The Public Company Accounting Oversight Board is seeing signs of progress on audit quality in its inspections.

“We’ve seen the large firms dedicate significant resources toward remediating deficiencies and improving quality control systems,” said PCAOB board member Jeanette Franzel during a speech Thursday at Baruch College’s financial reporting conference in New York. “To varying degrees across the large firms, we’ve also seen improvements in tone at the top, coaching and support to audit teams, training and monitoring of quality. And, in the smaller firms, we’ve seen many firms doing high quality work and taking their responsibility for audit quality very seriously. The bottom line is that, for the most part, we’ve seen a focus on audit quality backed by actions and resources.”

She pointed out that during the PCAOB’s 2015 inspections, 49 percent of the smaller U.S. firms that are inspected every three years had no deficiencies noted in part 1 of their PCAOB reports, in which inspectors look for signs that auditors did not perform enough work to support their audit opinions. For the large firms that are inspected annually, Franzel said they have been dedicating more resources toward fixing deficiencies and improving their quality control systems.

PCAOB board member Jeanette Franzel speaking at Baruch College in New York
PCAOB board member Jeanette Franzel speaking at Baruch College's Zicklin School of Business

In anticipation of the PCAOB inspections, many firms are taking proactive steps to better manage audit quality, Franzel noted. In particular, the PCAOB Inspections Division’s emphasis on studying the root causes of audit deficiencies, and more recently, audit successes, is prompting the profession to address a wide range of issues driving audit quality, she added.

However, Franzel acknowledged many problems remain at the audit firms. “Across the system, there are still firms that need significant improvement and others that are serious outliers,” she said. “We’ve also found significant deficiencies and risks to audit quality across the global networks and in other cross-border audits. We consider these firm-specific issues in our inspections planning and selection processes, as our inspection process evolves to address ever-changing risks.”

The PCAOB has been encouraging more firms to use audit quality indicators, such as the ones it proposed in 2015. The indicators are still not required by the PCAOB, but the board has been monitoring the use of the indicators by firms, audit committees, other audit regulators and academic researchers. The PCAOB staff is incorporating information from the indicators within its inspection program, analyzing various detailed measures as part of the inspections process for the large firms.

Franzel noted that some firms are actively using their own metrics to help them manage quality across their audit practices and for individual engagements. Some large firms are also publishing firm-level metrics in annual reports. The PCAOB hopes to publish a report later this year with observations from its remediation and root cause programs, including a discussion of the potential benefits of using audit quality indicators within a firm's system of quality control.

Auditing Technology and Diversity

Franzel also discussed the increasing use of technology by audit firms, including artificial intelligence, data analytics and distributed ledger technology such as blockchain.

“These potentially disruptive changes will present challenges and threats across the auditing profession, including the need for significant investments in technology, new management and technical skills, and even new firm business and organizational models,” she said. “Of course, these developments will present new corresponding risks to audit quality. And throughout the course of these technological changes, we cannot forget that our focus should remain on the critical role of auditors to provide assurance over management’s financial reporting and related controls for the protection of investors. If managed and implemented properly, these developments have the potential to enhance the value of the audit process and increase audit quality.”

Franzel also called for audit firms to make strides on achieving a diverse workforce. “Diversity in the accounting profession continues to be dismal,” she said. In response to prompting from Baruch professor Norman Strauss, a former EY partner, she acknowledged that the college, which is part of the City University of New York system, has a diverse student body in its Zicklin School of Business, but it’s an outlier. She told a story about a meeting she had recently with audit firm leaders to discuss diversity, and she was the only woman at the meeting.

“The profession must focus on inclusion and increasing diversity in order to have the talent and capabilities to fulfill its important mission of assurance and investor protection now and in the future,” said Franzel. “Leaders of the largest firms in the profession have acknowledged the slow progress and related challenges. Despite growing attention by audit firms to diversity in their workforces, progress in achieving diverse audit teams and firm leadership remains opaque and slow. This state of affairs also implicates the academic institutions that educate future accounting and auditing professionals. While the auditing profession faces a number of challenges and issues, diversity needs to be a top priority, backed with meaningful and impactful actions. In my view, this is a matter of priority for the sustainability of the profession.”

Accounting Standards

In a later panel discussion on accounting standards for private companies, Financial Accounting Standards Board technical director Susan Cosper said FASB is planning to issue its hedging standard over the summer, and to finish “redeliberations” in the second half of the year on its proposed long-term insurance contract standard.

“We’re also going to continue to focus on implementation activities, particularly with revenue recognition, to address questions as they arise from people and companies, as well as questions on leases,” she added. “For credit losses, we have a Transition Resource Group meeting planned for June.”

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Michael Cohn

Michael Cohn

Michael Cohn, editor-in-chief of AccountingToday.com, has been covering business and technology for a variety of publications since 1985.