I am honored to be here today at the mid-year auditing section conference of the American Accounting Association (AAA).
Before I get started, I must tell you that the views I express today are my personal views and do not necessarily reflect the views of the Board, any other Board member, or the staff of the PCAOB.
In preparing for this conference, I noted that the theme for the AAA's upcoming annual conference in August deals with viewing current significant challenges as "Brilliantly Disguised Opportunities." This is a fantastic theme, and I thought I'd take the opportunity to get all of us thinking along these lines now, as we begin 2013.
The "brilliantly disguised opportunity" I want to talk to you about today is strengthening audit quality in the aftermath of the recent financial crisis.
We find ourselves, once again, forced to evaluate the integrity of the assurance provided to the financial markets through financial reporting and auditing.
All participants in the supply chain of financial reporting and auditing, as well as the regulators and corporate governors, need to seize the "opportunities" we are currently facing to instill lasting change that will protect investors and help ensure that we can continue to pass along opportunity and prosperity to future generations of Americans.
Each of you, too — as educators of students entering the accounting profession and as researchers on the issues we are facing, plays a key role in the solutions.
At the PCAOB, we are taking on an ambitious list of significant issues to help ensure investor protection and high quality audits now and for the long term.
Today, I will discuss four of these key issues in audit oversight and our plans for change: audit quality, professional skepticism, inspections and remediation, and standard setting.
We've all heard those words before. Two are about how auditors do their work -- audit quality and professional skepticism; and the others are about how the PCAOB does its work -- inspection and remediation, and standard setting.
In 2013, the Board is looking at them anew. In revising our strategic plan last year, we stepped back, took stock, and looked at these issues with a long term view.
As the PCAOB marks its 10th anniversary this year, it is appropriate and necessary to evaluate our progress. The PCAOB is a relatively new regulator and still has work to do to establish sustainable regulatory approaches for the long term, while remaining nimble and responsive to emerging risks and issues.
The Board's recently updated strategic plan reflects this. Its near term priorities for 2013 include:
The first of these near term priorities that I want to talk about today is assessing and tracking audit quality. Ten years after the establishment of the PCAOB, it is fair to ask, "What is the present state of audit quality?" and "Has audit quality improved since the enactment of the Sarbanes-Oxley Act?"
We've had many stakeholders and members of the profession tell us that they believe audit quality has improved, and we, at the PCAOB, tend to agree. PCAOB inspections, however, continue to find serious audit deficiencies in public company audits on a regular basis. In addition, the results of our first round of inspections of audits of brokers and dealers are troubling.
In pursuing our core mission of protecting investors through audit oversight, the Board has a number of initiatives targeted at improving major areas of audit practice that establish audit quality.
In light of the many financial reporting and auditing crises over recent decades, I find it surprising that a generally understood and measurable concept of audit quality has not emerged.
This issue was raised at the outset of the recent financial crisis in a recommendation of the Department of the Treasury's Advisory Committee on the Auditing Profession (ACAP). The committee recommended that the PCAOB study the feasibility of developing key indicators of audit quality and effectiveness. And, earlier this week, the International Auditing and Assurance Standards Board issued a consultation paper on a proposed framework for audit quality that sets out key attributes that are conducive to audit quality.
A recent synthesis paper, Audit Quality: Insights from the Academic Literature, notes that despite more than two decades of research, there is little consensus about how to define, let alone measure, audit quality.
Furthermore, the various stakeholders in the financial reporting process have different views as to what constitutes audit quality. While some might define a quality audit in terms of audit inputs -- such as whether auditors follow standards -- investors and audit committee members may focus on certain audit outcomes -- demanding that audits uncover fraud, for instance. Many have also viewed audit quality in terms of the absence of negative outcomes such as restatements, litigation, or subsequently discovered material problems.
The divergence in views on audit quality has contributed to the "expectations gap" over what an audit should be. This has persisted for decades, and also causes a divergence in definitions of what constitutes an audit failure.
PCAOB uses its own definition of audit failure in inspection reports. It is a deficiency of such significance that the firm, at the time it issued its audit report, failed to obtain sufficient appropriate evidence to support its audit opinion on the financial statements and/or on the effectiveness of internal control. Under the definition, deficiencies include instances where a firm did not identify or address appropriately financial statement misstatements or improper disclosures, as well as failures by the firm to follow auditing standards.
The Board has made it a 2013 priority to identify audit quality indicators. A longer term goal is to track such measures for domestic global network firms and report on those measures over time.
