Public Company Accounting Oversight Board Research Articles

Are Critical Audit Matters Informative?

Breaking from a long stretch of using largely standard language in unqualified audit opinions, the Public Company Accounting Oversight Board (PCAOB) expanded audit reports to disclose Critical Audit Matters (CAMs) and the audit procedures used to address them. The first wave of CAM disclosures began for large accelerated filers after June 2019, with most disclosures occurring in February 2020. Using Natural Language Processing (NLP) techniques, this study examines the types of CAMs disclosed by auditors and the typical audit procedures used to address them. We then explore whether CAMs are informative to investors and security analysts. Our findings are consistent with greater amounts of CAM disclosures as indicators of greater uncertainty. We document that market reactions are more negative for firms with more CAM disclosures; analysts reduce their earnings forecasts to a larger extent for such firms; stock prices become more volatile; and the dispersion of analyst forecasts are greater for firms with more CAM disclosures. We further find that many issues related to CAMs are raised in earnings conference calls with analysts during the immediately subsequent quarter. While these findings indicate that CAMs are informative to investors and analysts, their effects are concentrated around the time of disclosure. We do not find evidence of a drift in returns after the initial disclosures.

Audit Partners' Judgments and Challenges in the Audits of Internal Control over Financial Reporting

SUMMARY Internal control over financial reporting (ICFR) audits have been the subject of intensive examination by the Public Company Accounting Oversight Board (PCAOB) and researchers but the process through which auditors make ICFR judgments is largely a “black box.” To understand ICFR judgments, we conducted semi-structured interviews with 20 audit partners. Common themes in our interviews suggest that the subjectivity inherent in the ICFR evaluation task contributes to resistance against ICFR audit findings and cougnterarguments from management. Moreover, auditors perceive that their judgments are being second-guessed by PCAOB inspectors. Auditors believe that managers have difficulty accepting that material weaknesses can exist without a detected error, that management's reflexive reaction is to deny/avoid a material weakness finding, and managers routinely claim that management review controls (MRCs) would have caught the detected control deficiency. Auditors cope with management's defenses by consulting with their national office and leveraging support from strong audit committees. Data Availability: Requests for the data should be accompanied by a description of intended uses.

Hiring Auditors with a Part II Quality Control Report: An Opportunity for Increased Earnings Management or Lower Audit Fees?

ABSTRACT The Public Company Accounting Oversight Board's (PCAOB) Part II inspection reports, which disclose systemic quality control issues that auditors fail to remediate, signal poor audit quality for triennially inspected audit firms. Auditors that receive a Part II inspection report typically experience a decrease in clients, which demonstrates a general demand for audit quality. However, some companies hire auditors that receive Part II inspection reports. We examine potential reasons for hiring these audit firms. We find that relative to companies that switch to auditors without Part II reports, companies that switch to auditors with Part II reports have higher discretionary accruals in the first fiscal year after the switch, which indicates lower audit quality and a heightened risk for future fraud. We find no difference in audit fees. Our results suggest that PCAOB Part II inspection reports may signal low-quality auditors to companies that desire low-quality audits. Data Availability: Data are available from the public sources cited in the text.

Audit risk calibration

AS5[v.Dec:2017] issued by the Public Company Accounting Oversight Board [PCAOB] requires the use of Analytical Procedures [AP] at the Planning and Substantive Phases of Assurance Audits for firms traded on active exchanges. We argue that one aspect of AP, relative to risk-setting, should be vetting the information that is produced/published by the audit client pertaining to Regulation G [v.SEC:2003] called: Non-GAAP information. In our research, we intend to leverage the longstanding Reg[G] requirements to extend the Non-GAAP information to firm performance profiles reported for the Environment, Social, and Governance[ESG]Platform on BloombergÒ. There are two research foci: (1) Offer an AP-Model that uses GAAP & ESG variables to contribute audit evidence useful in making the decision to launch an AP-Extended Procedures examination of the firm’s Enterprise Resource Planning & Control [ERP&C] protocols, and (2) Profile a random accrual-set of firms indexed on Bloomberg so as to offer population parameter estimates for refining the AP-Model. The AP-Model is based upon correlational associations for the ESG- & GAAP-variables from the: Income, Balance Sheet & Cash Flow Statements. If there seems to be a disconnect between the nature of these associations for the ESG-variables and those of the GAAP-variables, the auditor may use this as audit evidence in making the decision to conduct an Extended Procedures Examination of the firm’s [ERP&C] protocols. As for the other focus, we found that for the accrual of firms tested there is no inferential evidence that the ERP&C-protocols are consistent drivers for both the ESG- and the GAAP variable sets.

