audit fees are going up. If you work through the consolidating and eliminating entries, the end result is that corporate America is paying higher audit fees due to the large audit firms’ mismanagement of their human capital. On what planet does this make sense?
Looking for solutions
At a recent SEC reporting conference, I was pleased to see a 70–minute session devoted to “Current Profession Talent Practice Issues.” The four-person panel included two representatives from the largest audit firms, an academic, and a representative from the preparer community. The panel was informative, but it also was disappointing in that it never addressed the elephant in the room—the absence of work-life balance in public accounting that 1) drives college students away from majoring in accounting, and 2) causes young audit professionals to prematurely exit public accounting.
I shared my observation with the panel moderator that the unfavorable experiences of the audit staff at the largest audit firms are rapidly transmitted back to college campuses via social media. I added that the root cause issue is the audit firms’ mismanagement of their human capital. When the moderator shared my observation with the audience, she conveniently omitted my view that audit firm mismanagement of human capital was the problem. Denial of reality? Absolutely yes.
The panel identified one potential savior: the “upscaling” of the audit experience by mixing in attestation work in the glitzy space of environmental, social, and governance (ESG) attestation. On the drawing board, this sounds like a good idea. However, there are serious logic flaws. This means that to field a sufficient number of professionals to serve ESG attestation clients, the audit firms are planning to borrow from a population of surplus auditors that doesn’t exist. Second, upscaling will dilute the specialization in auditing, accounting, and internal controls needed to conduct high-quality audits.
There is already a tremendous mismatch between the inexperience of audit professionals and the complexity auditors need to master to perform audits of high quality. With heavy workloads at all levels, there is a heightened risk that the work of inexperienced staff will be inadequately supervised and reviewed. This is a train wreck that has happened many times in the past and will continue to happen many times into the future—unless something changes.
Shining a light on reality
The largest audit firms are eager to get their share of attestation work in the booming field of ESG reporting. The audit firms are promoting their ability to unlock shareholder value that comes with the measurement, public reporting, and continuous improvement of ESG measures. There is a bit of irony here. A close look at what makes up the “G” in ESG shows that “human capital management” is a significant component, including statistics about employee retention. The large firm audit leaders should practice what they preach to their prospective ESG clients.
Converging interests in human capital management transparency
The ESG proponents are not the only ones looking to shine light on human capital management. SEC Chair Gary Gensler has been a champion for expanded disclosures by public companies about their human capital management by amending Item 101 of Regulation S-K, noting that “Investors want to better understand one of the most critical assets of a company: its people. … This could include a number of metrics, such as workforce turnover …”
It follows that these concepts should also be applied to the largest audit firms that audit the lion’s share of the US market capitalization. As it stands currently, investors have no insight as to whether an individual audit was conducted as planned with an experienced team with high year-over-year engagement continuity and an appropriate level of supervision as promised—or was the audit the product of chaotic personnel changes that diminished experience levels and potentially undermined audit quality?
Yes, audit committees are tasked with making the auditor retention decision. Unfortunately, a key element of the auditor retention decision continues to be input from company management who tend to be resistant to auditor changes (favoring the devil they know versus the devil they don’t know). This is why we continue to have many long-tenured auditors of public companies (often extending out a decade or more). If investors had more visibility into the realities of how the audit firms conduct their audits, I doubt that the shareholder ratification of auditor appointments would continue to be perfunctory. For this reason, it is important for the investors to have more visibility to auditor performance on individual audits.
The opportunity in front of the PCAOB
In December 2019, the PCAOB published a concept release titled “Potential Approach to Revisions to PCAOB Quality Control Standards.” That release proposes requirements for audit firms to identify metrics to monitor the conduct of audits in real time for situations warranting corrective action. If done correctly, this means audit firm monitoring at the engagement level for potential threats to audit quality, such as:
- Excessive turnover;
- Low year-over-year staff continuity;
- Low experience levels;
- Insufficient specialist time;
- Excessive workloads; and
- Inadequate supervision and review (evidenced by high staff hours relative to partner and manager supervision).
Many audit firms are already doing something like this, but this information at the engagement level generally stays within the audit firm.
