The Public Company Accounting Oversight Board (PCAOB) issued its 2019 annual inspection reports on Feb. 2 for the seven largest U.S. audit firms, including each of the Big Four, BDO, Grant Thornton, and RSM.
For the third year in a row, the best performance out of the Big Four came from Deloitte, with only 10.3 percent of its inspected audits having significant audit deficiencies. The firm was at 11.5 percent for 2018 after a Big Four-best 20 percent a year prior.
Next behind Deloitte for 2019 was EY at 18.3 percent, followed by KPMG at 29.3 percent. PwC rounded out the pack with its decline to 30 percent.
The reports were in the new format introduced last year, with streamlined content, more tables and charts, and classified deficiencies. Significant audit deficiencies (Part I.A) are those where the PCAOB believes the firm, at the time it issued its audit report, had not obtained sufficient appropriate audit evidence to support its opinion on the issuer’s financial statements and/or internal control over financial reporting. Other deficiencies (Part I.B) are instances of noncompliance but do not relate directly to evidence the firm obtained to support its audit opinion.
Below is a deeper dive into findings for each of the Big Four firms:
Significant deficiencies for Deloitte went down to 10.3 percent (6 of 58 audits) from 11.5 percent (6/52) in 2018. The firm’s most identified deficiencies related to insufficient testing of the design or operating effectiveness of the controls selected for testing and, in some cases, overreliance on controls and not performing substantive testing. There were also findings the auditors did not sufficiently evaluate significant assumptions or data used in developing estimates.
Areas where deficiencies were most frequently noted included revenue and related accounts (2), inventory (2), investment securities (1), and intangible asset impairment (1). In both 2019 and 2018, there were deficiencies in both control and substantive testing of revenues.
Other noncompliance findings were failing to include all relevant workpapers in the audit documentation (7/55), a repeat finding from 2018, and failing to review and retain management representations relating to foreign affiliates (3/14).
In response to the inspection report, Deloitte & Touche Chair Lara Abrash and Deloitte CEO Joseph Ucuzoglu reaffirmed executing high-quality audits is the firm’s No. 1 priority. “In order to drive continuous improvements in quality, we are transforming the audit to leverage innovative technologies, along with enhancing the skillsets of our talent to prepare them for a digitally driven future,” they said. “We are confident that our ongoing digital transformation, along with the investments we continue to make in our audit processes, policies, and quality controls, are resulting in significant enhancements to our audit quality.”
EY’s significant deficiencies declined to 18.3 percent (11 of 60 audits) in 2019 from 25.9 percent (14/54) in 2018. The areas identified in 2019 primarily related to testing design or operating effectiveness of controls and testing controls and/or substantive testing over accuracy and completeness of data or reports.
The areas with most frequent deficiencies in 2019 were revenue and related accounts (7), business combinations (2), and long-lived assets (2). In both 2019 and 2018, EY’s revenue deficiencies related to control and substantive testing, including controls over systems, and the business combination deficiencies primarily related to testing controls and evaluating reasonableness of management’s assumptions relating to fair values of assets acquired and liabilities assumed.
Like Deloitte, EY was noted for noncompliance for failing to review and retain management representations relating to foreign affiliates (2/14).
“Performing high-quality audits with independence, integrity and professional skepticism is at the heart of our responsibilities as auditors. While we are facing significant uncertainties in our working world and society in general right now, our commitment to audit quality remains constant,” said EY U.S. Chair and Managing Partner Kelly Grier and U.S. Vice Chair of Assurance John King in response.
How second-tier firms fared
The PCAOB also published 2019 inspection reports for RSM, Grant Thornton, and BDO, with each showing improvement from 2018. Here are the highlights:
RSM’s significant deficiencies declined in 2019 to 20 percent (3 of 15 audits) from 29.4 percent (5/17) in 2018. The firm’s most common deficiencies were insufficient tests of controls and substantive testing and insufficient evaluation of significant assumptions or data the issuer used to develop estimates. Problem audit areas included revenue and related accounts (3) and business combinations (3).