This project is already underway and will include the identification of audit quality measures in the areas of audit process and results, as well as the development of methods for objectively measuring those audit quality indicators. Because of the complexity of these issues, our process for developing these measures likely will be iterative.
Due to the multi-dimensional nature of audit quality, a "balanced scorecard" approach with various indicators and measures likely will be necessary. I anticipate that the development, measurement, and analysis of audit quality indicators will inform PCAOB policy making and provide key information about the state of audit quality across firms and over time.
The results of this process will also provide us with information for reviewing, adding context to, or clarifying our current definition of "audit failure" for our inspection reports.
In my view, the PCAOB's project on audit quality indicators and measures will represent a significant development in helping to advance audit quality and the reliability of audits now and in the long term. The PCAOB is in a unique position to observe, track, and measure many aspects of audit quality inputs and provide benchmarking information to firms, promote firm accountability, and provide transparency and useful information to investors and other stakeholders. Such information will be useful in the marketplace as well, so that investors and audit committees can demand better audit quality and shift audit firm competition over price to competition over quality.
A key element of audit quality is the auditor's use of professional skepticism. Professional skepticism is particularly important in those areas of the audit that involve significant management judgment or transactions outside the normal course of business, and the auditor's consideration of fraud. These are often the high risk areas of the audit.
PCAOB inspections have identified numerous audits with deficiencies where auditors did not consistently and diligently apply professional skepticism. In many of those cases, the audit teams did not obtain sufficient appropriate evidence to support their audit opinions. This issue has been of such prevalence that we have identified the apparent failure to appropriately apply professional skepticism as a systemic quality control issue in some firms.
In addition, as part of the Board's outreach on auditor independence over the past 18 months, a major theme that the Board heard from a variety of stakeholders was the need for professional skepticism to be emphasized more in the education, training, and standard setting for auditors, as well as in the firms' cultures, tone at the top, and systems of quality control.
On December 4, 2012, PCAOB issued Staff Audit Practice Alert No. 10: Maintaining and Applying Professional Skepticism in Audits to emphasize and remind auditors of the requirement to appropriately apply professional skepticism throughout audits. It provides specific examples of audit deficiencies in which a lack of professional skepticism was at least a contributing factor.
The Practice Alert includes examples that raise concerns about a lack of professional skepticism, such as instances in which engagement teams did not:
The Practice Alert also identifies possible impediments to the application of professional skepticism, including:
Finally, the Practice Alert contains a discussion of how firms can promote the appropriate application of professional skepticism on audits through a robust system of quality control.
A number of firms are currently undertaking significant initiatives in response to PCAOB inspection findings to better understand the factors that influence the application of professional skepticism on their audits. To do this, they need to evaluate the specific factors that led to any lack of, or impairments to, the application of skepticism. This is a difficult but crucial area to get right in auditing.
As described in a recent literature synthesis on this topic, professional skepticism is a multi-dimensional concept that remains difficult to define and measure. It is often difficult to determine if a lack of skepticism is the primary cause of audit deficiencies, and if so, which factors led to the lack of skepticism.
Specifically, was it a problem with the auditor recognizing that a potential issue exists that may require more work or effort (lack of skeptical judgment)? Or was it a failure of the auditor to change behavior in response to an issue that was recognized (lack of skeptical action)? What were the specific characteristics and circumstances attributable to the auditor, the evidence, the client, and the audit environment that may have contributed to or caused the lack of appropriate professional skepticism in an audit?
The PCAOB will continue to focus on the appropriate application of professional skepticism in our inspections and our discussions with the firms. This is an area where the firms could benefit from academic thought leadership, research, and application tools. I encourage you — in the auditing section of the AAA -- to consider ways to provide relevant research results to the firms, and to assist firms in developing and implementing potential tools, such as surveys and other metrics, for tracking and assessing how professional skepticism is applied on audits. We would like to hear your ideas, too.
The third subject I'd like to talk to you about today — also among the Board's 2013 priorities — is our inspections and our oversight of the related remediation of identified deficiencies in firms' systems of quality control.
As you know, the largest PCAOB-registered public accounting firms — those auditing more than 100 issuers — are inspected annually by the PCAOB. Firms that issue 100 or fewer issuer audit reports each year are subject to inspection at least every three years.
During 2012, the PCAOB inspected nine firms that audited more than 100 issuers in 2011. As we were conducting the 2012 inspections, we were also issuing the inspection reports for the 2011 inspections of these firms. During 2012, we issued the 2011 inspection reports for six of the nine annually inspected firms.