If the audit quality indicators show that an audit was conducted outside of “safe zones of operation,” the investors should know what happened and what the audit firm did to assure that audit quality was not compromised. This audit quality indicator information should be required reporting externally in some fashion. A few possibilities that come to mind are:
- The critical audit matters section of the audit opinion;
- The audit committee report in the proxy statement; or
- A centralized database that is publicly accessible.
Without this information, it would be naive for investors to believe that all audits are conducted with uniform levels of experience, continuity, and supervision and review.
We are approaching the 20th anniversary of the Sarbanes-Oxley legislation. In the nearly 19 years of the PCAOB’s existence, the PCAOB has shown no inclination to focus on the inherent flaws in the large audit firm staffing model, instead leaving it to the audit firms to figure out how to improve audit quality. That hands-off approach has gotten us to a crossroads where audit quality today is under severe threat. We need to be sure that the auditing profession never finds itself in such a precarious position in the future. It is time for the PCAOB to be proactive. The downside is simply too great.
I’ll close with an observation made by former SEC Chief Accountant Don Nicolaisen during the proceedings of the Advisory Committee on the Auditing Profession: “The firms compete primarily on the basis of cost. That’s been the history of the profession and it has been disastrous for investors and for the firms.” The PCAOB has a unique opportunity to change that by using transparency to expose the flaws in the large audit firm business model and drive much needed improvement in how the audit firms manage their human capital.
About the author:
Robert Conway is a retired Big 4 audit partner and former leader of a PCAOB regional office. Mr. Conway is also the author of the book The Truth About Public Accounting.
I’ve said for years if forms don’t change the model there will be no people. No 9ne wants to work 60-70 hours a week to make the partners rich and get crapped on in performance reviews and promises of bonuses that end up being $500 to $1500. It’s about time CPA firms get their come uppance.
Compensation – Accounting used to be one of the top majors at Universities. Then, the accounting profession went to a 5-year program (150 hours) from a 4-year program. So students had to spend another year at the University (tuition, room and board and a year’s opportunity costs), and the Big 4 raised their starting salary by about $4,000 – hardly compensating for the increased costs and an extra year.
Accounting is no longer a holy grail profession. The pay lags others professions, including some other majors in the business school, but by a substantial amount to engineering, cyber, etc. Also, the Big 4 starting salaries are kept “below market” with each Big 4 (and thus other accounting firms) having entry level positions within $1,000 of each other.
And the audit profession is the worst professional choice of an accounting major. Considerable regulatory oversight, tighter margins than advisory, tax and it is high risk to one’s professional career. An audit is substantially based on price with one firm matching another’s price or going lower, but major companies (S&P 500) rarely switch their outside auditor.
The accounting profession has substantial challenges, but audit is by far the most challenged. And audit cannot increase starting salaries without the salary increase moving to tax and advisory. My advise is for business majors to stay away from audit.
The only way to fix the work life balance situation is for Congress to remove the overtime exemption laws for accountants, or at least public auditors. This is the only real solution. All firms will have to play by the same rules, audit firms will maintain their margins by raising fees. This is the lynchpin of the entire profession.
Most every other solution relies on too many layers of cooperation between, firms, government, and industry that have no historical precedent for being effective. Finally, it’s time for an Enron-level scandal in accounting as a result of offshoring to India and the Philippines. The SEC should come up with an ESG task force for Big 4 firms that asks one simply question. How many hours of the audit were outsourced to the 3rd world for under $10/hr? It shouldn’t be over 10%, and it should be disclosed.
The fact is, if investors want audit quality, they are going to have to pay for it. And yes, big 4 audit partners deserve to make their 500-1.5m pay, just like law and banking partners make similarly large salaries. The result is that feels will rise, and the only way to ensure the staff are compensated is through repealing overtime exemption rules. As of now, debt-ridden college students are subsidizing corporate profits by working unpaid overtime. Let’s be real, no investor committee is going to balk at an audit fee going from 2m to 3m. And that’s what it’s going to take, about a 30% increase in fees to get any semblance of quality.
Most audit partners would be happy to split consulting off. Consultants “sell air”, and the only way to do that is by leveraging the reputation of audit. I worked over 20 years for a big-4, and rarely were tax, financial advisory and consulting partners more profitable in their book of busines than audit partners. Sure, they had big revenue numbers, but their contribution to the bottom line was about the same.
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