How Frequently Does The Pcaob Inspect Registered Accounting Firms That Audit 100 Or More Issuers?

Much has changed since the PCAOB began its inspection programme in 2004. In just the last 10 years, the number of auditing firms registered with the PCAOB has increased past approximately 37%, 14 auditing standards have been issued, and the inspection process has matured. 1 per centum of auditing firms (the Big Four) are responsible for the audits of U.South. issuers that account for more than than 98% of global market capitalization, while 372 auditors are responsible for auditing the remaining 2% (Caleb Newquist, "The Big iv'south Stranglehold on the Inspect Marketplace Is Worse than Y'all Thought," July 17, 2013, http://bit.ly/2taSFFa). Given the demand to residual the PCAOB's increasing responsibilities with its stated objective of improving audit quality through its inspection program, more resources should exist devoted to inspections of this i%. By analyzing contempo PCAOB inspection trends and extracting auditing firms' inspection reports, this article provides descriptive evidence that aligns with this expectation.

The PCAOB Inspection Process

Auditing firms that perform more than 100 issuer-audits each year are inspected annually by the PCAOB, and those that perform 100 or fewer issuer-audits are inspected at least triennially. As of Sept. 1, 2016, there were 10 annually inspected firms: Deloitte LLP, Ernst & Young LLP, KPMG LLP, and PricewaterhouseCoopers LLP (collectively, the Large 4); and BDO United states LLP, Crowe Horwath LLP, Grant Thornton LLP, MaloneBailey LLP, Marcum LLP, and RSM US LLP (collectively, the "Side by side Six").

Inspection reports have 2 parts. The first describes the number of audits inspected and identifies inconsistencies with current auditing standards, merely does not identify the specific audits inspected. Although the PCAOB has discussed moving to a random pick process, inspections are mostly selected on the basis of perceived take chances (Jeanette Franzel, "Progress and Evolution in Audit Oversight to Protect Investors and the Public Involvement," keynote speech at 15th Annual Baruch College Financial Reporting Conference, May 5, 2016, http://bit.ly/2umRZvP). Consequently, audits selected for inspection are more probable to exist those of issuers with larger market place capitalizations, in riskier or more complex industries, or that accept experienced prior accounting or auditing issues. The results of this office are available to the public later on inspectors consummate their work and issue their report.

The 2d part communicates issues about the inspected auditing business firm'south systems of quality control (e.grand., policies, processes, and controls over personnel hiring, training, and retention). These findings, if any, are made public only if the auditing firm fails to remediate identified deficiencies to the PCAOB's satisfaction within one year. Of the more than 2,500 inspections performed since the program's inception, as of October 2016, simply 244 quality control reports accept been released.

There is prove that inspection results influence the actions of issuers and investors. For example, there is a positive association between PCAOB inspection findings of triennially inspected firms and auditing business firm dismissals (Brian Daugherty, Denise Dickins, and Wayne Tervo, "Negative PCAOB Inspections of Triennially Inspected Auditors and Involuntary and Voluntary Client Losses,"International Journal of Auditing, November 2011, http://bit.ly/2uhE4I5). This suggests issuers may perceive inspection findings as a point of low audit quality, also as that issuers may not fully cover the nature of most inspection findings. More than 90% of findings are related to the documentation and extent of auditing procedures, while very few are associated with cloth misstatements of fiscal statements (Colleen M. Boland, Veena Brown, and Denise Dickins, "The Impact of PCAOB Inspections on Audit Standard Setting," working newspaper).

Comparisons of Auditing Firms

Annually inspected and triennially inspected firms are unlike. The boilerplate/median number of audits of annually inspected firms was 641/296 in 2015, and the average/median audit fee was $1.6 meg/$517,000. Comparable data for 362 triennially inspected firms (excluding those that only audit broker-dealers) were 7/2 and $103,000/$50,000, respectively. Issuers of triennially inspected firms are generally smaller and, measured as market capitalization, less risky. Every bit a percentage of their practice, triennially inspected firms are also more probable to audit benefit plan issuers and small financial services issuers.