Grant Thornton’s significant deficiencies decreased slightly in 2019 to 22.6 percent (7 of 31 audits) from 25 percent (8/32) in 2018. Its most common deficiencies were insufficient evaluation of the appropriateness of the issuer’s accounting method or disclosures for a transaction, insufficient tests of control and substantive testing, and insufficient evaluation of issuers’ development of estimates. Deficient audit areas included revenue (6), inventory (2), and goodwill and intangible assets (2).
For BDO, significant deficiencies went down to 42.3 percent (11 of 26 audits) in 2019 from 47.8 percent (11 out of 23) in 2018. The firm’s most common deficiencies related to insufficient tests of controls and substantive testing and insufficient evaluation of significant assumptions or data the issuer used to develop estimates. The audit areas of revenue and related accounts (8) and income taxes (3) were the most frequently deficient in both 2019 and 2018, with testing cited for both.
Links to all inspection reports are available on the PCAOB’s website.
Significant deficiencies for KPMG declined to 29.3 percent (17 of 58 audits) in 2019 from 36.5 percent (19/52) in 2018. The firm had been at 50 percent (26/52) as recently as 2017.
KPMG’s most common deficiencies in 2019 related to failure to perform substantive procedures because of deficiencies in testing controls and overreliance on controls, insufficient testing to address identified risks, and insufficient evaluation of significant assumptions or data the issuer used to develop estimates.
Deficiencies in 2019 were most frequent, and almost the same in number as 2018, in the audit areas of revenue and related accounts (9), business combinations (3), inventory (2), allowance for loan losses (2), and derivatives (2). In both years, the significant number of deficiencies in revenue related to testing of controls and substantive testing.
Other instances of noncompliance included failures to make required communications to audit committees about other firms participating in the audit (3/19) and omitted information on Form AP relating to audit participation by other accounting firms (2/20). There was also inaccurate language relating to description of a critical audit matter (CAM) in 1 of 3 relevant audits.
“We recognize the importance the capital markets places [sic] on high quality audits and consistently executing at that level is our highest priority,” said KPMG Chair and CEO Paul Knopp and Vice Chair - Audit Scott Flynn in response. “To that end, we remain dedicated to the continuous improvement of our audit engagement performance and our system of audit quality control.”
PwC’s significant deficiencies increased to 30 percent (18 of 60 audits) in 2019 from 25.5 percent (14 out of 55) in 2018. The firm has seen its deficiency percentage rise in each of the last three years after its 19.6 percent deficiency rate in 2016 led the Big Four.
PwC’s most common deficiencies related to insufficient testing of accounts to address identified risks, failure to perform substantive procedures because of deficiencies in testing controls and overreliance on controls, and insufficient evaluation of significant data or assumptions the issuer used to develop estimates.
Deficiencies in 2019 were most frequently noted in the audit areas of revenue and related accounts (9), income taxes (4), allowance for loan losses (3), investment securities (3), and inventory (3). There were significant deficiencies related to business combinations and loans and related accounts in 2018, but no deficiencies noted in these areas in 2019. Income taxes was a new deficiency in 2019, related to both tests of controls and substantive testing.
Other instances of noncompliance primarily related to audit committee communications, including not making required communication of other accounting firms that performed audit procedures (4/16), of relationships affecting the firm’s independence (1/12), and of the nature and scope of tax services the firm provided (1/12). There were also findings of inaccurate or omitted information relating to audit participation by other accounting firms (7/32), including late Form AP filings.
“Bringing value to the capital markets by consistently performing quality audits remains our top priority, including addressing the matters raised in the Report in a thorough and thoughtful way,” said PwC U.S. Chairman and Senior Partner Tim Ryan and U.S. Vice Chair – Assurance Leader Wes Bricker in response. … ”We appreciate that many of our stakeholders will review the PCAOB’s report and this response. We wanted to therefore take the opportunity to provide a link to our 2020 Audit Quality Report and our most recent mid-year update to encourage our stakeholders to learn more about our system of quality control and how we delivered on our audit quality objectives over the past year.”