The Democratization of the Audit Process: Statement in Support of the Adoption of Firm and Engagement Metrics

Remarks as prepared for delivery

Good morning and thank you, Chair Williams.

I am pleased to support the adoption of Firm and Engagement Metrics.

As I noted in my statement in support of the proposal, this is a project many years in the making, and my time at the PCAOB has given me a front-row seat to its development. I was a staff member in the Division of Registration and Inspections in 2008, when the Treasury’s Advisory Committee on the Auditing Profession (or ACAP) report first recommended developing indicators of audit quality, and I remember distinctly the many conversations that ultimately led to our own 2015 concept release, with Greg Jonas leading a team dedicated to this effort. More recently, our Investor Advisory Group and Standards and Emerging Issues Advisory Group have discussed the topic at multiple meetings and provided valuable input and perspectives. That history, as acknowledged in the release, underscores how strongly investors and other stakeholders have sought this type of information.

In my estimation, the topic of quantitative indicators or metrics around the financial statement audit has one of the most well-developed bodies of thought, discussion, and scholarly research of any potential topic in auditing. The rule before us today has literally been over fifteen years in the making.

Because of this rich history, I have spent many years contemplating the value of audit quality indicators, or what we now call metrics. This includes studying firm level metrics disclosed by many firms in their annual quality or transparency reports as well as the work of numerous non-U.S. regulators in this space.

New Visibility into the Audit Process

I see Firm and Engagement Metrics as the latest step in a long series of efforts by the PCAOB to provide insight and transparency into the audit process – for the investing public, for audit committee members, for the academic community, and for other stakeholders. Other steps in this journey have included Form AP, which requires the disclosure of the names of engagement partners and other accounting firms who participated in the audit; and Critical Audit Matters, or CAMs, which cover challenging, subjective, or complex matters of auditor judgment conveyed to the audit committee.

The collective transparency offered by these endeavors is essential. I will say without hyperbole that it represents the democratization of the audit process. With this change, every investor, director, academic, and firm employee or partner, will have access to the same body of information. Previously, this information may only have been shared with the audit committee and management, and even then, only for that engagement. The availability of this information, in turn, promotes the trust and confidence in the auditors’ work that is essential to the continued healthy functioning of the capital markets.

At its core, an audit is about risk assessment, and the planning and execution of audit procedures. Both activities require a great deal of professional judgment, which can be difficult to assess from the outside.¹ These limitations hinder stakeholders’ ability to assess the quality of the audit, and in turn any related decisions are also hindered.

Audit committee members are well placed to ask questions of their own auditors about their own audit. But as one commenter on the proposal pointed out, an audit committee’s principal tool is inquiry, not observation, which, in audit parlance, is the weakest form of audit evidence.² Furthermore, for other engagements – even audited by the same firm – audit committee members have no greater visibility than any other user of the financial statements.

When one audit cannot be differentiated from another, investors and other stakeholders are left with looking at broad variations in firms and their reputations, which may or may not correlate with quality and do little to inform the work performed on a particular set of financial statements. That is one reason why I am pleased that the metrics before us today are assessed at both the firm and engagement level. As noted in the release, our oversight activities have revealed that there are identifiable performance differences both across firms and even among engagement teams within the same firm.

To serve their intended purpose, metrics are needed at both levels. Firm-level metrics provide insight into the manner in which firms manage and deploy resources, and engagement-level metrics demonstrate the execution of those efforts on individual audits. The disclosure of both firm- and engagement-level metrics will enable audit firms to differentiate their audit work and truly be able to compete on quality.

Collective Value

When doctors need to examine the workings of a patient’s heart, they generally do not cut the patient open. Instead, they order an echocardiogram, which uses sound waves to generate a picture of how blood is flowing through the various valves and chambers. I believe these metrics, when combined with Form AP information and CAMs, offer a similar “echo” of the audit process that investors, audit committee members, the academic community, and other stakeholders can examine and glean valuable information from to form conclusions about the audit.³

This suite of eight metrics primarily focuses on information about audit personnel and will provide valuable insights into the audit process. Of these metrics, I am pleased that training hours have been added since the proposal. Although shared service centers and the use of specialists are no longer included, I am pleased that the release acknowledges the expanding and evolving use of shared service centers and the commitment of PCAOB staff to study the impact of shared service centers on audit quality, on financial economics, and on staffing models.

While no set of metrics, no matter how carefully articulated, can fully capture the inner workings of an audit, the staff has worked diligently to distill over fifteen years of organizational efforts, recent commenter input, and significant work from the academic community to arrive at today’s recommendation. In turn, I look forward to the scholarly research the academic community will perform from the information provided by these metrics moving forward. I anticipate such efforts will lead to new information about the financial reporting ecosystem that will help improve audit quality even more. Such efforts will only serve to benefit our understanding of the drivers of audit quality.

Maintaining the Relevance of the Audit

I believe transparency into the audit process is of paramount importance if the audit is to remain relevant in the long term. In recent remarks, I called auditors the moral backbone of the capital markets, and I fully believe that.⁴ But for auditors to continue to be perceived as such by the broader public, we must ensure that audits remain understandable along the dimensions that investors and other stakeholders identify as most important. Otherwise, I fear audits will be viewed as interchangeable commodities where price is all that matters.

When firms compete on audit quality, and not just price, it preserves their standing as “the foot soldiers of integrity.”⁵ My hope is that firms and audit committees will openly and actively embrace the opportunity afforded by transparency efforts like this one. Doing so will serve the profession for years to come and further solidify trust and confidence in the financial reporting ecosystem.

Over the past year, as I have reviewed and considered all of the staff’s rule and standard recommendations, I reflect on whether a given standard or rule will stand the test of time. I believe all regulators strive for rules that will do just that. In this instance, I am confident that the increased transparency and comparability that these metrics will provide into the audit process will better inform stakeholder decisions, allow firms to compete on audit quality, and will ultimately democratize the audit process.

Conclusion

I would like to thank all the commenters who contributed their thoughts on this proposal; the final standard was enhanced by your feedback. I would also like to acknowledge the many staff members who worked over many years on the various permutations of this effort.

Thank you to the staff who worked diligently on this release to get us to today’s vote and took the time to meet with me and my staff on multiple occasions. This process was comprehensive and was responsive to our questions and concerns. I extend my gratitude to Barb Vanich, Jessica Watts, Stephanie Hunter, Karen Wiedemann, Clair Sever, Schuyler Simms, and Akiko Upchurch in the Office of the Chief Auditor; to Martin Schmalz, Erik Durbin, Nick Galunic, and Eric Carlson in the Office of Economic and Risk Analysis; and to Connor Raso, Katherine Kelly, Vince Meehan, and Marc Francis in the Office of General Counsel. I would also like to recognize the support provided by staff from the Division of Registration and Inspections, the Division of Enforcement and Investigations, and the Office of Communications and Engagement. 

And finally, I want to express my gratitude to my fellow Board Members and their staff for the many conversations in advance of today’s meeting.