The Truth About Public Accounting, Part II: PCAOB Inspection Hysteria — How to Fix It

While there is a consensus that the PCAOB’s existence has improved audit quality, it is also clear that the PCAOB has contributed an unhealthy level of hysteria to the auditing profession. That hysteria has led some professionals to make horrible choices (as seen in the KPMG inspection selection leak scandal). That hysteria has also driven good people out of public accounting at a time when the profession really needs to retain good people.

In my book, The Truth About Public Accounting, I describe how heavy workloads in public accounting have contributed to turnover that has undermined engagement continuity, experience levels, and supervision. This business model is inherently inefficient and undermines audit quality. There is no doubt that the hysteria arising from the prospect of PCAOB inspections has made the workload/turnover/supervision problem even worse. We should all be concerned.

In fairness to the PCAOB, a certain amount of inspection anxiety stems from audit professionals not having sufficient time, experience, and supervision to achieve the level of quality expected by the PCAOB. That is an audit firm problem, not a PCAOB problem. While it might be easy for the audit firms to point to the PCAOB as the villain, the audit firms need to look in the mirror. The best way to take the stress out of the inspection process is to rework the audit firm business model to give auditors the time, experience, and the supervision they need to achieve the level of quality expected by the PCAOB.

To date, the PCAOB’s approach to improving audit quality has been to identify deficient auditing and leave it up to the audit firms to figure out how to fix the deficient auditing. Improvements to the business model have not occurred because the business model is directly connected to a sacred cow: audit firm profitability.

In 18 years of standard setting, none of the PCAOB’s enacted standards have done anything to improve how the audit firms manage (or mismanage) their human capital. This needs to change. There has been some recent fleeting hope for change. The PCAOB issued a long-overdue concept release in December 2019 titled: “Potential Approach to Revisions to PCAOB Quality Control Standards.” This concept release discusses potential revisions to the PCAOB’s archaic quality control standards that largely pre-date the failure of Arthur Andersen and the audit failures of Enron, WorldCom, Tyco, HealthSouth, Adelphia, and Waste Management.

In my public response to the PCAOB’s concept release, I described how upgraded quality control standards could improve human capital management and audit quality by defining safe zones of operation for audits—with mandatory reporting to the audit committee when an individual audit is operating outside of pre-defined safe zones (i.e., excessive workloads, excessive turnover, low continuity, low experience levels, low levels of supervision, and the failure to meet project milestones for review of interim work and work performed by specialists). The reporting to the audit committee would also describe the remedial action taken by the audit team to assure that audit quality was not compromised by operations outside of the safe zones.

As it stands now, audit committees and investors typically do not know whether their audit was a victim of human capital mismanagement. A little transparency here can change that. If the incumbent auditor can’t deliver better workloads, experience levels, continuity, and supervision—audit committees should be looking at competing firms with a demonstrated track record of delivering experience using the metrics and processes described in The Truth About Public Accounting.

One caveat: Safe zones of operation will not guarantee audit quality, but it will improve each audit team’s foundational ability to conduct an audit of high quality. Conversely, audit operations outside of the safe zones will be significantly challenged to deliver audits of high quality. Audit committees and investors will be much better served with this information than without.

The PCAOB has unfortunately signaled that it will likely mimic the quality controls set forth by the International Auditing and Assurance Standards Board (IAASB) in its draft of International Standard on Quality Management 1 (ISQM 1)—for the sake of aligning global quality control standards. I do not see that approach leading to a meaningful change in how the audit firms manage (or mismanage) their human capital. That approach would be the easiest approach for the PCAOB to follow but not the best approach for the PCAOB to follow for the sake of the profession, audit committees, and investors.

I recently published The Truth About Public Accounting to draw attention to these and other issues confronting the profession. My book identifies everything I wish I understood when I first entered the profession. There is no shortage of conflicting pressures that can make your head spin and undermine good judgment. Whether you are an auditor, prospective auditor, investor, audit committee member, or regulator, it is important that you understand the Truth About Public Accounting.

You can learn more about my book on Amazon by clicking here.

About the author:

Robert Conway is a retired Big 4 audit partner and former leader of a PCAOB regional office. He currently provides expert witness services in controversies pertaining to GAAP and PCAOB compliance. Mr. Conway’s website is at www.TheTruthAboutPublicAccounting.com and his email address is RetiredAuditPartnerACAP@Live.com.

Related article:

The Truth About Public Accounting, Part I: How the Sausage Is Made and Those ‘Best Places to Work’ Surveys

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