Update on Trends and Issues in Audits of Internal Control over Financial Reporting

On Saturday, August 6, I participated in a panel session on Internal Control over Financial Reporting (ICFR) at the Annual Meeting of the American Accounting Association (AAA) and used these slides.

The presentation provided an update on issues and trends in audits of ICFR and related PCAOB inspection findings. I presented similar information at the 2015 AAA annual meeting, which may be a helpful reference when reviewing the 2016 presentation. In my presentation, the views expressed are my own, and do not necessarily reflect those of the PCAOB Board or staff.

Below is a brief summary of the information provided in my 2016 slide presentation.

U.S. Big Four Firm Audit Deficiencies

  • For the U.S. Big Four firms, the level of audit deficiencies related to ICFR improved in the 2014 inspections (generally performed in 2015) when compared to the previous year, although the rate is still high at 30 percent of the integrated audits inspected.
  • A similar number of audit deficiencies were found in the 2014 inspections compared to the previous year for an auditor's selection of controls for testing that are important to the auditor's conclusion about whether the company's controls sufficiently address the assessed risk of misstatement (AS No. 5.39).[1] Fewer deficiencies were found in 2014 when compared to the previous year in testing design effectiveness (AS No. 5.42) and operating effectiveness of controls that were identified for testing (AS No. 5.44).
  • Although the lower number of deficiencies in testing design and operating effectiveness of controls is encouraging, the lack of progress in selecting the appropriate controls to test is concerning. In cases where the auditor has not properly identified important controls to test, the auditor doesn't even get to the stage of testing the design and operating effectiveness of those controls.
  •  PCAOB 2015 inspection results for the U.S. Big Four firms show improvements in the area of auditing ICFR and a trend of overall reductions in audit deficiencies.

Percentage of Adverse Internal Control Opinions

An auditor's opinion on a company's ICFR is "adverse" when the auditor reports at least one material weakness in ICFR, meaning that the company's ICFR was ineffective.

  • The number of adverse ICFR opinions has increased since 2010, climbing from 3.4 percent of ICFR opinions in 2010 to 6.0 percent in 2014.
  • The preliminary percentage of adverse ICFR audit opinions for 2015 is 5.4 percent, but that figure will likely increase as it is based on a preliminary count of filings through July 20, 2016. For comparison purposes, the preliminary percentage of adverse ICFR opinions for 2014 at a similar cut-off point last year was 5.2 percent. That figure rose to 6.0 percent based on subsequent filings.

Financial Restatement Activity of Public Companies and Other Issuers with ICFR Opinions

  • Consistent with prior years, the vast majority of public companies and other issuers with restatements had "clean" ICFR opinion in that same fiscal year.

[1] As part of the PCAOB's reorganization of its auditing standards, AS No. 5 was renumbered as AS 2201, effective Dec. 31, 2016. See PCAOB Release No. 2015-002.