Audit regulators are beginning to look at how they might evolve their approach to inspections to spend less time looking at the highest-risk audits.
Audit quality has improved, and regulatory inspections have helped drive that improvement, but it might be time to retool the inspection approach to reach the next level, said Jeanette Franzel, a member of the Public Company Accounting Oversight Board, in a speech at a financial reporting conference. “We are currently exploring the potential for more random selection of audits and audit areas to inspect,” she said.
Currently, the PCAOB follows a risk-based approach to selecting audits for inspection, specifically targeting the audits where inspectors are most likely to find deficiencies. That has led to hundreds of inspection reports that in recent years have produced alarmingly high numbers of deficiency findings. Now the board is considering whether at least some audits should be selected randomly, she said, to help assess compliance in areas the PCAOB currently does not inspection. “This may provide information about how firms’ quality control systems are operating across a wider span of issuer audits,” she said.
The board hears different views on what it might find it if were to select audits for inspection more randomly, according to Franzel. “Some have speculated that the less risky audits may have lower incidences of audit deficiencies due to less complexity inherent in those audits, while others speculate that audit deficiencies could actually be higher in that group due to less focus and attention being placed on those audits by the firms,” she said.
Another possible change to the inspection approach would be to focus more on a firm’s quality control system than on audits themselves, said Franzel. Currently, quality control is judged based on the number and types of audit deficiencies that are identified, along with testing certain aspects of quality control. “In my optimistic view, we could see a time when a large firm improves its quality control system so that it prevents audit deficiencies,” she said.
Under that scenario, a PCAOB inspection look more at that quality control system that is the basis for producing high audit quality work. “Such an approach could be highly efficient and effective at catching quality control weaknesses early, with a focus on preventing audit deficiencies,” Franzel said.
Cindy Fornelli, executive director of the Center for Audit Quality volunteered a statement in response to Franzel’s suggestions, supporting the idea but encouraging plenty of study and caution before big changes are made. “As the PCAOB explores changes to the inspection process, it will be critical to continue to engage in a robust dialogue with the profession and the public about how the board is inspecting and evaluating the work of public company auditors,” she said.
Franzel’s speech also offered a rare view into the scope of the PCAOB’s enforcement efforts. Under Sarbanes-Oxley rules, the board’s disciplinary proceedings are completely private when allegations are made and cases are investigated and litigated, unless those who are party to the action agree to make it public. As such, the public has little visibility into what kinds of cases are pending.
With no names but plenty of numbers, Franzel provided a statistical snapshot of the PCAOB’s enforcement history and current caseload:
160 -- enforcement proceedings resolved through March 31, 2016, since the board was created under Sarbanes-Oxley
125 -- sanctions against firms
112 -- sanctions against associated persons
86 -- bars against individuals to associate with a registered firm (29 are permanent; 57 include the right to petition for termination of the bar)
64 -- revocations of PCAOB registrations (36 are permanent; 29 include the right to petition for termination of the bar)
11 -- suspensions
2 -- cases where the PCAOB granted petitions to terminate bars
1 -- firm that escaped disciplinary action under the board’s policy to give credit for extraordinary cooperation
1 -- disciplinary order that includes an admission of facts, findings and violations
0 -- PCAOB action on petitions to terminate a revocation of registration
0 -- cases where parties to an action consented to public proceedings, although the PCAOB “routinely” seeks consent as permitted under Sarbanes-Oxley.
18 -- actions involving cross-border audits in countries such as Australia, Denmark, Hong Kong, India, Indonesia, Israel, Italy, Japan, Malaysia, Nicaragua, and Spain
no numbers -- a “robust pipeline of cases” focused on the following additional “priority” areas: lack of independence and integrity of the audit, lack of professional skepticism associated with serious audit deficiencies, and non-cooperation with the board's inspection process or enforcement proceedings.