Audit Quality, Firm Independence, and the Firm Business Model

I welcome our regulatory guests from over 30 jurisdictions around the world to the Public Company Accounting Oversight Board's 9th Annual International Institute on Audit Regulation.

At the outset, I must say that the views I express today are my own and do not necessarily reflect those of the Board or staff of the PCAOB.

I chair the PCAOB's Investor Advisory Group and until April 2015 chaired the Investor and Other Stakeholders Working Group of the International Forum of Independent Audit Regulators ("IFIAR").

I want to share with you some of what I have heard, and am hearing, from these groups.

A number of these investor views are also represented in the PCAOB's most recent Strategic Plan.[1]

Audit Quality

Audit quality continues to be a key focus of investors. Investor representatives, along with audit regulators from around the world, remain concerned about the continued high number of observed audit deficiencies. Audit quality is not where it should be.

In April 2015, the International Forum of Independent Audit Regulators published the results of its 2014 Inspections Findings Survey.[2] The findings of that survey are consistent with our own PCAOB inspectors' observations, namely that the areas of fair value measurements, internal controls, and revenue recognition continue to have the highest number of inspection findings.

While acknowledging that audit quality has improved over the years, investors expect more. They expect regulators to ensure that auditors fully understand and address the importance of auditor independence, objectivity and professional skepticism when conducting an audit, especially in light of the inherent conflicts of interest in the issuer-pay model. They also expect that auditors are held accountable when infractions are noted, and that deficiencies identified by regulators are remedied expeditiously.

Investors also expect auditors to be vigilant in addressing concerns related to management bias. As more items in the financial statements are now based on fair valuation, it is imperative for auditors to critically assess management's assumptions and inputs for determining fair value. The PCAOB has a standard setting project on estimates and fair value measurements to address such concerns.

Growing Lines of Business at Audit Firms and Independence

Investors continue to be concerned that firms may be focusing on growing their consulting practices at the expense of audit quality.

Revenue from advisory and consulting services now represents 41percent of total revenues across the four major United States firms, exceeding audit's 35 percent share. This is the second year in a row that advisory and consulting revenue has overtaken audit revenue at the U.S. Big Four firms. This trend and possible implications to audit quality is of concern to investors.

Memories fade with time but it is important to recognize that in the United States, the Sarbanes-Oxley Act of 2002, which created the PCAOB, was enacted as a result of multiple accounting scandals and billions of dollars of investor losses resulting from the failures at such companies as Enron, WorldCom, Tyco, Adelphia, Parmalat, and a host of others.

The first words of that law are, "An Act to protect investors" and the PCAOB's mission is clearly stated "…to protect the interest of investors and further the public interest in the preparation of informative, accurate, and independent audit reports…"

At the time, I was the Staff Director and Chief Counsel of the Senate Banking Committee working for Chairman Sarbanes. Hence, my interest and deep commitment to investor protection.

The Sarbanes-Oxley Act ended the era of self-regulation by establishing the PCAOB as an independent regulatory organization and I am delighted that we now have so many independent regulatory agencies throughout the world, many of which are represented here today.

In the United States, at the time of passage of the Sarbanes-Oxley Act, accounting firms could engage in both auditing and consulting activities for the same client at the same time which led to considerable independence and conflicts issues. The Act provided for enhanced auditor independence by barring audit firms from consulting for their audit clients and prohibiting a number of other specific activities.

The PCAOB's Strategic Plan for 2015–2019 recognizes these concerns in two separate sections: one dealing with the need to "Monitor and Analyze the Business Models of the Audit Firms" and the other, the need to "Monitor Emerging Threats to Independence and Develop Appropriate Responses." [3]

With respect to monitoring and analyzing the business models of the firms, the Board plans to "[c]ollect and analyze information describing the business models for registered accounting firms, with a focus on identifying and responding to potential audit quality risks posed by such business models, including consideration of potential policy options that could mitigate such risks."[4]

With respect to monitoring emerging threats to independence, the PCAOB plans to monitor audit practice for such threats and develop appropriate responses, including "PCAOB reporting on the evolution and structure of and audit and non-audit services offered by larger accounting firms and possible implications of their multi-disciplinary business model to independence and audit quality."[5]

Regarding both of these issues, monitoring emerging threats to independence and the evolving business models of the firms, it is especially important, given today's global environment, that all of us, as regulators, work collaboratively to address problems as they arise. This means making sure that adequate safeguards are in place and enforced to protect investors and ensure the highest possible audit quality.

Current Trends in the Audit Industry

Before I concluded my tenure as Chairman of the Investor and Other Stakeholders Working Group of IFIAR, our group worked together with IFIAR's Global Public Policy Committee Working Group – then-chaired by Brian Hunt, the CEO of the Canadian Public Accountability Board—to produce a paper titled, "Current Trends in the Audit Industry."[6]

The paper notes that "[c]hanges in the economic environment and the market for audit services have impacted how the audit industry operates and how it is perceived by users and the general public." It discusses important issues facing the audit industry including:

  • Commoditization of the audit;
  • The perceived value and relevance of the traditional audit including the auditor's responsibility to detect fraud;
  • The impact of an increased focus by the larger audit firms to grow their non-audit services with a specific focus on advisory/consulting services; and
  • The impact of advances in technology and greater availability of and access to data.

I commend this paper to you as I believe the issues discussed in it are highly relevant to your oversight and policy responsibilities.

Other Initiatives

Investor representatives clearly want audit firms to compete on the basis of quality and not price. As such, they support the PCAOB's initiative, and those of regulators worldwide, to identify audit quality indicators to distinguish firms from each other and thereby provide for greater competition among firms based on quality. You will be hearing about the PCAOB's and other jurisdiction's initiatives on audit quality indicators on Friday.

Investors also want regulators to exercise more oversight of the global network firms and their affiliates with an enhanced focus on audit quality and coordinated enforcement with our international counterparts. As noted in the Board's strategic plan, through our participation in IFIAR, bilateral engagement with non-U.S. regulators, and interaction with global leadership of the global network firms, the PCAOB is exploring how firm culture may affect auditor independence, objectivity, and professional skepticism across jurisdictions.[7]

Such outreach has benefited our efforts in identifying and implementing appropriate and effective responses to audit risks due to cultural differences, both at home and internationally.


In conclusion, what investors most want from us, as regulators, is that we ensure that audits are conducted by well-trained auditors who are independent, objective, professionally skeptical and committed to investor protection.

As I have repeatedly stressed in the past at these fora, what is most important for us, as regulators, is to protect the interest of investors and ensure that auditors are watching out for the best interests of investors through high quality audits.

Thank you and I am happy to answer any questions.

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