At that place are also differences between the Large Four and the Next Six. The average/median number of audits of the Big Iv was one,297/one,366, and the average audit fee was $i.9 1000000/$673,000, compared to 175/134 and $489,000/$292,000, respectively, for the Next Half-dozen. Collectively, these data reveal a lack of comparability among the auditing practices of Big Iv, Next Six, and triennially inspected firms.

Comparisons of Inspection Information

To determine whether these differences impact the PCAOB's inspection processes and outcomes, the authors examined inspection reports of the Big Four, Adjacent Six, and a sample of 65 triennially inspected firms that responded to a survey distributed to all U.South.–based triennially inspected firms with at least one not–broker-dealer client. The sample firms are representative of all triennially inspected firms in that they are geographically dispersed, perform an average of vii audits, and have average inspect fees of $147,000.

The authors compared iv measures of PCAOB inspection outcomes from 2010–2014 for the Big Four and Next Half dozen, and over the final two inspection periods for the triennial sample (covering 2009–2015): 1) the percent of audits inspected, ii) the percentage of audits inspected with findings, 3) the percentage of audits inspected with findings resulting in a restatement, and iv) the number of quality command reports released. The results are presented inExhibit 1.

Exhibit 1

Comparing of PCAOB Inspection Outcomes

Measure; Mean Big Four firms; Next Six firms; Triennially inspected sample firms Number of audits reviewed; 1,091; 496; 266 Percentage of audits inspected; 4%; 11%; 20% Percentage of audits inspected with findings; 36%; 44%; 35% Percentage of audits inspected with

Every bit depicted, inspections cover 4%, 11%, and 20%, respectively, of the Large Four, Next Six, and triennially inspected firms' total audits. Given the risk-based choice process and risk of their audits, 1 might look to find that larger auditing firms take more than findings per audit inspected, simply this is not the example. The percentage of audits inspected with findings is approximately the same for both annually inspected and triennially inspected firms (36% and 35%, respectively). In that location is also no difference between annually and triennially inspected firms in terms of the severity of inspection findings (2% and 1%, respectively); however, the percentage of audits inspected with findings for the Next Six (44%) is marginally higher than that of the Big Four (36%).

These inspection outcomes may be more representative of the overall practices of triennially inspected firms than they are of annually inspected firms, since tests of a larger proportion of a population may be more representative. The median number of issuers served by triennially inspected firms is two, and so in many cases, the PCAOB inspects all or a majority of a firm's audits.

The lack of variation in inspection outcomes between annually and triennially inspected firms may be attributed to several factors. Auditors may devote additional resources to high-hazard audits, reducing the likelihood that insufficient auditing procedures are performed. Alternatively, audit quality may not differ betwixt firms, or systematic differences in the inspection process may make information technology less likely that inspect quality differences among firms volition exist detected.

In contrast, the boilerplate number of quality control releases for each group is meaningfully different (eight, three, and 2, respectively). Of the 20 Big 4 firm inspections conducted from 2007 to 2011, 8 quality command reports (40%) were released between 2010 and 2014, compared with 200 out of 2,000 (10%) for triennially inspected firms. These results are not unexpected, as the complication of managing an auditing practice probable increases with the size of the workforce (eastward.1000., hiring, preparation, evaluating). Quality control releases may too be the PCAOB sending a point to auditors and stakeholders about the importance of strong quality command practices and procedures.

Closer examination reveals that although the number of findings among the Big 4 varies, trends in findings do not vary significantly yr-to-yr for either the Big Four or the Next Six, nor do trends differ significantly between them (encounterExhibit 2). Consequent with the overall data presented inExhibit 1, a larger per centum of Adjacent Six audits inspected have findings (between xl% and 51%) than do Large Iv audits inspected (between 32% and 40%).