What Are the Trends in PCAOB Inspections and the Reported Audit Deficiencies?

Although the Public Company Accounting Oversight Board (PCAOB) inspections commenced in 2003, few studies have analyzed the recurring nature of audit deficiencies both within and across U.S. and non-U.S. firms. This study investigates longitudinal trends in PCAOB Part I audit deficiencies and compares these deficiencies between initial and subsequent inspections. We classify the audit deficiencies contained in the inspection reports into three categories relating to Generally Accepted Accounting Principles (GAAP), Generally Accepted Auditing Standards (GAAS), and Internal Controls over Financial Reporting (ICFR). Using 1,551 inspections conducted over the period 2003–2017, we find that 67% of Part I audit deficiencies in the related reports pertain to GAAP and that triennially inspected audit firms have the highest occurrence of these deficiencies. On average, 22% of audit deficiencies relate to GAAS, with the highest incidence of these deficiencies attributable to annually inspected audit firms. Although ICFR has the least audit deficiencies (11%), we find a significant increase from 2009. We find no significant differences in the mean number of GAAP, GAAS, and ICFR audit deficiencies between first- and second-round inspections. However, we find a significant increase in the mean number of ICFR audit deficiencies between the third- to fifth-round inspections. The audit areas of “revenue recognition,”“inventory,” and “fair value measurements” (i.e., those requiring significant auditor judgment) are the most frequent audit deficiencies identified by the PCAOB. This study provides insights into the frequency and nature of audit deficiencies to stakeholders such as investors, auditors, audit committees, and users of financial statements.

Public interest oversight on professional accountancy: How do accountants perceive it in Turkey?

Research Question: The study investigates consequences of the public oversight establishment on accounting profession and also attempts to understand the thoughts and perceptions of the licensed/certified professional accountants on the public oversight activities in Turkey as an emerging country. Motivation: Public oversight activities have been evolved since it has existed less than two decades. After the Sarbanes & Oxley Act, first initiative was appeared in the United States as the PCAOB Public Company Accounting Oversight Board, then many countries have followed. Public interest oversight institutions play a crucial role as a leader of integrity in ensuring high quality auditing within accurate and informative framework. Idea: This study can be model or benchmark for the studies that can be realized in the other developing countries that might be trying to develop and improve accounting and auditing profession. The study shows the public oversight on accountancy has been a need for a better financial reporting for an effective and efficient financial market. Data: In the survey, members of licensed professional accountants, members of licensed prospective future professional accountants, and licensed auditors were included. Tools: Using a questionnaire, a survey was conducted as a methodological approach to determine the thoughts, perceptions, and expectations of respondents. Findings: The study concludes that professional accountants are aware of public oversight regulations and activities in Turkey. They are mainly thinking that public oversight activities will be impacting positively to the Turkish public accounting profession. Also, professional accountants mainly perceive that public oversight activities will be contributing efficient and effective financial reporting for financial and money markets in the country. Particularly financial statement audit environment has been changed and up scaled due to inspection activities of the public oversight organization on the auditors and audit firms. The results of the study might be interesting for the stakeholders of the public oversight activities on accounting profession.

Standard-setting in auditing: Insights from PCAOB inspections

We explore whether the Public Company Accounting Oversight Board (PCAOB) consistently follows its own standard-setting policies. We do this using a methodology that combines the reports of audit partners, the timing of enacted auditing standards, and the issuance of PCAOB inspection findings. Rules governing standard-setting are critical to ensure that auditing standards are appropriate, efficient, and are therefore likely to be generally accepted. Our results suggest that in some instances auditors were penalized for omitting evidence from their working papers which is not specified in the standards, in effect, changing or removing auditor judgment in the amount and nature of audit evidence to be gathered in corroboration of management’s assertions and creating new auditing standards outside of the formal standard-setting process. Beyond the societal benefits of standard-setters adhering to their own policy-making rules, changes in auditing procedures impact the behavior of both auditors’ and managers and is costly. Although subject to limitations, we believe our results are informative to policy makers and other participants in PCAOB standard-setting.

