2020 Inspection Cycle Report Synopses

Last week I blogged about the Public Company Accounting Oversight Board (PCAOB) and whether it has been living up to its mandate to protect the public interest. I also addressed PCAOB inspection reports and the deficiencies identified by the board. These are discussed next.

Deficiencies identified by the PCAOB 

Part I—Inspection Observations

Part IA: Deficiencies that were of such significance that the board believes the firm, at the time it issued its audit report(s), had not obtained sufficient appropriate audit evidence to support its opinion on the issuer’s financial statements and/or internal control over financial reporting (ICFR).

Part IB: Deficiencies that do not relate directly to the sufficiency or appropriateness of evidence the firm obtained to support its opinion(s) but nevertheless relate to instances of non-compliance with PCAOB standards or rules.

Part II— Observations Related to Quality Control

Criticisms of, or potential defects in, the firm’s system of quality control. Notably, Section 104(g)(2) of SOX restricts the board from publicly disclosing Part II deficiencies unless the firm does not address the criticisms of potential defects to the board’s satisfaction no later than 12 months after the issuance of the inspection report.

It should be noted that the firm whose audits are being inspected has an opportunity to respond to a draft of the inspection report, excluding any portion granted confidential treatment.

Summary and Analysis of the 2020 Inspection Reports.

In a publication by The Audit Committee and Auditor Oversight Role, there is an analysis of the audit deficiencies in the largest six accounting firms for the year 2020. A great deal of important information is provided, as discussed below.

On November 1, 2021, the PCAOB released the 2020 inspection reports for the U.S. affiliates of the six global network audit firms. The overall percentage of these firms’ inspected audits that the PCAOB found deficient fell from 24 percent in 2019 to 16 percent in 2020. The drop in aggregate deficiencies was largely driven by a major improvement in the inspection results of  PricewaterhouseCoopers (PwC).

In 2019, the Board found deficiencies in 18 out of 60 (30 percent) of the PwC audits it inspected. In 2020, the Board found only one deficient audit (2 percent) out of 52 engagements inspected – a record low for any Big Six firm. Like PwC, Deloitte’s deficiency rate also dropped into the single digits at 4 percent. In contrast, the Board found deficiencies in over half of inspected BDO engagements, up from 42 percent last year.

As discussed in the Comments section below, the 2020 reports suggest five observations:

• Overall, large firm audit quality appears to have improved modestly in 2020.

• Changes in the inspection process do not appear to have significantly impacted deficiency findings.

• There are pronounced differences between the inspection results of the six large firms.

• Internal Control Over Financial Reporting (ICFR) audit deficiencies seem to be leveling off.

• Assumptions underlying estimates and use of information provided by the entity are stumbling blocks in financial statement audits.

Comparisons of Firm Performance

The table below summarizes the results of the 2020 inspections of the six firms. A similar table, which appeared in 2019 PCAOB Large Firm Inspection Reports, January-February 2021 Update, showing results of the 2019 inspections, follows the 2020 table.

Questions have been raised whether COVID influenced the PCAOB inspection process and that may account for the decline in audit deficiencies in the 2020 inspection reports. The decline in PwC's deficiency rate seems to imply that may be the case. For its part, the PCAOB denies that had happened.

The decrease in audit deficiencies is welcome news and, hopefully, signals what will become a steady decline in audit reports that do not meet Part I and Part II PCAOB audit deficiencies. However, we need to wait until the 2021 results come in to determine whether there is, at least the beginning of, a decline in audit deficiencies that is sustainable, which is what is needed to protect the public interest.

I'm concerned that the 2020 results are skewed. I have my doubts about there being a sustainable downward trend in deficiencies. For one thing, the PwC rate seems unbelievable. Might it be do to a lack of resources and the staff needed at the PCAOB to do a solid job on audit inspections? The results could be skewed because of COVID and the inability of the PCAOB to do as thorough a job as they have done in the past. Only time will tell.

Blog posted by Dr. Steven Mintz, The Ethics Sage, on February 9, 2022. You can sign up for his newsletter and learn more about his activities at: https://www.stevenmintzethics.com/. Follow him on Facebook at: https://www.facebook.com/StevenMintzEthics and on Twitter at: https://twitter.com/ethicssage.