Improving the Quality of Audits


Welcome to the Miami-area PCAOB Forum on Auditing in the Small Business Environment. This is our tenth year of holding forums in cities across the United States on auditing in the small business environment. In fact, next month will be the tenth anniversary of our first forum, which we held at Costa Mesa, California.

The Role of PCAOB's Forums in Improving Audit Quality

The cumulative attendance at our small business forums over these ten years has reached about 6,350.

The goal of these meetings is to create an opportunity for discussion and dialogue among staff of the PCAOB and the Securities and Exchange Commission and auditors in smaller firms by providing opportunities for auditors to learn about the PCAOB's work, and to provide feedback and ask questions about PCAOB activities.

I believe that such proactive interaction and dissemination of knowledge contributes to improvements in audit quality. Also, these forums provide an excellent opportunity to hear from you about your experiences in applying PCAOB rules and standards that help inform our oversight activities.

We have many important topics to discuss today that relate directly to the quality of audits that you and other registered public accounting firms conduct on behalf of your ultimate client — the investors in the public companies and other issuers that you audit.

On the agenda today are a number of key areas of PCAOB auditing standards, including those related to risk assessment procedures and auditing revenue, common financial reporting issues facing smaller issuers right now, and current issues on PCAOB's standard-setting agenda.

Also, we will review the new Auditing Standard No. 18, Related Parties, which becomes effective for fiscal years beginning on or after December 15, 2014.[1]

In addition, we will spend a considerable amount of time discussing practical aspects of auditing under PCAOB standards, using case studies involving common inspection findings and the relevant auditing standards.

We will discuss serious misconduct that resulted in recent enforcement action at the PCAOB. Finally, we will cover the process for remediation of audit firm quality control deficiencies detected during PCAOB inspections.

Ensuring that all audit firms consistently perform high quality audits is important to the Board as well as the investing public. Auditors have been given an important and trusted role in the capital markets.

Clearly, reliable financial statements with auditor assurance are important to your clients, their investors, and the broader financial markets. A strong, high quality audit function is essential to the effective functioning of the capital markets, which in turn, affects the well-being of American families and our economy as a whole.

For that reason, we can never be complacent when addressing the quality of audits. The Board uses all of its oversight tools to monitor and react to risks and opportunities that can impact audit quality, including outreach at forums such as this one.

Inspections of Smaller Audit Firms

First, I would like to discuss inspection findings. The Board is concerned about the number of serious audit deficiencies that our Inspections staff continues to find across firms and audits.

I would like to highlight some of the issues our staff observes in practice at smaller audit firms. We will discuss these issues in greater detail today, including in the case studies.

Most of the issues we are currently observing are consistent with the findings summarized last year in the Board's report on the 2007-2010 inspections of domestic firms that audit 100 or fewer public companies each year.[2]

The Board is working to publish a report that summarizes our more recent inspections findings, and I hope that we can issue that report soon (and do so on a more regular and timely basis in the future).

Auditing Revenue

Deficiencies in auditing revenue and receivables persist, including in areas related to testing revenue recognition, presentation, and disclosure, and certain other areas of testing. The first case study will focus on this topic.

We will discuss Staff Audit Practice Alert No. 12, Matters Related to Auditing Revenue in an Audit of Financial Statements, which the PCAOB recently issued in light of these significant auditing practice issues observed by Inspections staff.[3]

The discussion will also cover the new accounting standard on revenue recognition that was jointly issued by the Financial Accounting Standards Board and the International Accounting Standards Board in May. The auditing matters discussed in the Practice Alert and at today's forum are likely to continue to be relevant to auditing revenue under the new accounting standard.

Auditing Issues at Smaller Audit Firms in Other Difficult Areas

In addition to revenues and receivables, inspection findings persist for smaller firms in the following financial reporting areas: inventory, allowance for loan losses, financial instruments, and non-financial assets (including assets acquired in business combinations, goodwill and other intangibles, and other long-lived assets).

The auditing standards that are associated with the above frequently identified deficiency areas for small firms are the following:

  • AU Section 342, Auditing Accounting Estimates,
  • AU Section 328, Auditing Fair Value Measurements and Disclosures,
  • AS No. 13, The Auditor's Responses to the Risks of Material Misstatement,
  • AU Section 329, Substantive Analytical Procedures,
  • AS No. 15, Audit Evidence,
  • AS No. 14, Evaluating Audit Results,
  • AU Section 350, Audit Sampling, and
  • AS No. 5, An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements.

