The Public Company Accounting Oversight Board is seeing some improvements in audits of internal control over financial reporting, but also some contradictory findings.

In a speech last week during the American Accounting Association’s annual meeting in Chicago, PCAOB member Jeanette Franzel discussed some of the trends in the board’s inspections. “ICFR audit deficiencies continue to be the most frequent inspection findings, which is a concern,” she said. “Yet, we may be seeing the beginning of a positive trend line, and I am hopeful that the number and nature (severity) of ICFR findings will continue to decline.”

She is seeing some contradictory patterns in the PCAOB inspection findings of auditing firms that could lead to additional research. “The data on adverse opinions on ICFR are ‘noisy’ in several respects and present opportunities for additional inquiry and study,” said Franzel. “For instance, the data show an apparent contradiction that would benefit from additional inquiry: an overall increase in the percentage of adverse opinions on ICFR while, at the same time, an overall increase in the percentage of ‘clean ICFR’ opinions for issuers that announce a restatement. The data does not indicate any systemic impact on audit fees that could be attributable to recent changes in ICFR auditing or inspections.

However, there are variations in audit teams’ and firms’ effectiveness in implementing changes to their ICFR audit procedures, which may be impacting the amount of audit work for some issuers. Keep in mind that sometimes audit fees are impacted by the simple fact that issuers have inadequate controls.”

Franzel noted that although firms have been making some progress in their remediation efforts in the area of internal controls over financial reporting, some firms still have significant work to do to meet the requirements of the PCAOB auditing standards.

During the 2014 inspection cycle, the most frequent areas of ICFR audit deficiencies were in the areas of selecting the appropriate controls to test, testing design effectiveness to determine whether the company’s controls satisfy the control objectives and can effectively prevent or detect errors or fraud that could result in material misstatements, and testing the operating effectiveness of the controls.

“Audit engagement teams often did not obtain an understanding of a company's flow of transactions in order to identify and select the appropriate controls to test,” said Franzel. “In certain other cases, inspections staff observed that auditors selected controls to test that were not responsive to the fraud risks that they had identified. In addition, audit engagement teams continue to struggle with the testing of management review controls in that they often did not evaluate whether the management review controls operated at the necessary level of precision that would address the assessed risk of material misstatement.”

PCAOB inspections staff have also seen engagement teams rely on management review controls to compensate for other identified deficiencies without fully understanding or appropriately testing whether that management review control operated effectively at the necessary level of precision, she added.

Franzel pointed to concerns she has heard about the potential impact on audit fees.

“Some issuers may be seeing additional ICFR audit work being conducted by audit firms as a result of deficiencies identified through a PCAOB inspection of their own audits and/or as a result of systemic changes being made in response to deficiencies found in multiple ICFR audits conducted by the firm,” she said. “Other issuers simply may not be well-prepared for their audits in that their controls are not as strong as they should be and/or those controls are not supported by strong documentation and evidence. These situations can also lead to more audit costs, as well as more costs to the issuers if controls need to be improved. At the same time, I've heard anecdotal accounts about auditors adding work that is potentially not value-added, while driving up audit fees, in response to PCAOB inspection findings. We've also heard that constructive and productive communication is sometimes lacking between auditors and audit clients, with the engagement teams simply telling an audit client that certain work must be done in a particular way ‘because of PCAOB inspections.’”

Franzel acknowledged there might be some justification for those concerns. “I believe that there probably are some cases out there where auditors are doing too much work or not the right kind of work in an attempt to respond to or avoid a PCAOB inspection finding, and that communication between the auditors and clients on these matters has not been productive,” she said. “To the extent that this is happening, ‘we’ collectively, including the firms, audit teams, issuers, and the PCAOB, need to get a handle on this, so that valuable audit resources are not being diverted from areas that are high risk.”

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