In addition, during 2012, the PCAOB conducted 244 triennial inspections at 167 domestic and 77 foreign firms.
The length of time it takes to complete preparation of the inspection reports has been an ongoing challenge for the PCAOB, but we've recently made significant progress in clearing a backlog of older inspections. During 2011, the Board processed numerous older inspection reports, issuing a total of 344 inspection reports that year. (As a reference point, the Board conducted a total of 254 inspections during the previous year.)
During 2012, the Board continued to make progress in clearing most of the remaining backlog of older inspection reports. The Board issued a total of 257 inspection reports during 2012. (This compares to a total of 213 inspections conducted during 2011.)
The Board also is working through the related remediation determinations that follow the issuance of inspection reports. Firms are given 12 months from the date of the inspection report to remediate any deficiencies noted in their quality control systems, which are included in the nonpublic Part II of the reports. Otherwise, they face publication of that portion of the inspection report.
As we become more current in our issuance of inspection reports and remediation determinations, we are taking a fundamental look at our processes for issuing these reports. We want to develop processes and tracking metrics to help improve the overall timeliness of these reports and to prevent backlogs from occurring in the future.
In addition, we plan to conduct a thorough review of the content and readability of our inspection reports. This review will include proactive outreach to users, such as yourselves, to help us identify ways to improve the usefulness of the reports.
Before I move on, let me talk a minute about our inspection findings. As I'm sure you know, the number of serious deficiencies we reported spiked in our 2010 inspections, and remained high in the 2011 inspections. Common areas where we found audit deficiencies included revenue recognition, fair value of financial instruments, testing and evaluating internal controls, related party transactions, the auditor's assessment of and response to fraud risk, and the auditing of equity financing instruments, among others.
Quality control findings in the nonpublic Part II of our inspection reports focus on issues that may have caused the audit performance deficiencies reported in Part I, as well as other aspects of the firm's management of its audit practice that could negatively impact audit quality. Some examples of areas of specific concern that have appeared in Part II include problems in the areas of professional skepticism, internal inspections, and firms' quality control processes related to specific aspects of auditing, such as testing and evaluating internal control over financial reporting, fair value, and other areas.
The Board regularly engages in constructive dialogue with firms to encourage them to improve their practices and procedures. Successful remediation and sustained improvements in audit quality are clearly the goals of this process.
Fortunately, we have seen most firms take their responsibilities for remedial efforts and improvements seriously.
Based on the timing of the related remediation periods and the firms' efforts in those areas, it is reasonable to expect that firms would achieve significant improvements in their PCAOB inspection results for the audits of the 2012 financial statements -- which will be inspected during 2013 -- in those areas identified as problems during the 2010 and 2011 inspections. I would also hope that we see some improvements emerge in the firms' inspection results for the 2012 inspection cycle in comparison to the 2010 inspections.
Lastly, I'd like to speak to you today about 2013 enhancements in the area of standard setting.
The PCAOB is uniquely positioned to use its insight from inspection activities to improve existing auditing standards to support high quality audits to protect investors and the public interest. As we look to what the PCAOB has accomplished through its standard setting, and what still needs to be done, we have taken on an ambitious project to broadly reexamine our standard-setting approach.
In our current strategic plan, we included a new strategy for standard setting for audits of emerging growth companies, in light of the recently enacted Jumpstart Our Business Startups Act (JOBS Act). We expect to continue to devote significant time and resources to preparing analyses to assist the Securities and Exchange Commission in making determinations under this Act regarding the applicability of new PCAOB standards to emerging growth companies, as well as continuing to explore ways to further incorporate economic analysis into our rulemaking processes.
For the long term, we are doing the work necessary to establish a vision and framework to guide and prioritize our standard-setting activities. Such a framework would be flexible and adjustable to respond to emerging risks and trends.
As part of this framework, we will consider using a combination of various approaches and related criteria for standard-setting projects, depending on the circumstances. We are thinking about the different categories or "tracks" for our standards projects. For instance, when we determine that a project is necessary because of unique circumstances related to U.S. issuers, we choose to take on a project even if other standard-setting organizations are not dealing with the issue. In other cases, there may be issues that other standard-setting organizations have raised or have acted upon where we can leverage that work to varying degrees in our own related projects.
