Two of the largest U.S. accounting firms, rocked by scandal and large SEC fines, are changing course in an effort to bolster their scrutiny of public company finances and repair their reputations.
Both KPMG LLP and PwC LLP have taken similar steps to address ethics lapses that resulted in SEC enforcement cases in 2019. Both have updated audit practices for risk assessment, worked to put better tools and technology into the hands of auditors, and emphasized the importance of ethics and integrity.
The changes offer insights into how auditors, who serve as the eyes and ears for investors, will continue to ensure the market has access to reliable financial reporting. But critics say the changes may be worthwhile but don’t alter the fundamental pressure audit firms face to keep lucrative clients as the pool of public companies shrinks.
Audit method improvements and new tools will help auditors to do a better job, but no one system will prevent audit failures. It all comes down to people with the right training, support, and incentives, said Gia Chevis, director of innovation in accounting data and analytics at Baylor University.
“You still have to have good people of integrity executing at a high level,” Chevis said.
KPMG Reforms Part II
The changes, which KPMG detailed in its most recent audit quality report, follows a sweeping restructuring of the audit practice after the firm confessed that some of its most senior staff had conspired to cheat on its annual regulatory inspection. The scandal resulted in prison time for former staffers and a record $50 million settlement with the Securities and Exchange Commission, for what the regulator described as extensive misconduct.
In 2018, the firm overhauled the leadership team running the audit practice, moved internal inspection teams that evaluate the work of auditors outside of the audit practice and revised performance evaluations for partners and other senior leaders, among other steps.
Over the past year, KPMG continued its reforms by revising compensation and staff evaluation frameworks, updating its risk assessment, internal controls and estimates methods, increasing partner supervision and reviews, and expanding the number of partners available to provide real-time support to audit teams.
The firm also emphasized the role of its new cloud-based audit system to improve the effectiveness of its auditing. The tool will help the firm better analyze large data sets to focus on areas with the most risk, and provide consistency across the firm, said Jackie Daylor, KPMG national managing partner for audit quality and professional practice.
“It’s really the platform for the future and we are using it that way,” Daylor said.
Big data could also help the firm identify weaknesses within its own audit work. KPMG is exploring what combination of factors could contribute to effective auditing—like partner tenure, staffing levels, even the order the work is handled.
“We know there’s really no silver bullet here,” Daylor said. Still, she hopes the data can help the firm to be more proactive and step in sooner with extra resources, or more oversight for teams who need it.
Tech &Training Pave the Way
The Big Four firms have invested heavily—billions of dollars globally—in new technology aimed at reducing the drudge work of auditing along with human errors and to free auditors to focus on more complex aspects of the work. It could ultimately, one day, improve audit quality, said Joe Schroeder, associate professor of accounting at the Indiana University Kelley School of Business.
While investments in technology and training are important, so are putting checks and balances in place to prevent similar misconduct. And KPMG appears to be making necessary changes, Schroeder said.
Meanwhile, competitor PwC LLP has taken similar steps to address lapses in how it adheres to strict conflict of interest rules. The firm agreed to a $7.9 million settlement last year for providing prohibited services to audit clients and not telling the clients’ audit committees about the work.
“We remain committed to leading with a strong culture of quality and excellence. We understand that this is a continuous journey that requires persistent work and the willingness to learn,” Chairman Tim Ryan and Assurance Leader Wes Bricker, said in a mid-year update on the status of the firm’s audit quality.
The firm highlighted mandatory independence training for staff and partners, extra reviews of contracts or proposals and communications with audit committees and additional independence coaching before or during an audit.
Earlier this month, PwC announced that had added a third independent director to the firm’s governance board and would form an advisory group to offer ideas and feedback on culture, risk management and other areas that impact audit quality. It’s a step that Bricker had urged firms to make in 2018 while he was chief accountant at the SEC.
KPMG took that advice, adding independent directors to its board, hiring a chief culture officer, and re-evaluating its corporate values.
The firm’s leaders want to be clear about what the firm stands for and for staff to be held accountable for upholding those values. “All of that plays into audit quality,” Daylor said.
Courage is among those values. For auditors, Daylor said that means looking beyond the transaction in front of them to see the bigger picture and maintaining their professional skepticism while working alongside their corporate clients.
Barbara Roper, director of investor protection for the Consumer Federation of America, said the value of the independent audit rests in the auditor’s ability to stand up to management. But the firms themselves have to be willing to take the financial risk of losing a lucrative client.
To turn rhetoric into reality, and demonstrate that firms are serious about quality, Roper said they should be transparent about how they measure audit quality—from inspection deficiencies to independence to skepticism—and use those metrics when promoting and compensating senior leaders.
“It’s got to be more than lip service,” she said.