Representatives from the Public Company Accounting Oversight Board (PCAOB) had one overarching message at the Baruch College auditing conference on Tuesday: the overseer is “laser-focused” on investor protection and is gunning for auditing firms that are reckless or negligent.
PCAOB Chair Erica Williams, appearing in a pre-recorded video shown to the 75 or so auditors, policymakers, and academics in attendance, emphasized the record $11.9 million in fines the PCAOB has hit auditors with in calendar year 2023. Williams promised more enforcement actions penalizing firms for audit deficiencies before the year was out.
The “more” arrived two days later when the board announced three enforcement orders against China-based auditing firms, totaling $7.9 million in fines. That included $7 million in penalties levied against PwC Hong Kong and PwC China for “failing to detect or prevent extensive, improper answer sharing on tests for mandatory internal training courses.”
The PCAOB only gained access to the audit work of China-based accounting firms last year, with the passage of the Holding Foreign Companies Accountable Act. The PCAOB is on an aggressive schedule to inspect the audits of U.S.-listed companies performed by Hong Kong and mainland China firms, Williams said. “Under our current schedule, our teams will complete a full three-year cycle of inspections in just 27 months.”
PCAOB inspections of the work of U.S. public accounting firms uncovered a high percentage of audits with deficiencies in 2022. But regulatory fines, monitors, and bans from the profession won’t solve all of the industry’s issues.
“Ultimately, the responsibility falls on audit firms to correct the problems that lead to deficiencies in their audits.”
George Botic, a board member who has worked for the PCAOB since 2003, said auditors and audit committees have “a more clear and direct responsibility” for audit quality than issuers or regulators. Sharing audit inspection results will lead to company boards and audit committees to hold audit firms accountable, said Williams.
Ultimately, “the responsibility falls on audit firms to correct the problems that lead to deficiencies in their audits,” she said.
Public company auditors follow myriad rules, principles, and documentation requirements, and the PCAOB launched a bevy of proposed updates to U.S. auditing standards this year. They addressed core auditing principles and responsibilities, including reasonable assurance, professional judgment, due professional care, and professional skepticism.
But Botic, appearing in person at Baruch, blamed audit firms’ larger problems — like alleged cheating on CPA ethics exams — on their cultures: “It has become increasingly clear to me that audit firms need a clear culture [of audit quality] to drive the right behaviors, which in turn are necessary to ensure the consistent execution of high-quality audits,” he said.
Essential to addressing audit firm culture, Botic said, was for firms to ask the following: “What is the firm’s tone at the top and tone at the middle? What is being rewarded (e.g., coming in under budget, keeping the client happy)? Is high audit quality being rewarded equal to the assessment of financial penalties for instances of poor audit quality?”
The prolonged and sometimes bitter criticism of public accounting firms extends beyond simple standards and practices to business models and market incentives.
But that doesn’t mean auditors can’t up their game working within the existing framework. On individual audits, the Securities and Exchange Commission’s Office of the Chief Accountant (OCA) had some general recommendations on how to improve. In short, firms need to take the “skillful audit” approach rather than the “limit” approach, said Anita Doutt, senior associate chief accountant at the OCA (which oversees the PCAOB).
In the limit approach, an audit firm does “check the box” audit planning, focusing on “what it can look away from, performing the bare minimum in compliance with the standards to support the conclusions in the audit report,” said Doutt.
In the skillful approach, the auditor focuses not only on minimal requirements “but also on what they should review and inspect, thereby engaging in a robust comparative audit process that supports high quality, reliable financial reporting,” she said.
No auditors should be content with the limit approach to auditing, Doutt said, especially in areas like fraud detection — likely to be a battleground in 2024 due to the proposal to require auditors to detect noncompliance with laws and regulations — and auditor independence.
“Sometimes we see audit teams that don't know why they're testing journal entries."
Chief Auditor, PCAOB
Doutt said a practical application of the limit approach to auditor independence is when firms consider “how close to the line can they go without having a per se violation of [the] standard.”
While new technologies like artificial intelligence, already partly in use at the Big Four, will make auditors more efficient and increase the number of transactions that can be reviewed, it won’t matter much if auditors are just going through the motions, said Barbara Vanich, chief auditor of the PCAOB.
“Sometimes we see audit teams that don't know why they're testing journal entries,” she said. “It doesn't matter whether they have no tool or the most sophisticated technology if they don't understand where things [can] go wrong. And they sometimes waste time looking in the wrong place.”