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Audit Quality Is More Complex Than One Board’s Inspection Data

[By Dennis McGowan]

Aug. 31, 2023

An accounting regulator’s study that found a decline in audit quality of public companies doesn’t reveal the full picture of overall audit health, says Dennis McGowan of the Center for Audit Quality.

Audit quality is a continuous journey that requires constant attention from public company auditors and their primary regulator, the Public Company Accounting Oversight Board. PCAOB Chair Erica Williams recently called into question the overall quality of audits, based on the board’s inspection findings.

As a former public company auditor, I can say confidently that audit quality can’t be measured by inspection findings alone—investors and the public need to understand the fuller picture, which tells a different story.

PCAOB found that approximately 40% of 2022 audits inspected contained at least one error—a 6% increase over 2021. Auditors can always do better, and the profession works tirelessly to address any issues revealed by the board’s inspection process. But this data alone doesn’t suggest there’s a problem with audit quality. Even the board acknowledged the limitations of the inspection process, noting that the results don’t serve as a rating tool.

For the past 20 years, the PCAOB inspection program has selected a sampling from the thousands of audits performed in the US each year. In large part, the board selects audits and audit areas using a risk-based approach, focusing on highly complex areas that are more likely to have material misstatements. But others are randomly selected.

As someone who has lived through a PCAOB inspection, I know how the process can improve auditor performance. I worked hard on the audit that the PCAOB selected for inspection. I was confident in the decisions and conclusions we, as a team, reached to support the opinion. PCAOB inspectors reviewed the mix of prescription and judgment that is part of every audit, evaluating whether we adhered to their standards.

The result was an inspection finding that meant our team failed to collect sufficient evidence to support our opinion—a deficiency, in audit and PCAOB speak. A deficiency isn’t in itself an indication of low audit quality, but it requires remediating work to determine the impact on the audit.

I was stung, and so were my colleagues, because we all took pride in our work. But we learned and grew from this process. We gathered additional evidence to support our opinion, which stood without changes. And we went on to apply valuable lessons to future audits.

The PCAOB inspection results are just one indicator of audit quality. Financial statements are also a key benchmark. By this measure, audit quality is extremely high.

Based on a Center for Audit Quality analysis of PCAOB inspection reports of the largest firms in 2021, none of the audits identified as deficient by the board resulted in changes to the audit opinion or a restatement of company financials. That means none of the board-identified errors had a material effect on the auditor’s opinion—just like in my own experience with the inspection process. This result isn’t an anomaly; over the last 20 years, there has been on average a 10% year-over-year decline in restatements.

The audit profession is a people business, and people aren’t perfect. We are, however, always striving to do better. The profession welcomes a conversation on how we can continue to work with the PCAOB and others to keep pushing audit quality higher for the protection of investors and capital market efficiency.

[Bloomberg Tax]

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