Can Auditor-Developed Independent Estimates Reduce Management’s Biasing Influence?

The Public Company Accounting Oversight Board (PCAOB) acknowledges that developing independent estimates likely reduces the influence of management bias when auditing accounting estimates. We test this notion, finding evidence that both confirms and contradicts the PCAOB’s perspective. We find that auditors developing an independent estimate after receiving management’s persuasion tactic are, indeed, less susceptible to the tactic’s biasing influence. However, auditors developing an independent estimate before receiving management’s persuasion tactic remain susceptible to the tactic’s biasing influence. Recency effects explain these results. A supplemental experiment that omits independent estimate development confirms this theory. Without an independent estimate, auditors exhibit primacy effects. Our research informs auditing estimates, regulatory guidance, and the de-biasing ability of independent expectations.

Common Auditors and Private Bank Loans

We show that when banks and borrowers share the same audit firm, borrowers receive lower interest rates, after controlling for potentially confounding director connectedness. The common auditor effect is observed only for opaque borrowers, and is greatest when the same audit engagement office audits the bank and borrower. A common auditor connection also matters more for longer-tenured auditors, for geographically proximate borrowers, and when the syndicate involves fewer lenders. The effect does not hold for auditors recently sanctioned by the Public Company Accounting Oversight Board (PCAOB). Finally, the interest rate discount is not the consequence of homophily or biased decision-making, based on a comparison of post-loan performance of firms with common-auditor loans versus those with non-common-auditor loans.

Comments of the Auditing Standards Committee of the Auditing Section of the American Accounting Association on the Concept Release,Potential Approach to Revisions to PCAOB Quality Control Standards

SUMMARYOn December 17, 2019, the Public Company Accounting Oversight Board (the Board or PCAOB) issued a request for comment on its Concept Release, Potential Approach to Revisions to PCAOB Quality Control Standards. The Board is considering revising its Quality Controls (QC) standards to focus firms on improving their QC systems. To reduce the compliance burden, the Board is considering aligning its QC standards with those of the proposed International Standard on Quality Management 1, Quality Management for Firms That Perform Audits or Reviews of Financial Statements, or Other Assurance or Related Services Engagements (proposed ISQM 1). The comment period ended March 16, 2020. This commentary summarizes the participating committee members' views on selected questions on three aspects of a QC system presented in the Concept Release: Resources (Questions 31, 32, 34, 36, 37), The Monitoring and Remediation Process (Questions 45, 46, 47), and Roles and Responsibilities of Individuals (Question 52).Data Availability: The Concept Release, Potential Approach to Revisions to PCAOB Quality Control Standards, including questions for respondents, is available at: https://pcaobus.org/Rulemaking/Docket046/2019-003-Quality-Control-Concept-Release.pdf.

Group audits and earnings informativeness

The Public Company Accounting Oversight Board (PCAOB) has cited investors as the main stakeholder group requesting greater disclosure about the involvement of auditors other than the group auditor. This study investigates the following: 1) whether (any) differences in investor perceived earnings quality of group audits are associated with the component auditor belonging to the same network as the group auditor and; 2) whether this association is affected by the location of the client. We find that earnings informativeness is lower for group audits conducted by audit firms related by a global network. However, this finding is pertinent only to non‐US‐domiciled companies. We also find that since the escalation of PCAOB scrutiny, the earnings informativeness of non‐U.S. companies has increased.

Do PCAOB Inspections Improve Working Capital Accrual Reliability? Evidence from the PCAOB Annual versus Triennial Inspection Exposure

SYNOPSISIn this study, we examine whether the ability of working capital (WC) accruals to predict future earnings and cash flows differs between registrants whose auditors are subject to annual Public Company Accounting Oversight Board (PCAOB) inspections and those whose auditors are subject to triennial PCAOB inspections. We find that WC accruals of clients audited by auditors subject to annual PCAOB inspections enhance earnings persistence more and map into future cash flow realizations better than those audited by auditors subject to triennial PCAOB inspections. These findings are stronger for operating asset accruals than for operating liability accruals. Furthermore, after PCAOB inspection reports are released, improvements in WC accrual reliability are more evident for clients audited by annually inspected auditors than for clients audited by triennially inspected auditors. Overall, our findings suggest that more frequent PCAOB inspections help to improve WC accrual reliability.JEL Classifications: M41; M42; M48.Data Availability: The data are publicly available from the sources identified in the paper.

