Board Member Botic to Accounting Students: “The DNA of a Financial Statement Auditor”

Remarks as prepared for delivery 

Good evening and thank you Professor Rogers for the kind introduction. It is great to be with you and to be back in Blacksburg this evening. I always welcome the opportunity to speak with accounting students as you represent the future of the accounting and auditing profession, and it is even more special to be here with you at Virginia Tech.

Before I continue, please know that my comments this evening are my own and should not be attributed to the Public Company Accounting Oversight Board (PCAOB) as a whole or any Board or staff member.

Let me first offer my congratulations as many of you are on the cusp of entering the accounting and auditing profession. A well-functioning economic system is based on a foundation of sound and credible financial reporting. This has never been more important. I remain optimistic and excited about the future of accounting and auditing and am confident that your careers will take you in directions that you cannot predict. Your journey will be one of enormous potential.

Many years ago, like you today, I was also a student completing my Master’s of Accounting degree and spent many hours in Pamplin Hall. I recall frequent walks around this beautiful campus and drill field to the university library.

As I took those walks, I often contemplated, with both excitement and some anxiety, what the future might hold. I never imagined I would have the opportunity to work for an audit regulator (which, at the time, did not exist) that would provide me the opportunity to work with so many incredibly talented and dedicated auditors, lawyers, and other professionals as well as with numerous audit regulators from around the world to protect investors and drive audit quality.

Although I was only at Virginia Tech for a little over a year, the experiences during that time have had a long-lasting impact on my professional career and my life more broadly. I fondly remember multiple tax classes with Professor Eugene Seago. I also recall my first class on accounting systems with Professor Robert Brown.

You are all in similarly excellent hands. Earlier this evening, I had the privilege to meet and talk with many members of the accounting faculty. Their teaching and scholarship ensure the greatness of this profession and this university will continue well into the future. I want to recognize Professor Jennifer Joe in particular, a member of the PCAOB’s Standards and Emerging Issues Advisory Group.

As one goes through life, it is interesting what sticks with you. My education at Virginia Tech prepared me to enter the profession at a major accounting firm, first in tax, then moving to audit, and then to work at a regulator for now over twenty years.

One of the key takeaways from my classes was the need to consider the big picture. To not become overly focused on what is directly in front of me without stepping back and considering how it all fits together and to take the longer view. I believe this perspective has served me well in all aspects of my life and particularly now as a PCAOB Board Member.

As you transition to entering the profession, undoubtedly your career will take both expected and unexpected twists and turns. I encourage you to reflect on the individuals you meet along the way, in particular, your professors and others here at Virginia Tech who have provided advice and, when you needed it, a little encouragement. I can assure you that remembering those encounters, including the briefer ones, can help you to reset and keep your eyes focused on the bigger picture as you progress on your journey.

For our remaining time this evening, I would like to share with you some thoughts on three themes: first, the importance of the financial statement auditor to society; second, the PCAOB’s primary oversight activities; and finally third, what I believe are the key traits, or the DNA, of a financial statement auditor. We will have plenty of time for questions at the end of these prepared remarks.

A. Importance of the Financial Statement Auditor to Society

I have been a member of the accounting and auditing profession for over 30 years. My experience has shown me, time and time again, the vitally important role our profession serves in establishing trust. Trust not only in the execution of an individual audit but also trust across the broader capital markets.

The auditor’s role is critical to the accuracy of financial information. Trust in the auditor’s work allows investors – whether they are managers of large mutual funds or ordinary families trying to put money away for savings, home ownership, their children’s education, or their own retirement – to participate in our markets with confidence.

The financial statement auditor is a necessary component of a well-functioning and efficient capital market that promotes economic stability and resiliency. It has been said that along with lawyers, investment bankers, and valuation experts, auditors are one of the pillars of capitalism.¹

Investment in our capital markets has reached an all-time high. Approximately 58% of U.S. households owned stocks in 2022, underscoring the importance of the trust provided by the audit profession.²

Financial statement auditors bring independence, professional skepticism, and a deep understanding of both a company’s operations and internal controls. These characteristics ensure the transparency, accuracy, and reliability of financial statements.

The role of the financial statement auditor has long been acknowledged. As early as 1946, it was recognized that “[t]he certified public accountant acknowledges a moral responsibility . . . to be as mindful of the interests of strangers who may rely on [the auditor’s] opinion as of the interests of the client who pays [the auditor’s] fee. This is at the same time a heavy burden and a proud distinction. It marks the certified public accountant as an individual of the highest integrity . . . a highly useful servant to society as a whole.”³ These words are as true today as they were when written nearly 80 years ago.