Exhibit 2

Summary of Inspection Findings of the Big Four and Next Six

Beyond inspection outcomes, the authors expect the PCAOB to devote more than time and resources to inspections of the Large Four; the data confirm this expectation. For inspection year 2014, inspectors spent, on average, 426 days inspecting each of the Large Four (seven days per audit), compared to 87 days for each of the Next Six (five days per audit) and iv for the triennial firms (two days per audit). Conversations with two Big Four audit partners draw the inspection procedure as by and large starting with a coming together between representatives of the business firm and the PCAOB during the fourth quarter preceding the yr to be inspected. In contrast, anecdotal comments and a triennially inspected firm's response to a PCAOB inspection written report suggest the PCAOB occasionally performs "desk reviews" (i.e., remote inspection of electronic files) of triennially inspected firms (Brian Daugherty and Wayne Tervo, "PCAOB Inspections of Smaller CPA Firms: The Perspective of Inspected Firms,"Accounting Horizons, June 2010, http://bit.ly/2uh2jpO).

Also of interest is the lag between the last day of inspection and the release date of the inspection report. In 2014, the median lags for the Large Four, Next Six, and the sample of triennially inspected firms were 206 days, 355 days, and 24 days, respectively. These differences may reflect variation in the complexity of the audits; alternatively, they may reflect the negotiating power of annually inspected firms or differences in the inspection procedure and reporting—the latter of which is investigated beneath.

Example Inspection Findings and Analyses

The PCAOB periodically publishes reports nigh its inspection procedure that describe findings common among many auditing firms, besides equally areas intended for future inspections (e.g., PCAOB Release 2015-007; PCAOB Staff Inspection Bulletins 2016/1, 2016/3). These areas include the auditing of bookkeeping estimates (east.g., business combinations, harm of intangibles, financial instruments, revenue-related estimates and reserves, the assart for loan losses, inventory reserves, and taxation-related estimates) and the appropriate awarding of—

Auditing Standard (As) 5,An Audit of Internal Control over Financial Reporting That Is Integrated with an Audit of Fiscal Statements;
AS thirteen,The Auditor's Responses to the Risks of Material Misstatement;
AS fourteen,Evaluating Audit Results; and
AS 15,Audit Testify.

A search of inspection reports of annually inspected firms covering audit years 2010–2014 and of the sample triennially inspected firms covering audit years 2009–2015 for findings related to these auditing standards identified example findings for each standard from an annually inspected house (three Large Four and iii Adjacent Vi) and six different trienni-marry inspected firms, which were examined for qualitative differences. A summary of the search is presented below; a total presentation of the findings will be included with this article online at http://world wide web.cpaj.com.

The authors' analysis sug gests that findings of annually inspected firms are more descriptive and have greater specificity than those of triennially inspected firms.

The authors' analysis suggests that findings of annually inspected firms are more descriptive and have greater specificity than those of triennially inspected firms. For instance, a finding associated with noncompliance with Equally 13 of a triennially inspected firm merely states that the house failed "to perform sufficient procedures to test the valuation of bachelor-for-sale investment securities." A comparable finding from an annually inspected house states that the firm:

Tested the valuation of the majority of the issuer'due south investments in securities at an interim date; withal, the House failed to perform sufficient procedures to provide a reasonable footing for extending its conclusions on the valuation of those securities to the balance canvas date. Specifically, with respect to disinterestedness securities, the analytical procedures that the Business firm performed to curlicue forward its conclusions to year-end consisted just of determining that the issuer's returns, past industry sector, were directionally consistent with publicly reported returns for the industry sector, and the publicly reported returns used in the comparing were for a menses that was longer than the whorl-forward menses. For debt securities, the House compared the issuer's yield for its debt portfolio to corresponding publicly bachelor yield rates, simply the publicly available information used in the comparison were for a period that was longer than the curlicue-forrad period. In addition, in this analysis, the Firm failed to incorporate the furnishings of the issuer's purchases and sales of debt securities during the roll-forward flow.

The use of linguistic techniques also confirms differences in the findings of annually and triennially inspected firms. Annually inspected firms' findings are more complex (word count of 623, compared to 139 for triennially inspected firms) (Joshua J. Filzen and Kyle Peterson, "Fiscal Statement Complexity and Meeting Analysts'Expectations,"Contemporary Bookkeeping Inquiry, Wintertime 2015, http://bit.ly/2tTDjlA). Measuring "tone" using Philip J. Stone's General Inquirer word list and software, the example annually inspected firms' findings are also significantly more negative (3% of total words are negative) than the findings of the triennially inspected firms (one%). It is possible that PCAOB inspectors evaluate annually inspected firms more stringently due to the riskier nature of their audits.

