Regulators explore what’s wrong with audit supervision

Audit regulators are clearly tuned into the notion that supervision is a problem in the audit profession—possibly a root cause behind persistent findings of deficiencies in audit inspections—but they haven’t quite sorted out how to address it.

The Public Company Accounting Oversight Board updated its standard on audit supervision several years ago and considered but never acted on additional guidance. Now the board is perhaps revisiting supervision in a longer-term project, according to its standard-setting agenda. Staff at the PCAOB are planning to develop a consultation paper to stoke discussion around how to get improvements in audit firms’ quality control systems.

That will include exploration of how firms assign and document supervisory responsibilities, according to the PCAOB’s agenda. “The staff is exploring whether changes to PCAOB quality control standards—including improvements related to assignment and documentation of firm supervisory responsibilities—could prompt firms to improve their systems of quality control,” the PCAOB says.

In a broader initiative to try to identify indicators of audit quality so they can be better managed, the PCAOB also is exploring the extent to which “staffing leverage,” or the ratio of audit partners to professional staff, is a factor in audit quality. In the PCAOB’s concept release exploring indicators of audit quality, the PCAOB says “sufficient time to oversee the work of the audit staff is typically critical to quality.” The concept release provides a detailed illustration of how audit quality might be affected by staffing leverage and workloads for both partners and audit staff.

The PCAOB has noted supervision concerns directly in inspection reports as well. In a republished 2008 report for PwC, for example, where concerns about quality control were published after the firm failed to address them to the board’s satisfaction, inspectors said many of the quality control issues identified in its report relate to deficiencies in supervision and review activities. “This observation provides cause for concern about the effectiveness of this critical aspect of the audit process, including the timing and quality of the supervision and review activities and the attention devoted by senior members of the engagement team to such activities,” inspectors wrote.

“There is this inference that we keep finding engagements where we think the auditing standards aren’t being followed properly,” says Phil Wedemeyer, an audit committee member at Atwood Oceanics and a former auditor and staff member at the PCAOB. “That means the firms don’t have the right answer to supervision. That’s the noise in the system. I haven’t seen anything yet that says they have their finger on that.”

Audit firms disclose staffing data in Form 2 filings with the PCAOB, but those filings do not require a breakdown of partners compared with staff or more junior auditors. Instead, the form requires the number of accountants, the number who are certified or licensed, and the total personnel.

“There is this inference that we keep finding engagements where we think the auditing standards aren’t being followed properly. That means the firms don’t have the right answer to supervision. That’s the noise in the system.”

Phil Wedemeyer, Audit Committee Member, Atwood Oceanics

In voluntary disclosures through annual “transparency reports,” some audit firms provide data to show the ratio of partners to staff auditors. PwC, for example, provides total numbers for partners and other audit staff that suggest its ratio of partners to other audit staff in 2015 was 1:12.4. That's more staff for partners to manage than in 2014, when the ratio was 1:11.4, or in 2013 when it was 1:11.6. EY says in its 2015 report that its ratio of partners to all professional staff was 1:9.7 in 2015, or fewer staff for partners to manage than in 2014, when it was 1:9.1, or in 2013 when the ratio was 1:8.9—but it’s not clear whether those numbers were calculated in the same way. KPMG and Deloitte do not publish comparable data, and none of the Big 4 firms agreed to discuss the subject. That makes true comparability across the firms impossible.

Jeff Burgess, national managing partner of audit services at Grant Thornton, says he would expect staffing ratios to be more consistent across the Big 4 in the range of 1:12 to 1:15, with the next tier of audit firms in the range of 1:8 to 1:10. “I think you would typically find the bigger four firms having a higher number of employees per partner than we do,” he says.

Wedemeyer says he has no doubt audit firms are closely counting and tracking their staffing ratios. “It’s a quality control metric, and it’s a profitability metric,” he says. A lower ratio would suggest each partner has more time to supervise the staff under his or her charge, but a higher ratio would suggest a more profitable practice, he says.

That tension between quality and economy has led to regulatory concern over the audit profession’s business model, says Bob Conway, a retired audit partner and former staff member at the PCAOB. “One of the greatest risks the audit firms bring to each audit lies in the audit firm’s business model,” he says. “Yet those charged with procuring audit services typically have had little insight into the audit firm business model and how that model might vary from firm to firm.”

EY AUDIT EXECUTIVE INVOLVEMENT

Below EY describes how audit partners and professional staff are involved in audit quality.
We believe that audit quality is enhanced by timely, direct executive participation in audits. We annually review the assignment of partners to the entities that we audit to make sure the partner in charge has the knowledge, skills, abilities, experience and capacity to fulfill his or her responsibilities, and we comply with the audit partner rotation requirements.
Providing appropriate supervision and on-the-job coaching for our people is very important to the delivery of quality audits. The ratio of partners to all professional staff has risen due to our significant investment in hiring staff-level professionals, as described in section 3. We are continuing to provide appropriate supervision and coaching for our more junior professionals.

Source: EY

Audit committees—the buyers of the audit service—could benefit by having more data on how the audit business works, says Conway. “Until now, audit committees have had limited information to distinguish one Big 4 firm from another, beyond the industry expertise,” he says. “As a consequence, audits are priced like commodities and audit professionals are squeezed for productivity and audit quality in an attempt to make it all work. The information void about the audit firm business model has undermined the ability of free enterprise to work its magic.” Conway is hopeful that concept will take root as the PCAOB considers audit quality indicators and decides on how to move forward with that effort.

In the absence of any hard data, audit experts are advising audit committees to ask lots of questions. Ron Steger, a retired KPMG partner now serving as an audit committee member at Overseas Shipholding Group, says he has studied the PCAOB’s concept release on audit quality indicators and wants to incorporate some of the ideas into audit committee activities sooner rather than later. “Audit committees can go through what these indicators are and consider their approach,” he says.

The release explores a number of questions related to audit quality, and some of them are good questions for audit committees to ask, Steger says. “How many public company audits does this partner sign?” he says. “And for the reviewing partner, how many engagements does that partner handle?” Those are indicators of the audit leaders’ workloads, which will give an indication of how much time will be devoted to individual audits. “I got very few questions like that when I was in practice,” he says.

Tom Ray, former chief auditor at the PCAOB now an independent consultant and lecturer at Baruch College, says audit committees should ask questions so they understand how an audit will be conducted. “If they don’t have an idea of how the audit team is structured or if the roles or responsibilities are not clear, it seems it would be difficult for them to truly exercise oversight,” he says.

Different engagements will logically be staffed differently depending on facts and circumstances, says Ray, especially the nature of the company and the risk that is identified. “On complex engagements, audit staffing is going to look much different,” he says. “At a minimum, audit committees will want to talk to the audit partner to understand: What is your plan to deal with the riskiest areas? What level of staff is responsible for this, and how many people do you have on it?”

Dan Goelzer, former acting chair of the PCAOB now a partner at law firm Baker & McKenzie, says there’s no clear-cut equation for the right staffing level on any given engagement, but audit committees would be wise to ask questions. “Look at the work loads of the people on the engagement team,” he says. “How many hours are they working during peak periods? I’m not sure any of this can be reduced to a formula, but through dialogue you can get a sense of at least how an engagement partner is supervising the work.”