Who Really Performs the Audit? Examining the Effects of Voluntary Disclosure of the Use of Other Auditors on Investors' Perceptions of Audit Quality

SUMMARY Under Rule 29, the Public Company Accounting Oversight Board (PCAOB) requires principal auditors to disclose the extent of use of other auditors on an audit engagement. This mandatory disclosure occurs on Form AP, available on the PCAOB's website. Principal auditors may voluntarily disclose this same information in an appendix to the audit report. We experimentally examine how the joint effects of the principal auditor's extent of use of other auditors and their use of voluntary disclosure influence investors' perceptions of audit quality. Results indicate that investors perceive audit quality to be lowest when principal auditors use other auditors to a greater extent and only file the mandatory disclosure. We find voluntary disclosure in the audit report attenuates the perceived effect of using other auditors. Additionally, after a restatement, investors place no additional blame or liability on principal auditors that use other auditors to a greater extent or choose voluntary disclosure.

The Effects of the Type and Content of Audit Reports for Financially Stressed Initial Public Offerings on Information Uncertainty

SUMMARY The Public Company Accounting Oversight Board (PCAOB) has expressed concern that audit reports do not contain sufficient variation to provide useful information to the market. Using a sample of financially stressed initial public offering (IPO) firms, we investigate whether information uncertainty is affected by (1) three different types of audit reports—unqualified (clean), hybrid (with explanatory language about financial stress), and going concern (GCAR)—and (2) audit report disclosures. We provide evidence that audit reports (hybrid and GCAR) and audit report disclosures provide useful information to the market by finding a significant reduction in information uncertainty. Just as important, we find that management discretionary going concern disclosures do not complement or substitute for the reduction in information uncertainty associated with hybrid audit reports and GCARs. We provide evidence that current audit report types and disclosures of financially stressed IPO firms provide information to the market. JEL Classifications: M40; M42; G14. Data Availability: The data used in this study are available from public sources indicated in the paper.

Repeat offenders: examining cases of multiple years of internal control weaknesses

Purpose This study aims to identify characteristics of firms reporting multiple years of material weaknesses in internal control over financial reporting (MWICFR), labeled “Repeat Offenders”, and examine their characteristics and the types of material weaknesses they report using both broad and COSO-based classification schemes. The analysis compares these firms with firms reporting only one year of MWICFR and examines the differences between Repeat Offenders reporting consecutive and non-consecutive weaknesses. Design/methodology/approach Univariate and multivariate analyses were conducted on a sample of 1,793 firm-year observations, split into Repeat Offenders and non-Repeat Offenders, and collected from AuditAnalytics and Compustat from 2007 to 2015. Findings On average, 40% of adverse opinions in ICFR each year can be attributed to Repeat Offenders. Compared to one-time MWICFR firms, Repeat Offenders are significantly more likely to report general material weaknesses and, within the COSO framework, are significantly more likely to report issues with Segregation of Duties and Processes and Procedures. Repeat Offenders reporting consecutive years of MWICFR are significantly more likely to have general weaknesses than non-consecutive Repeat Offenders and are also significantly more likely to report issues with Segregation of Duties and Personnel. Research limitations/implications Prior studies have examined unremediated ICFR issues in the periods immediately following SOX implementation. This study extends this literature with a longer, more current sample period, focusing on both broad and COSO-specific control issues, as well as examining consecutive and non-consecutive MWICFR and firms with more than two years of MWICFR. Originality/value This study underpins recent Securities and Exchange Commission and Public Company Accounting Oversight Board concerns regarding pervasive ICFR issues. This study identifies some of the characteristics of firms associated with weaker ICFR and pinpoints more specific areas within internal controls that frequently lead to adverse opinions.

