U.S. accounting firms’ monitoring of their own work will receive a lot more scrutiny in 2020, as their regulator continues to look for ways to boost audit quality.
Inspections serve as the backbone of the Public Company Accounting Oversight Board’s oversight and their findings have helped improve the effectiveness of auditing in the years since the 2002 Sarbanes-Oxley Act created the PCAOB. Under new leadership, the board last year launched a multi-year overhaul of its inspections program—changes that range from how it plans for those routine reviews to the structure of the resulting public report.
This year, PCAOB inspectors are also expected to pay close attention to auditor independence, improper alteration of records and audit evidence, and how the firms are adapting to new accounting and auditing standards.
To really move the needle on audit quality, regulators can’t just focus on what went wrong with any individual audit. They must look at an audit firm’s overall system of checks and safety rails, said Dan Goelzer, a former board member.
Although the board is not breaking completely with past inspection practices, it is shifting the emphasis to quality control, Goelzer said.
As the board considers overhauling its rules for quality controls, it will want to understand how the firms have built up those systems over the years and how they operate today, he said.
Each year, the largest U.S. audit firms undergo board scrutiny through random inspections of their audits, while smaller firms and foreign affiliates face PCAOB inspections every three years. In 2020, inspectors will place more attention on the audits of larger issuers with higher market caps, said George Botic, the board’s inspections director, said at a December conference in Washington.
As part of the inspection process, the board historically reviewed firms’ quality controls—a system of firm governance and training intended to ensure compliance with PCAOB and Securities and Exchange Commission rules. The results, however, aren’t released publicly unless the firm fails to address any violations. That won’t change.
The board has “significantly increased” its emphasis on those controls, board Chairman William Duhnke told lawmakers during a Jan. 15 House oversight hearing.
Firms with a global network are feeling that shift already, as board inspectors have started asking for more documentation about their policies and procedures, said John Fiebig, president and co-founder of Adigeo LLC.
“I think it’s good that they are doing this, and I think it will keep firms more focused on their system of quality control,” said Fiebig, a former PCAOB deputy director of inspections who oversaw the reviews of those largest firms.
The question of auditor independence may also tie into the extra attention inspectors place on those firm-level controls, said Mike Walworth, founder and CEO of GAAP Dynamics, a training company based near Richmond, Va. Regulators will likely be watching everything from how they monitor independence to how they report violations, he said.
Inspection findings suggest that firms and their staff don’t understand the rules or don’t have the right safeguards in place to prevent violations, Botic said..
“Firms should ensure that they have the appropriate senior leadership focus and resources devoted to independence,” Botic said. “This is certainly an area where tone at the top matters.”
New and Old Standards
Firms should expect to hear questions about how they are preparing for a change in audit standards for estimates and the use of outside experts, Walworth said.
The new rules will take effect beginning with audits for 2020 calendar-year-end companies, meaning firms will begin using them this year.
Complying with long-standing rules related to audit-work papers are another area where firms can expect deeper probing by inspectors, Botic said.
Some firms have ignored those rules and are still improperly altering their work papers, resulting in enforcement cases, Fiebig said.
“It’s not the first mistake that gets you in trouble, it’s the second,” he said.
Adding or fixing mistakes after an audit report has been signed is one of the worst offenses a PCAOB-registered firm can make, said Walworth.
PCAOB rules require auditors to have all the evidence they need in place on the date they sign off on the audit. Firms should have their own rules in place to ensure that no one touches that documentation after it’s been signed, Walworth said.