The Public Company Accounting Oversight Board (PCAOB) on Nov. 1 issued its 2020 annual inspection reports for the largest U.S. audit firms, including each of the Big Four, BDO, and Grant Thornton.
PwC fared best of the group, with only 1.9 percent of its inspected financial statement audits identified as having significant deficiencies. This outcome was a significant improvement from 2019 (30 percent) and the three prior years that all had double-digit deficiency percentages.
Next behind PwC among the Big Four was Deloitte at 3.8 percent, followed by EY (15.4 percent) and KPMG (26.4 percent). All four experienced improved inspection results from 2019, continuing a three-year trend of declining deficiencies at each firm except PwC.
The PCAOB focused its 2020 inspection procedures on how firms addressed areas of current audit risk and emerging topics. Because of the potential impact of COVID-19 on audit procedures, inspections focused on audits of issuers with fiscal years primarily ending in 2019 and the first half of 2020.
Following are further details of the inspection findings for each Big Four firm.
Only one of PwC’s 52 audits reviewed returned significant deficiencies, compared to 18 of 60 in 2019 (30 percent). Its performance bucked a trend of three straight years of increasing deficiency percentages.
The lone deficiency related to testing controls and overreliance on controls, which was a repeat finding from 2019 inspections (6 of 60 audits reviewed). This issue was noted in the audit areas of revenue and inventory.
Other instances of noncompliance primarily related to audit committee communications, including not making required communication of other accounting firms that performed audit procedures (4/17) and of the nature and scope of tax services the firm provided (1/14). There were findings relating to critical audit matters (CAMs) consisting of not including in evaluation procedures matters communicated to the audit committee about material accounts or disclosures (4/46) and using language in the audit report communication of a CAM that was inconsistent with the audit documentation (2/46). There were also findings of inaccurate or omitted information relating to audit participation by other accounting firms in Form AP filings (5/16).
“Our 2021 audit quality report addresses how we provide our people with the support and tools they need to maintain independence, uphold our values, and execute a quality audit,” said PwC U.S. Chair and Senior Partner Tim Ryan and U.S. Vice Chair – Trust Solutions Co-Leader Wes Bricker in response. “It provides an update on how we have delivered on our audit quality objectives over the past unprecedented year as we navigated the disruption caused by the COVID-19 pandemic.”
Deloitte & Touche
Deloitte had recorded the best performance among Big Four firms each of the previous three inspection years.
Significant deficiencies for Deloitte went down to 3.8 percent (2 of 53 audits) from 10.3 percent (6/58) in 2019. The firm’s identified deficiencies in 2020 were in auditing revenue and accounts receivable. They included insufficient testing to address an identified risk and insufficient procedures related to audit scope, roll-forwards, and substantive analytical procedures.
How second-tier firms fared
The PCAOB on Nov. 1 also published its 2020 inspection reports for Grant Thornton and BDO. Here are the highlights:
Grant Thornton’s significant deficiencies went down to 17.2 percent (5 of 29 audits) from 22.6 percent (7/31) in 2019. Deficiencies were due to insufficient tests of controls and substantive testing and insufficient evaluation of issuers’ assumptions relating to fair values. Deficient audit areas included revenue (3), business combinations (1), and cash and equivalents (1).
BDO’s significant deficiencies increased to 54.2 percent (13 of 24 audits) from 42.3 percent (11/26) in 2019. 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. Deficient audit areas included revenue and related accounts (8), business combinations (3), and income taxes (2).
In both 2020 and 2019, there were deficiencies in control and substantive testing of revenues.
Other noncompliance findings were failing to include all relevant workpapers in audit documentation (5/53), a repeat from 2019 and 2018; not including all matters that were, or were required to be, communicated to the audit committee regarding material accounts or disclosures in their procedures related to their determination of CAMs (12/34); and not making required communication to the audit committee about critical accounting policies and estimates (2/34).
“Our outstanding results in the 2020 PCAOB inspection report are reflective of our continued focus on executing high-quality audits and further illustrate our position as the sustained leader of audit quality,” Deloitte stated. “… While we are proud of our recent inspection results and market-leading growth, we are relentlessly focused on continuous improvement.”
Ernst & Young
EY’s significant deficiencies declined to 15.4 percent (8 of 52 audits) from 18.3 percent (11/60) in 2019. Deficient areas identified primarily related to insufficient testing of data or reports used in substantive testing, failing to obtain sufficient audit evidence because of overreliance on and insufficient testing of controls, and not evaluating significant assumptions or data used by management in developing estimates—a continuation of similar findings in 2019 and 2018.
The areas with the most frequent deficiencies in 2020 were revenue and related accounts (5), inventory (2), and goodwill and intangible assets (1). In both 2020 and 2019, EY’s revenue deficiencies related to control and substantive testing, including controls over systems. Inventory deficiencies in 2020 were the same as those noted for revenue and related accounts.
EY was further cited for failure to comply with required audit committee communication related to its conclusion about going concern (1/10) and for omitted information relating to audit participation by another accounting firm in a Form AP filing (1/14).
“We respect and value the PCAOB’s inspection process, which helps us identify areas where we can continue to improve and strengthen audit quality to the benefit of investors, other stakeholders, and the capital markets in general,” said EY U.S. Chair and Managing Partner Kelly Grier and U.S. Vice Chair of Assurance John King in response. “Our ongoing dialogue with the PCAOB inspection team, through both the inspection and reporting processes, continues to help us identify areas where we can enhance our auditing and quality control processes.”
Significant deficiencies for KPMG declined to 26.4 percent (14 of 53 audits) from 29.3 percent (17/58) in 2019. Despite its annual improvement since reaching 50 percent in 2017, KPMG had a significantly higher deficiency rate than its Big Four peers.
The firm’s most common deficiencies in 2020 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.
Issues were most frequent in the audit areas of revenue and related accounts (5) and investment securities (4).
In 2020 and 2019, deficiencies in revenue and investment securities related to testing of controls and substantive testing. In both years, deficiencies in the allowance for loan losses and goodwill and intangibles related to tests of controls.
Among other instances of noncompliance were not including all matters that were communicated to the audit committee regarding material accounts or disclosures in their procedures related to their determination of CAMs (5/39) and not communicating in writing and documenting discussions related to certain tax services (1/10).
“We value and respect this process and have reviewed the observations identified in Part I of the report,” said KPMG Chair and CEO Paul Knopp and Vice Chair - Audit Scott Flynn in response. “We have taken appropriate actions to address the engagement-specific findings in accordance with PCAOB auditing standards as well as our own policies and procedures.”
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