Issues in Audits of Internal Control over Financial Reporting

A note about audits of internal control over financial reporting: Fewer smaller audit firms than larger firms that we inspect are engaged to perform an audit of management's assessment of internal control over financial reporting that is integrated with the financial statement audit.

Nevertheless, we find deficiencies in integrated audits that audit firms perform under the applicable standard, Auditing Standard No. 5. We will not spend as much time today on this topic as in prior forums, so I would encourage you to read and consider the guidance in Staff Audit Practice Alert No. 11, Considerations for Audits of Internal Control over Financial Reporting, issued just a year ago.[4]

Auditors should pay particular attention to this area as their clients begin to implement the updated COSO framework for internal control ("COSO 2013").[5]

Addressing Deficiencies to Improve Audit Quality

To address these and other audit deficiencies, and to continue to improve audit firms' systems of quality control, there are some effective remedial steps and corrective actions that firms can take right now.

Root Cause Analysis

First, I encourage audit firms to establish a robust process for identifying the "root causes" of audit deficiencies. A better understanding of root causes increases the likelihood that remedial or corrective actions will be effective.

To this end, our Inspections staff suggests that firms develop a formal, observable and regular process to analyze audit deficiencies.[6] And our Inspections staff looks for potential root causes as well, so you should discuss your process and results with the inspectors.

This process could include aggregating the deficiencies identified in inspections, assessing their nature and frequency, and the performance of in-depth inquiries to identify the reasons they may have occurred. Designing, implementing, and monitoring the corrective actions that respond to the inspection findings will be more effective with a better understanding of those root causes.

Remediation Activities

Second, when responding to any quality control criticisms in the non-public Part II of a PCAOB inspection report (during the remediation period), the Inspections staff encourages all firms to start their remediation activities early and to reach out to the PCAOB staff early in the remediation period.[7] This will maximize the benefits of the PCAOB remediation process.

Our Inspections staff devotes considerable attention and time during the inspection process to encourage firms to evaluate possible root causes for deficiencies. They suggest looking within the firm's structure, operations, processes and any other areas that may detract from audit quality.

Today we will discuss the inspection procedures relating to firms' remediation plans and actions. In general, firms have taken appropriate steps to remediate identified quality control findings and we have seen many smaller firms make improvements. Remediation remains an area of strong focus of the Board and staff.

* * *

Audit quality requires constant attention and work. Auditing is difficult and filled with competing tensions, and we can and should continue to learn from years of experience. I hope that you find today's program useful and that you will actively participate in today's discussions and take this information back to your firms. We also welcome your input and feedback throughout the program.

* The views expressed are my own, and not necessarily those of the Public Company Accounting Oversight Board, of any other Board member, or of the Board's staff.

[1] The SEC approved this new standard last week. See SEC Exchange Act Release No. 73396, Order Granting Approval of ProposedRules on Auditing Standard No. 18, Related Parties, Amendments to Certain PCAOB

Auditing Standards Regarding Significant Unusual Transactions, and Other Amendments to PCAOB Auditing Standards, Oct. 21, 2014.

[2] PCAOB, Report on 2007-2010 Inspections of Domestic Firms that Audit 100 or Fewer Public Companies, Release No. 2013-001, Feb. 13, 2013, at

[3] PCAOB, Staff Audit Practice Alert No. 12, Matters Related to Auditing Revenue in an Audit of Financial Statements, Sep. 9, 2014, at

[4] PCAOB, Staff Audit Practice Alert No. 11, Considerations for Audits of Internal Control over Financial Reporting, Oct. 23, 2014, at

[5] The Committee of Sponsoring Organizations of the Treadway Commission (COSO), Internal Control-Integrated Framework, May 14, 2013. In addition, I spoke at length last spring about related internal control audit issues that participants today may find helpful. Jeanette M. Franzel, Board Member, Effective Audits of Internal Control in the Current "Perfect Storm", Orlando, FL, Mar. 26, 2014, at

[6] See PCAOB Release No. 2013-001, at 36-40.

[7] Portions of such criticisms may be made public if the firm does not address them to the satisfaction of the Board within 12 months of the inspection report. See PCAOB, Information Concerning the Quality Control Remediation Process Under PCAOB Rule 4009, at