You are entering a vibrant, resilient, and noble profession. I believe the work of the financial statement auditor benefits society and, more broadly, supports our way of life.

Arthur Levitt, a former Chairman of the U.S. Securities and Exchange Commission (SEC), spoke to this when he said “[t]he auditing profession is, in my mind, one of the most noble in our marketplace. At the very core of the auditor’s mandate is preserving the sanctity and purity of the numbers. In that sense, it is also one of the most elegant.”⁴

The nobility of the profession and its role in society are both very important to me and are concepts I hope you will come to appreciate as much as I do.

B. The PCAOB’s Primary Oversight Activities

Shifting to the PCAOB and keeping with the theme of investor protection and the public interest, the PCAOB’s mission is “to oversee the audits of public companies [and SEC-registered brokers and dealers] in order to protect investors and further the public interest in the preparation of informative, accurate, and independent audit reports.”⁵ Investor protection is our North Star and our Why.   

Twenty-three years ago, the Sarbanes-Oxley Act (Act) established the PCAOB as an independent oversight board for the audits of public companies. The Act was approved unanimously by the Senate and received only three votes against it in the House of Representatives.⁶ The PCAOB was created as a District of Columbia nonprofit corporation to oversee accounting professionals who provide independent audit reports for public companies (and later broker-dealers) with SEC reporting obligations. Our funding primarily comes from assessments of public companies.

Of the five-member Board, only two members can be CPAs. Along with Board Member Christina Ho, I am honored to be one. This composition of the Board is important to ensure the independence of the PCAOB from the auditing profession.

The SEC has oversight authority over the PCAOB, including the appointment of Board members, approval of the PCAOB’s annual budget, standards and rules, and appeals of inspection reports and remediation determinations.

The Board establishes a long-term strategic plan to direct the organization’s efforts. Our current strategic plan is for the period through 2026 and focuses on four key goals.⁷

The first goal is to modernize our standards. In May 2022, the Board announced one of the most ambitious standard-setting agendas to date. I think we can all agree that the world has changed significantly since the PCAOB was established and adopted as interim the auditing standards as they existed over 20 years ago in 2003. To make sure our auditing standards keep pace with developments in business practices and advancements in technology, continue to meet the needs of investors, and ultimately serve the capital markets, we intend to modernize our interim standards to ensure they are fit for purpose by issuing new standards, where necessary.

The second goal of the strategic plan is to enhance inspections. To accomplish this goal, we intend to:

• increase the transparency of our inspection reports and improve accessibility of inspection information on our website;
• issue our inspection reports more timely after the completion of an inspection;
• place a greater emphasis on remedial actions taken by firms to address quality control criticisms; and
• publish staff Spotlight documents throughout the year to highlight new or emerging risks and inspection trends as well as provide examples of good practices implemented by firms observed during our inspections.

The third goal is to strengthen enforcement. To achieve this goal, we will rigorously enforce PCAOB standards and rules and hold firms and associated persons accountable.

The fourth goal of the strategic plan is to improve our organizational effectiveness. Here, we are enhancing our engagement with staff as well as stakeholders to ensure our internal procedures work effectively and allow us to become a more agile organization. 

The PCAOB’s primary audit oversight activities include: registering accounting firms, setting standards, inspecting the work performed by registered accounting firms, and enforcing our standards.

First, is the registration of accounting firms. While registration with the PCAOB is voluntary, it is a fundamental requirement for accounting firms that perform or play a substantial role in the audits of public companies and broker-dealers.

There are nearly 1,600 accounting firms currently registered with the PCAOB, approximately 850 of which are located outside of the U.S. in 82 jurisdictions.⁸ Forty-seven percent of the firms that register do not in fact issue audit reports on public companies.

It is interesting to note that each member firm of a global network will register individually. Even though certain firms may share common attributes such as a brand name, audit methodology, and an information technology platform, each member firm will register and be subject to our oversight.

Registered firms have annual and special reporting requirements. These firm reports can be accessed on our website.

To illustrate the Board’s focus on importance of registration, on February 27, 2024, the Board issued Proposals Regarding False or Misleading Statements Concerning PCAOB Registration and Oversight and Constructive Requests to Withdraw from Registration.⁹ The comment period on these proposals ends on April 12, 2024.

The second area is our standard-setting activities. The PCAOB sets auditing and attestation standards for auditors of public companies and broker-dealers. In addition, we set broader standards and rules for quality control, ethics, and independence for firms and associated persons that perform audits under our standards.