As part of these efforts, we are looking to find a mechanism to eliminate the notion of "interim" standards — the title we use for the original AICPA standards the Board adopted when it began operations back in 2003. We have a 2013 project entitled, "Reorganization of PCAOB Auditing Standards." This project involves developing an approach to integrating and reorganizing the interim auditing standards (referred to as "AU") with the auditing standards issued by the Board (referred to as "AS"). This project is intended to make it easier for users to navigate the standards and facilitate users' ability to compare PCAOB standards to the International Standards on Auditing (ISA) and other standards.
This reorganization project is included in the Board's recently released standard-setting agenda. The agenda has been updated and improved with a new format where projects are divided into six month increments. It will be updated periodically. The new format allows for greater flexibility, while also providing greater transparency into ongoing developments.
The agenda is highly ambitious. The following five projects are scheduled for action in the first half of 2013:
The timing of two other potential 2013 standard-setting projects is dependent on third parties:
An additional eight projects also remain on our standards agenda:
We plan to make substantial progress during 2013 on the current agenda while also continuing to develop a long term view and framework for setting standards beyond the current project list. This is a substantive workload, and it is something to watch throughout the coming year.
As you can see, the Board's 2013 agenda is brimming with opportunities to make needed improvements in auditing while enhancing our audit oversight.
I expect the firms to demonstrate meaningful, measurable progress in audit quality in the next few years. At the same time, the PCAOB is working on better tools to measure and monitor audit quality levels.
A major driver of audit quality throughout the audit process is professional skepticism, and the Board is overseeing firms' initiatives to look closely at factors that lead to any lack or impairment of professional skepticism, and how to adjust their quality control systems to strengthen its application.
PCAOB inspections and remediation oversight is a profound regulatory tool. We will be working hard this year to refine the analysis of inspection findings, and we will begin improvements to the timing, content and readability of our inspection reports.
Finally, the Board has adopted an ambitious list of standard-setting activities for this year, while improving its standard-setting processes and project-tracking.
The PCAOB was established as the result of a devastating financial crisis, and was given a key role in protecting investors and the public interest in audit oversight. Since that time, much progress has been made, but more needs to be done.
After nearly 10 years on the job, the PCAOB is working hard to make sure audit firms remember to focus on the fundamentals of good audit quality and investor protection.
I look forward to continuing to work with the academic community to further our goals in these areas.
 Public Company Accounting Oversight Board Strategic Plan: Improving the Relevance and Quality of the Audit for the Protection and Benefit of Investors, 2012—2016. November 30, 2012. http://pcaobus.org/About/Ops/Pages/default.aspx
 PCAOB's Global Network Firm Inspection Program, established in 2011, involves the inspections of certain U.S. domestic annually inspected audit firms and their non-U.S. affiliates.
 U.S. Department of the Treasury, Final Report of the Advisory Committee on the Auditing Profession to the Department of the Treasury, October 6, 2008. In response to the recommendation, on October 22, 2008, the PCAOB's Standing Advisory Group discussed the recommendation and the work of other organizations related to audit quality indicators.
Panel Discussion — Feasibility of Audit Quality Indicators
 International Auditing and Assurance Standards Board, A Framework for Audit Quality (Consultation Paper), January 15, 2013.
 Knechel, W. Robert; Krishnan, Gopal V.; Pevzner, Mikhail B.; Stefchik, Lori; and Velury, Uma. (2012) "Audit Quality: Insights from the Academic Literature." Auditing: A Journal of Practice & Theory (in press).
 Staff Audit Practice Alert No. 10: Maintaining and Applying Professional Skepticism in Audits. (December 4, 2012).
 Hurtt, R. Kathy; Brown-Liburd, Helen L; Earley, Christine E.; and Krishnamoorthy, Ganesh. 2012. "Research on Auditor Professional Skepticism—Literature Synthesis and Opportunities for Future Research." Auditing: A Journal of Practice & Theory. (in press).
 Those firms are BDO USA, LLP; Crowe Horwath LLP; Deloitte & Touche LLP; Ernst & Young LLP; Grant Thornton LLP; KPMG LLP; MaloneBailey, LLP; McGladrey LLP; and PricewaterhouseCoopers LLP.
 As described in more detail in PCAOB Release No. 2012-003, Information for Audit Committees about the PCAOB Inspection Process, PCAOB inspection reports contain four parts, with Part I describing identified deficiencies in the performance of inspected audits and Part II describing any criticisms of the inspected firm's system of quality control.
 Pub. L. 112-106