Regulators are beginning to experiment with a more randomized approach to audit inspections, exploring whether it might provide auditors with a greater incentive to do their best work, and they are considering providing data analysis of inspection results.
Jim Doty, chairman of the Public Company Accounting Oversight Board, said the board’s Center for Economic Analysis has opened a project to study inspection results statistically and consider whether the PCAOB should allocate some portion of its inspection resources to randomly selected audits. Currently, the board follows a well-refined risk-based process to select engagements for inspection, searching for the audits that are most likely to contain problems, as well as the areas within those audits that are most likely to be problematic.
“Could some randomization help us make better inferences about how pervasive audit deficiencies may be?” said Doty in remarks to a national conference of the American Institute of Certified Public Accountants. “Could some random selection increase the deterrent effect of our inspections program?”
In today’s inspection process a “very small percentage” of inspections are conducted on audits selected randomly rather than based on risk, said PCAOB member Jay Hanson in a discussion with members of the media at the conference. “We are having some economists and statisticians help us look at what we’re doing and evaluate: is there a better way to get a more well-rounded picture of audit quality and not just on the toughest areas?”
While inspectors may choose a small percentage of audits randomly, they still look at the classic tough areas in those audits, like revenue recognition, fair value, estimates, and internal controls, said Hanson. “The things we go to look at are the same troublesome areas we find in other audits,” he said. “We’re not looking randomly at everything the team did in the audit.”
Early results of the statistical analysis of inspection results are intriguing to Doty. “When we identify a significant deficiency in an engagement, such that the audit report should not have been issued when it was, most firms now tend to agree with our finding,” he said. “We've learned that, the next year, both the engagement partner who had the deficiency and other engagement partners in his or her office react in a positive manner. There is a spillover effect.”
According to the emerging data, “We see a statistically significant increase in effort by the engagement partner and quality reviewer,” said Doty. “We see a statistically significant decrease in restatement risk. And we see no statistically significant change in fees.”
On the other hand, when inspectors find no deficiency that merits inclusion in the inspection report, “then we tend to see a statistically significant decrease in effort and increase in restatement rate,” Doty said. “This is consistent with a hypothesis that, after such an inspection, the spotlight is perceived to move on.”
In addition to experimentation with random audit selection, the PCAOB also is exploring whether to begin posting data that arises from its inspection process on its website, said Helen Munter, director of inspections for the PCAOB. Even after long discouraging calculation and scrutiny of deficiency rates in audits, the board is discerning whether and how to make data available because it recognizes the public has an interest in it, she said.
“It will be good information as to what the findings have been, what the numbers have been, what the trend lines are,” said Munter. “The analysis of the data is what’s truly important, and that is what we hope to provide.”