I mentioned earlier our ambitious rulemaking agenda. When we consider the need for a new standard or rule, we generally first solicit feedback from our two advisory groups, the Investor Advisory Group (IAG) and the Standards and Emerging Issues Advisory Group (SEIAG). The composition of these groups provides the Board and staff with diverse insights and perspectives. The PCAOB’s Office of the Chief Auditor may also conduct its own outreach to various stakeholders. In addition, insights and perspectives on existing standards and/or the need for a new standard can be provided by our inspection and enforcement staff.

The public and interested parties also have the opportunity to provide feedback on our proposals by submitting comment letters. Each comment letter is reviewed and considered as potential standards and rules are finalized. It is a comprehensive process that is transparent and, I believe, helps us get to the right answer that will drive quality audits and ultimately protect investors and the capital markets.

You can follow the status of our projects on our website and please know that you, even as students, are invited to comment.

As part of ensuring transparency, the PCAOB’s standard-setting agenda is updated twice a year and is available on our website. Standard-setting projects are divided among short-term, mid-term, research, and rulemaking. Projects on our short-term standard-setting agenda include a new quality control standard (QC 1000), firm and engagement metrics, and non-compliance with laws and regulations (or NOCLAR). We have also added Critical Audit Matters (or CAMs) to our research agenda along with Data and Technology.

Our third main oversight activity is the inspection of registered firms. To provide context regarding the extent of our inspection activities, in 2023, we inspected 227 audit firms and portions of over 900 audit engagements in 37 jurisdictions.¹⁰

Our inspection staff, comprising over half of total PCAOB staff, assess registered firms’ compliance with applicable auditing standards, professional standards, and rules of the PCAOB and SEC. Each firm inspection results in the issuance of an inspection report, a portion (Part I) of which is made available on our website. We currently inspect 14 U.S.-based firms annually because these firms issue over 100 audit opinions in a calendar year. The number of annually inspected firms has fluctuated as firms merge, acquire new public company audits, or reduce the number of public companies they audit. Firms that issue 100 or fewer audit opinions in a calendar year are inspected at least once in a three-year period. These “triennially inspected” firms can range from small firms with less than five public company audits to large regional firms.

In addition to reviewing audit engagements, each firm inspection includes reviewing aspects of the firm’s system of quality control. A firm’s system of quality control represents the bedrock of a firm’s ability to consistently conduct high quality audits. Our inspection teams evaluate areas such as firm leadership messaging on audit quality (or “tone at the top”), and how the firm performs consultations, provides technical accounting and auditing training, and evaluates and compensates its partners, as well as the firm’s framework for complying with PCAOB and SEC independence requirements. The nature of the system of quality control varies with the size of the firm; therefore, we have a scaled inspection approach rather than a “one size fits all” approach to quality control.

During our review of individual audit engagements, our inspectors may identify areas of non-compliance with applicable standards. Common areas of identified audit deficiencies include revenue, inventory, long-lived assets, accounts impacted by business combinations, allowance for credit losses, equity, and internal control over financial reporting (or ICFR).¹¹ These areas generally require significant auditor judgment. I will add that it is very troubling that many of these areas represent deficiencies that have been repeating over many years.

Any public company with SEC reporting responsibilities, even if the company is not based in the U.S., has an audit requirement that is subject to PCAOB standards and rules. To date, we have inspected firms in 57 jurisdictions.¹² Certain of our inspections of non-U.S. firms are conducted jointly with a home country regulator. Through our Office of International Affairs, we have entered into 26 bilateral agreements with home country regulators to facilitate these inspections.

Fourth and last is our enforcement activities. The PCAOB uses its investigative authority to identify serious audit deficiencies that pose risks to investors and uses its disciplinary authority to impose sanctions and penalties, where appropriate. Our enforcement activities are designed to act as a deterrent to ensure firms remain diligent and comply with applicable standards and rules.

In general, the Board is imposing stronger sanctions, including increasing penalties, to promote greater accountability and to deter misconduct. In many instances, this move towards stronger sanctions is reflective of the long-standing nature of our commonly identified inspection deficiencies and, in certain cases, the egregious nature of the misconduct.

We had 46 settled orders in 2023, more than any other year in our history.¹³ Two of these settled orders related to the sharing of answers on training exams. Given how central integrity is to the auditing profession, these instances of cheating are disturbing and are, in my view, a poor reflection on the entire profession.

In 2023, we imposed a variety of sanctions on firms and associated persons found to have violated relevant rules and standards. These sanctions included, in part, the revocation of firm registrations, suspensions and bars of associated persons, undertakings to design, implement, or modify policies and procedures, requirements to engage independent monitors or consultants, and civil money penalties.

It is worth highlighting that the Act provides that all the money we collect as part of our enforcement activities fund student scholarships.¹⁴ Through our scholarship program, which has awarded $22 million in scholarships since its inception, we hope to encourage more students to consider a career in auditing and help those currently in accounting programs offset the costs of tuition.

