We’re not sure how many more times it needs to be said and it’s shocking Public Company Accounting Oversight Board Chair Erica Y. Williams does not have severe audit firm-induced trichotillomania (to our knowledge) because here she is again warning auditors that the PCAOB is tired of them being so terrible at auditing.
To get her point across she had to write a whole-ass op-ed in the Wall Street Journal:
High-quality audits are essential to the integrity of U.S. capital markets and the protection of investors. As President George W. Bush said when signing the law creating the Public Company Accounting Oversight Board to oversee audits of public companies: “The fundamentals of a free market—buying and selling, saving and investing—require clear rules and confidence in basic fairness. The only risks—the only fair risks—are based on honest information.”
It is therefore unacceptable that audit quality is trending down for the second year in a row. A PCAOB report released Monday finds that when inspection reports are finalized later this year, PCAOB inspectors expect that approximately 40% of the audits they reviewed in 2022 will have had one or more deficiencies, in which the audit firm failed to obtain sufficient appropriate evidence to support its opinion. That is up 6 percentage points from 2021, which was 5 points higher than the deficiency rate in 2020.
This means audit opinions were signed without completing the audit work required to verify the financial statements. That is a serious problem at any rate, and 40% is completely unacceptable
The “Staff Update and Preview of 2022 Inspection Observations” Spotlight released this month [PDF] explains:
Audit deficiencies rose in 2022. In a concerning trend, the percentage of audit engagements reviewed that are expected to be included in Part I.A of an inspection report is higher in 2022, in nearly all firm categories, than in 2021. PCAOB staff expects approximately 40% of the audits reviewed will have one or more Part I.A deficiencies, up from 34% in 2021 and 29% in 2020. The most significant increase in 2022 was observed within the Global Network Firms (GNF) category of firms inspected by the PCAOB (including both U.S. and non-U.S. GNF). The following table illustrates this unsettling trend in the issuer program by firm category.
Cool. Firms are probably going to blame the decline in audit quality on the after-effects of the pandemic and staff shortages again to which Williams already has a snippy retort, expressed in prepared remarks given at the AICPA & CIMA Conference on Current SEC and PCAOB Developments in December:
[S]ome firms have told us that the combination of the COVID-19 pandemic, remote auditing, the Great Resignation, and the war for talent have made it difficult to maintain stable audit teams and provide training to newer hires.
As we near the end of 2022, these factors are no longer new, and no one should be caught off guard by the challenges they present.
And again in this WSJ op-ed:
Some firms point to the continuing effects of Covid-19, including the great resignation and heightened competition for talent. Three years after the pandemic began, these challenges are no longer new and firms should have a strategy to meet them.
At the same time, Covid-19 can’t simply explain away a 40% deficiency rate. Many of the deficiencies PCAOB inspectors identified have recurred for years, well before the pandemic.
Because threats, fines, and strongly worded prepared remarks don’t seem to be working to incentivize firms to get better at doing the thing they’re supposed to be doing, the PCAOB is now going to try public shaming. For this to effective they need the cooperation of the public and clients–both current and prospective. She says:
Transparency is one of the most powerful tools the PCAOB has to improve audit quality. Sharing our inspection results empowers audit committees and boards of directors—which are responsible for hiring auditors of public companies—to hold audit firms accountable directly.
As part of its efforts to improve transparency, earlier this year the PCAOB began including more information in our public inspection reports than ever before, including information about auditor independence violations. Last week we added more tools on our website to make it easier to compare deficiency rates across audit firms.
The tool she’s talking about makes the public portion of every inspection report easily searchable on the PCAOB’s website. And this data has been compiled in a data set available for download in CSV, XML, and JSON formats. It’s a bit awkward to use but as an example, say you want to search for inspection reports with a part I.A deficiency rate of 80 percent or higher. Gotchu:
Or, because the PCAOB has kindly provided a special search box, you can search the 3780 total results by firm for six global networks. Of those 3780 total results here’s the scoreboard for how many times each firm appears (note this is for all inspection reports, not only the terrible ones):
- BDO International Limited (68 results)
- Deloitte Touche Tohmatsu Limited (144 results)
- Ernst & Young Global Limited (165 results)
- Grant Thornton International Limited (70 results)
- KPMG International Cooperative (147 results)
- PricewaterhouseCoopers International Limited (166 results)
Writes Williams:
We hope boards of directors and audit committees will use PCAOB inspection reports to hold audit firms accountable for high-quality results and ask tough questions on behalf of their investors.
Audit committees should know the deficiency rate of the audit firm they hire and how it compares with other options. They should ask audit firms if the audits of their company have been inspected and, if so, for the results. They should find out whether the specific auditors who are assigned to work with their company have had their audits for other clients inspected and what the results were.
Similarly, investors should engage with investor relations and the audit committees of the companies in which they invest and encourage them to seek out audit firms with quality records.
In other words, she is straight up telling clients to avoid firms with terrible inspections. RIP Marcum.
If clients heed this advice, PwC will have its pick of the best clients and KPMG will be banished to the audit leper colony. That’s assuming upcoming inspections follow historical trends. EY hasn’t been doing so great in recent years, coming in at a 21.4 percent deficiency rate in its 2021 inspection — their worst since 2018 — and allegedly bracing themselves for bad grades this year so who knows where they’ll end up. Deloitte came in better than them at 13 percent but compared to themselves that’s the worst deficiency rate Deloitte has had since 2017 when they scored 20 percent.
For now we have to wait for the actual inspection reports but it’s not looking good for firms. Thus Williams ends her op-ed:
Ultimately, the responsibility falls on auditors to correct the problems that led to deficiencies in their audits. But accountability from their clients offers a powerful incentive to find solutions. The root causes of increased deficiencies vary from firm to firm, and there is no one-size-fits-all explanation for deteriorating audit quality.
Now is the time for solutions, not excuses.
Investors trust audits to verify the financial reporting that underpins our capital markets. Auditors must deliver quality results worthy of that trust.
Let’s circle back when inspection reports start coming out later this year.