Of note, the auditing firm Marcum LLP moved from existence a triennially inspected business firm to an annually inspected firm in 2015 by increasing its issuer audits from 99 to 102. A comparison of Marcum LLP's last inspection report every bit a triennially inspected firm (March 28, 2013) to its first as an annually inspected firm (June 16, 2016) reveals no meaningful differences. For audit year 2012, xi audits were inspected, which is consistent with the inspection rate of the Next Six; of those inspected, none had findings. For inspect twelvemonth 2015, eight audits were inspected, and none had findings. At that place were also no credible differences in terms of the reports' complication or tone. Since an increment of iii audits likely did non touch the structure of Marcum LLP, this is not surprising.

Final Analysis

Compared to triennially inspected firms, the audit practices of the Large Four are meaningfully more risky and complex. The trends and analyses presented here provide evidence that the PCAOB's inspection program reflects differences in the profiles of its registered auditing firms.

In terms of 2 inspection outcomes (the percentage of audits with findings, and the percentage of audits with "severe" findings), there is no measurable difference betwixt annually and trienni-marry inspected firms. This is somewhat unexpected in calorie-free of the PCAOB's focus on college-risk audits; possible explanations include the following: annually inspected firms devote additional resources to high-risk audits, audit quality does not differ between annually and triennially inspected firms, or systematic differences in the inspection process brand information technology less likely that inspect quality differences among annually and triennially inspected firms volition be detected.

There are, however, meaningful differences when comparing quality control releases of the Big Four and triennially inspected firms: the Big 4 have had a larger percentage of their quality control reports released. The time devoted to Big Four and Adjacent 6 inspections and reports is also meaningfully longer than that of triennially inspected firms. These results may reflect the additional operating complexity of larger auditing firms or the PCAOB's want to signal the importance of strong systems of quality control practices and procedures. Finally, the inspection reports of annually inspected firms are more circuitous and negative in tone than those of triennially inspected firms.

There are meaningful differences when comparison quality control releases of the Big Four and triennially inspected firms.

Before the Sarbanes-Oxley Human action of 2002 (SOX), the market typically reacted negatively if an issuer replaced its big auditing firm with a small firm (John Dunn, David Hillier, and Andrew P. Marshall, "The Market Reaction to Auditor Resignations,"Bookkeeping and Business Inquiry, March 1999, http://bit.ly/2tTXXSD; Hsihui Chang, C. S. Agnes Cheng, and Kenneth J. Reichelt, "Market place Reaction to Accountant Switching from Large Four to Third-tier Modest Bookkeeping Firms,"Auditing, November 2010, http://fleck.ly/2uhzuJE). Many attributed this effect to perceived differences in audit quality amid large and pocket-sized auditing firms. SOX modified the relationship betwixt issuers and their auditors (e.g., the auditor must report to an independent audit committee, and virtually nonaudit services are prohibited) and created the PCAOB. Since SOX, the results of at least 2 studies suggest that stock price penalty for down-tier accountant changes may exist a thing of the by (Denise Dickins, "Should Congress Mandate Audit House Rotation?"Regulation, Winter 2006, http://bit.ly/2vkZuAQ; Chang et al. 2010). Consistent with the descriptive analyses presented here, the market may perceive that the PCAOB'due south inspection process and other SOX-mandated systematic changes are working to maintain a more than consistent level of inspect quality among auditors and issuers.

Colleen M. Boland, PhD, CPA is an assistant professor at the University of Wisconsin–Milwaukee, Milwaukee, Wis.

Brian Daugherty, PhD, CPA is an assistant professor at the Academy of Wisconsin–Milwaukee, Milwaukee, Wis.

Denise Dickins, PhD, CPA, CIA is an associate professor at Eastward Carolina University, Greenville, N.C.

Anna J. Johnson-Snyder, PhD, CPA, CFE is an assistant professor at Bradley University, Peoria, Ill.