“Keeping that in mind, I continue to observe that some accounting firms are actively growing their consultancy practices,” said Beswick.
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He noted that the SEC’s Office of the Chief Accountant is occasionally asked about transactions involving accountants who are expanding their non-attestation service practices. “Some of the expansion relates to businesses that are fairly removed from an accountant’s professional mandate to perform quality audits,” he added. “For instance, we are aware that accountants have been acquiring businesses that provide project management, system architecture and design, and other IT services. At a minimum, these transactions can raise transitional issues with respect to compliance with the auditor independence rules. However, in my mind, more important is how the accounting firm views its non-audit service practice and whether this results in the accounting firm devoting the appropriate resources to its audit practice.
“My interest goes beyond technical compliance with the rules, which is very important, of course,” Beswick added. “I also question whether the accountants’ expanding practices into areas unrelated to their primary competencies weakens the public trust. I am disheartened when I read an article in the press that raises questions about the propriety of non-audit services that accountants provide to their audit clients. It is firmly rooted in the independence principles that independence is needed in both fact and appearance. As you all know, perception is reality, and negative perceptions can undermine investor confidence in audits. I am also concerned that expanding into businesses that have little relevance to the accountant’s primary competencies probably does little to promote audit quality and has the potential to distract a firm’s leadership and other personnel from providing appropriate attention to their audit practice. Such expansion runs the risk of damaging the accountant’s reputation.”
Audit Independence Conflicts
PCAOB chairman James Doty discussed the tension between these roles in his speech as well. “As I have learned in this job, getting the accounting right is indeed not the same thing as getting the auditing right,” he said. “My sense from accountants I talk to is that auditing is receiving well-deserved attention in its own right. Our economic success depends on the confidence of the users of capital and the providers of capital alike. Corporate managers hire internal accountants — many of you here today—to ensure they have accurate and detailed information on which to base management decisions. Managers ignore opportunities to glean trends and insights from this data at their peril. Mistakes in this information can send a company into a business line or market that squanders resources. We now know that the true cost of financial misstatement is much greater than stock market fallout, concomitant lawsuits and insurance claims.”
Doty said it was time to focus on auditing as a discipline in its own right and improve the training of auditors, while teaching them about the history of fraud. “Many accounting firms devote inestimable time and attention to the study of the fine points of the applicable accounting regimes,” he said. “But with this history, it is high time that we focus on auditing as its own discipline, to be studied, nurtured and trained. All auditors should be versed in the case studies on fraud. It is simply not the case that frauds do not repeat; although there may be new twists, familiar elements reappear.”
Doty is concerned about the growing role of consulting revenue at auditing firms. “Large audit firms' revenues from consulting are growing rapidly, at some firms more than 15 percent a year,” he pointed out. “Audit fees have stagnated at, basically, the inflation rate. Thus audit practices have shrunk in comparison to audit firms' other client service lines—not all of which are schooled in, or depend upon, the fundamental exercise of skepticism. This threatens to weaken the strength of the audit practice in the firm overall.”
He noted that after nearly 10 years of inspecting the audits of issuers, the PCAOB has identified hundreds of engagements that did not meet PCAOB standards in significant respects. “These are serious audit deficiencies in procedures and actions that mean, essentially, that the audit opinions involved were not adequately supported,” said Doty. “Moreover, inspection findings have increased at many firms over the last several years. This is a hard message. It is to be expected that the inspection findings are a disappointment to a profession proud of its reputation for technical excellence. Some firms have seen even more findings this year.”
However, Doty acknowledged that the PCAOB has seen good news from its audit inspections too, especially when the firms use the inspection results to improve their practices. “Yet I say with confidence that I have seen dramatic improvements in audit quality in response to the findings,” he said. “When a firm accepts the findings, and undertakes a rigorous root cause analysis, it can design actions to reduce and eliminate recurrence. The audit firm takes a significant step on the road to excellence when it acknowledges that the number and vector of our findings indicate root cause, systemic issues, and not merely episodic failures in execution. That involves self-monitoring and testing—not just waiting to see if the PCAOB finds the problem in other audits.
“Inspectors have seen it done,” Doty added. “This requires, when a firm is grappling with evidence of a lack of skepticism in certain past audits, the firm demands—through its words, actions and subsequent testing—pervasive and explicit evidence of skepticism in the work papers. It means the firm issues meaningful, believable and consistent messages internally that quality is not one of many goals, but the firm's number one priority. It means these communications go to—and are honored by—all professionals, because the firm engages all professionals in the remediation efforts. I hope you are seeing these actions and improvements in your firm. Not all firms have gone to these lengths. But this is what quality means.”