C. The DNA of an Auditor

Now that we have discussed the role of the audit profession to society and the oversight activities of the PCAOB, let us move to our final area, the DNA of an auditor. Reflecting on my experiences as a practicing auditor and during my time at the PCAOB, I have often contemplated whether there are certain characteristics that have an outsized influence on the ultimate success of an auditor. Traits that might go beyond those characteristics commonly cited as being necessary for a successful auditing career such as maintaining strong technical accounting and auditing knowledge and skills, a willingness to work hard, having a positive attitude, and striving for a high degree of integrity.

As important as each one of these and many other traits are – and they are all important for an auditor’s success – I submit that there are four unique characteristics that collectively represent the DNA of a successful financial statement auditor. Just as an entire genetic DNA sequence is made up of only four chemical bases, these four components interact and combine to capture a successful auditor’s essence. These four attributes are:

• a commitment to the auditors’ responsibility to investors and the public interest;
• a drive to obtain an understanding of a company’s business, operations, and strategy;
• a dedication to lifelong curiosity; and
• an obligation to professional skepticism.

I will discuss these one by one, explain the importance of each, and show how, when woven together, they create the fabric necessary for an auditor’s success. I also very much welcome your views on these four characteristics.

Investors and the Public Interest

First, a commitment to the auditors’ responsibility to investors and the public interest is foundational to the financial statement auditor’s success. It has been stated that “[d]octors, lawyers, and other professional[s] render services which are of immediate concern only to the person who receives them (though society as a whole is, of course, affected indirectly); but the services of a certified public accountant, which consist largely of expressing opinions on financial statements, are frequently of as immediate concern to large numbers of persons who never see the accountant . . . .”¹⁵

The U.S. has the largest capital markets in the world. Investments flow into our markets because of the strength of our financial system. In fact, investors poured a record $56 billion into U.S. equity funds in the week ended March 13, 2024.¹⁶ Well-functioning capital markets depend on credible financial reporting underpinned by rigorous independent audits.

This focus on serving investors and the public interest is what makes the auditing profession so noble. Recently, I heard someone remark that auditing should continuously strive to be the public good it was designed to be. A successful auditor, no matter their role, takes that to heart.

Because of the strength of our capital markets, people no longer feel the need to hide cash under the floorboards – they invest in our markets instead. Auditors must have a deep appreciation of their role in protecting investors and the public interest to exercise their duties properly.

Understanding the Company’s Business, Operations and Strategies

A drive to obtain a comprehensive understanding of the public company’s business, its operations, and strategies is the second building block in an auditor’s DNA.

While this may be a challenge when auditors first enter the profession, it is incumbent on every auditor to learn all they can about the operating environment, competitive landscape, risks, and future plans and strategies of every company they audit. And it is precisely because this task is challenging that a thirst to dig into these areas is so important to becoming a stronger auditor and performing a high-quality audit. “[E]xamining the financial condition and performance of businesses, and the ability to look at the company’s operations with the same eyes as an active owner or manager gives [the auditor] the practical outlook that a penetrating audit requires.”¹⁷

A starting point is studying the company’s Form 10-K, but it does not end there. It is incumbent upon the auditor to evaluate analyst reports, press releases, news articles, and, if available, short seller reports. Of course, this information needs to be supplemented by conversations with employees and management of the company.

Collectively, this knowledge will provide insight to empower and enhance the judgements the auditor makes throughout all phases of the audit.

The company’s operating environment and strategies tell a story that informs the design of the audit approach. As the auditor performs the risk assessment and evaluates the flow of transactions from both a control and substantive viewpoint, understanding the company’s business will enable the auditor to develop a perspective from which to perform audit procedures. That perspective will provide the auditor a lens with which to better identify inconsistent financial relationships.

This approach will differ from that of an auditor who is merely “ticking and tying” and executing mechanically on the required procedures without making the connections between account balances and perhaps the warning signs of error, fraud, or misstatements.

A successful financial statement auditor is one who understands how different components relate to one another, not just independently, but in their particular context. A company’s business and strategy, in other words, provides the lens to sharpen details and bring the right areas into focus. The successful auditor then, is one who is driven to develop that lens in order to peer through it and obtain those insights.

Lifelong Curiosity

The next characteristic in the DNA of an auditor is a dedication to lifelong curiosity. This curiosity will help to prevent repetition and familiarity from dulling the auditor’s ever-needed critical sense.¹⁸ The auditor’s curiosity is closely correlated with the need to understand the company’s business. An auditor is less likely to learn more about the company’s operations and long-term strategies without possessing a curious nature.

