“Quality means doing it right when no one is looking.”  ~ Henry Ford

 

If quality is at the core of the audit function, why audit the auditor, some may ask? The answer – with all due respect to Mr. Ford – is that quality is often enhanced when someone is ‘looking.’ In fact, even the threat of ‘looking’ can impact an auditor or company being audited.

 

The good news: Communications between auditors, audit committees is going well

 

It’s therefore good news that the overseer of public company audits, the Public Company Accounting Oversight Board, announced yesterday that, based on its inspections of audit firms conducted in 2014, 93% of audits are in compliance with the PCAOB’s standard on Communication with Audit Committees.

 

But, is that ‘enough’? Communications between auditors and audit committees are going well, but what is being discussed?  Although the bulk of those discussions presumably covers issues specific to a company’s financial reporting and audit, what about the deficiency rate identified by the PCAOB on the firms’ compliance with PCAOB auditing and quality control standards?

 

The not-so-good news: Audit deficiencies on the rise

 

Close to one year ago, on May 7, 2015, the PCAOB issued the first installment in a new outreach program called Audit Committee Dialogue (ACD).

 

The PCAOB’s initial ACD was significant in providing high level inspection results in a readily understandable manner, and in articulating specific questions that audit committees could direct to their auditors. Additionally, the ACD included information about emerging issues.

 

The four most predominant areas of audit deficiencies disclosed in the ACD last year, based on the PCAOB’s inspections of the six largest audit firms (BDO, Deloitte, EY, Grant Thornton, KPMG and PwC) in 2013, were: (deficiency rate in parenthesis, vs. 2010 rates unless otherwise indicated):

 

• Internal Control: auditing internal control over financial reporting (ICFR) (39%, almost doubled from 15%)
• Risk Assessment: assessing and responding to risks of material misstatement (26%, up slightly from 25% in 2012)
• Estimates: auditing accounting estimates (13%, up from 8%), including fair value measurements (11%, a small reduction from 15%)

 

The PCAOB also cautioned audit committees on the risks associated with ‘referred’ audit work conducted on affiliates of U.S. companies overseas, on which the overall deficiency rate had doubled, from 21% in 2010, to 42% in 2013.

 

International Inspection Results Reported by IFIAR

 

The 42% overall deficiency rate found by PCAOB inspectors on cross-border ‘referred’ audits approximated the 43% overall deficiency rate (down from 47% in 2014) for global audits generally, based on a report issued earlier this year by the International Forum of Independent Audit Regulators (IFIAR)..

 

The largest categories of deficiency findings also closely tracked the U.S. audit inspection results, with IFIAR’s 2015 Survey Inspection Findings reporting the largest categories of deficiencies by the six largest international accounting firm networks as follows (Note: these results are for audits of ‘public interest entities’ or PIEs, which include companies listed on an exchange, and financial institutions)

• Internal Control Testing (23% down slightly from 24%)
• Allowance for Loan Losses (22%, up from 13%)
• Inventory (19% up from 16%)
•  Fair Value Measurement (18%, down from 20%)
•  Risk Assessment (14%, doubled from 7%)
•  Revenue Recognition (15%, up from 14%)

 

Lew Ferguson, Chair of IFIAR’s Global Audit Quality Working Group, observes that, “Tracking inspection findings gives IFIAR a better understanding of trends and recurring issues in inspections through the perspective of the member regulators, and supports an indepth conversation with the global networks about audit quality.”

 

SIFI: Present, past and future

 

IFIAR also reported aggregate inspection results for Systemically Important Financial Institutions (SIFI’s), including Global SIFI’s (G-SIFI’s), with the largest number of deficiencies (vs. 2014) found in:

• Internal Control Testing  (40%, up from 27%)
• Audit of Allowance for Loan Losses and Loan Impairments (51%, up from 17%)
•  Insufficient Challenge and Testing of Management’s Judgments (42% up from 14%)
• Valuation of Investments and Securities (27%, unchanged since 2014)
• Use of Experts and Specialists (26%, up from 11%)

 

In response to a question about communications between IFIAR and financial institution regulators, Ferguson said, “IFIAR meets regularly with the Financial Stability Board to discuss its inspection survey findings relating to systematically important financial institutions (SIFIs), which include Global SIFIs, the largest financial institutions. In fact, the survey was originally launched in part to respond to a request from the FSB for more information about these specific audits.”

 

Six largest international audit networks commit to 25% reduction in audit deficiencies

 

The ‘indepth conversation’ between IFIAR and the global audit networks referenced in Ferguson’s comments further above, included a commitment by the six largest international audit networks to reduce audit deficiencies by 25% within the next four years.

 

Related developments

 

It will be interesting to see if a discussion of audit quality, specifically relating to inspection findings, will be on the agenda for the upcoming PCAOB Standing Advisory Group (SAG) meeting slated for May 18-19.

 

Separately, the growth in cross-border business, audits and regulatory influence is a factor in an AICPA proposal to further evolve its joint venture with the Chartered Institute of Management Accountants (CIMA). The proposal would bring together the operations and strategy of the two associations under a single umbrella, while maintaining the separate membership bodies, with a combined membership of over 600,000 members worldwide. Read more in Acting Today for a Stronger Profession Tomorrow, and CPAs to Vote on Plan to Create International Association.

 

With a whirlwind of activity on the accounting, auditing and U.S. Securities and Exchange Commission front (including an open commission meeting moved to April 13 on, “whether to issue a concept release …on modernizing certain business and financial disclosure requirements in Regulation S-K” – aka the Disclosure Effectiveness project) and with tax season coming to an end, another quote may come in handy: 

 

 “If you can’t explain it simply, you don’t understand it well enough.” ~Albert Einstein