This curiosity also helps to place knowledge about the business into context. How are anticipated changes to interest rates going to impact the operations and investments made by the company? How do future strategies affect product lines and the projected cash flows used in impairment analyses? Will global conflicts have local repercussions? How will planned investments in technology change the way the company performs tasks? Reading newspapers daily, setting up alerts for topics related to the industry and the specific company being audited, and asking questions of specialists are all ways to further hone this curiosity.     

This dedication to a lifelong curiosity is what binds understanding the company’s business to the final component of the auditor’s DNA: an obligation to professional skepticism.

Professional Skepticism

In a recent statement, Paul Munter, the SEC’s Chief Accountant, rendered a call “for the auditor to exercise objective, impartial judgment and rigorous professional skepticism in gathering and evaluating evidence throughout the audit to support the audit opinions provided.”¹⁹ I appreciate this renewed focus on professional skepticism. While professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence, I want to touch on another aspect of skepticism.

To me, skepticism also encompasses the auditor having the confidence and self-assurance to question and challenge management explanations that do not make sense as well the courage to dig deeper. It is about having that courage to ask probing questions and following up on answers, when warranted.

Recently, a colleague and I spoke about the need for auditors to be comfortable asking uncomfortable questions. We discussed the article that journalist Bethany McLean published in Fortune in 2001 titled “Is Enron Overpriced?”²⁰ The article, published nine months before Enron filed for bankruptcy, raised questions about Enron’s opaque business model. Ms. McLean epitomized skepticism in that article. She had the courage to raise the tough questions and express her concerns about Enron’s valuation in the face of so many others staying silent.

With respect to an audit, there will likely be additional time and cost incurred when an auditor asks more probing questions and follows-up on unresolved matters. In fact, a recent academic paper studied the costs of being skeptical on an audit, which can result in additional time spent investigating red flags which ultimately do not identify misstatements. The paper termed this “costly skepticism,” and noted supervisors may penalize the auditor in performance evaluations for “pulling the thread” in this situation.²¹

As a profession, it is imperative that we actively encourage and reward professional skepticism, regardless of the outcome. A PCAOB Spotlight issued in 2023 emphasized that firms’ appraisal, promotion, and compensation processes should promote, rather than discourage, the application of professional skepticism.²² Skepticism should be top of mind for auditors and must be encouraged and cultivated throughout the firm.

To summarize, these four characteristics are interdependent on each other. As previously mentioned, an auditor must have a curious mindset to delve into the company’s business operations, plans, and strategy. This knowledge of the business will help identify the risks as well as the appropriate audit response to those risks. The combination of curiosity and knowledge of the business will fortify a mindset of professional skepticism.

Firm Culture

Finally, I would be remiss if I did not mention the important role that firm culture plays here. A strong firm culture is necessary to ensure auditors can develop and refine the components of auditor DNA, and of equal importance, ensure that these four attributes are replicated with each class of newly minted auditors.

Firm culture should be proactive, encouraging, and create an environment that is unambiguous about its priorities, whereby an auditor feels empowered to ask the challenging and probing questions and can take the time to fully understand the company’s business, operations, and strategy. In the end, each auditor should feel confident that all levels of firm leadership support them such that they know leadership has their back. Without this certainty, the DNA of even the best auditor can, in time, be damaged. Firms must aspire to create an environment for auditors to flourish.

Conclusion

As I conclude, I want to go back to where we started this evening and again say congratulations and thank you for studying accounting and auditing. You are entering a vibrant, resilient, and noble profession that is essential to economic growth, the strength of the capital markets, and society as a whole.

We need students, like you, that are investor and public interest focused, motivated to understand business, curious, and willing to demonstrate professional skepticism entering this great profession to maintain the public’s trust in the financial markets.

Before I pause to take your questions, I would like to end my remarks with another quote from former SEC Chairman Arthur Levitt. In October 2000, Chairman Levitt spoke of the “light of independence.”²³ I think his statement is applicable beyond independence and is relevant as you embark upon your careers and enter the profession:

One generation of accountants passes on the light of independence to the next. That light sustains the profession’s life through a culture of integrity, a mission of objectivity and an ethic of responsibility. You have been handed a precious legacy. What you do with it will determine the future of this profession. It is a heavy burden but an awesome privilege. Lift the light far and wide for the next generation of accountants to see. Lift the light far and wide for America’s investors to see. And, lift the light far and wide not just as a profession – but as individuals – committed, passionate and resolute to a fidelity that is as much about the profession’s past as it is about the profession’s future.

Thank you for your attention, and I welcome your questions.