Are going‐concern issues disclosed in audit reports associated with subsequent bankruptcy? Evidence from the United States

The Public Company Accounting Oversight Board (PCAOB) has expressed interest in the following issues related to going‐concern modified audit opinions (GCOs): auditor's communication of factors that led to the GCO, the role of liquidity versus other factors in GCOs, and the subsequent failures of clients with GCOs. We use a sample of 2,921 first‐time GCOs spanning the years 1999 to 2015 in the United States and find that profitability factors are cited in 81% of GCOs while liquidity issues are cited in 56% of GCOs. Overall, 16.8% of the first‐time GCO clients entered bankruptcy within one year. After controlling for the probability of bankruptcy, client size, and auditor type, for clients of Big N auditors, the disclosure of profitability factors in the GCO is associated with a higher likelihood of subsequent bankruptcy; in contrast, for clients of non–Big N auditors, disclosures of liquidity and solvency problems are associated with a higher likelihood of subsequent bankruptcy. Our findings provide an empirical grounding for the debates surrounding GCOs and provide useful information for standard‐setters and financial statement users.

Does Audit Firm Hiring of Former PCAOB Personnel Improve Audit Quality?

The so-called “revolving door” for employees moving from the Public Company Accounting Oversight Board (PCAOB) to the accounting firms it regulates has received heightened scrutiny recently. Hendricks, Landsman, and Pena-Romera (HLP) (2019) document that large audit firms exhibit improved inspections performance after hiring PCAOB personnel, consistent with an “inspections expertise” hypothesis that these hires help in managing inspection risk. We extend HLP (2019) by examining whether these individuals also bring “technical expertise” that enhances hiring firms’ audit quality. Using a sample of large auditors’ engagements from 2010 to 2016, we document positive associations between audit firms’ employment of former PCAOB employees and multiple audit quality proxies. These associations are stronger for higher misstatement risk clients. The precision of internal control audit opinions also improves in the presence of these individuals. These results suggest that former PCAOB employees are beneficial to firms’ audit quality particularly in areas emphasized by the regulator.

Audit Partners’ Judgments and Challenges in the Audit of Internal Control over Financial Reporting

Internal control over financial reporting (ICFR) audits have been the subject of intensive examination by the Public Company Accounting Oversight Board (PCAOB) and researchers, and the SEC has signaled ongoing interest in the monitoring of ICFR. However, the process through which auditors make ICFR judgments and decisions has remained largely a “black box”, that has been relatively unexplored. To better understand how auditors make ICFR judgments, we conducted in-depth, semi-structured interviews with twenty highly experienced audit partners. Common themes in our interviews suggest that the subjectivity inherent in the ICFR evaluation task contributes to resistance against ICFR audit findings and counterarguments from management. In addition, auditors perceive that their judgments are being second-guessed by PCAOB inspectors. Auditors perceive that managers have difficulty accepting that a material weakness can exist without a detected error, management’s reflexive reaction is to deny/avoid a material weakness finding, and that managers routinely claim that management review controls (MRCs) would have caught the detected control deficiency. Consistent with the PCAOB’s practice alert to auditors on the importance of evaluating MRCs, the partners stressed the importance of evaluating the design and operating effectiveness of their client’s MRCs. Auditors cope with management’s defenses by consulting with national office and leveraging support from strong audit committees. Implications for research, practice, and public policy are discussed.

Second-Year Evidence on the as 3101 Critical Audit Matters Disclosure

In 2019, the Public Company Accounting Oversight Board (PCAOB) expanded audit reports by requiring auditors to provide a critical audit matters (CAM) disclosure in the independent audit report, based on Auditing Standards (AS) 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion. We provide some insights on how CAM disclosures has evolved from year 1 to year 2. Overall, on average, June 30th year-end filers’ auditors reported the same top 3 CAM categories in 2019 and 20202. Firms reported less CAMs in the second year of the CAM disclosure requirement, with the audit firm average number of CAMs reported moving closer to the mean for all firms reporting. In 2019, the range between firms was more significant than in 2020. The findings reported in this study are useful in informing internal auditors, regulators and standard setters, as well as providing a CAM expectation benchmark for internal auditors and audit committees. The insights are also relevant for external auditors who are required to consider various aspects of the objectivity and the quality of the internal auditor.

Audit Quality: A Bibliometric Analysis (1981-2020)

The increase in the number of studies on audit quality and the interest of both researchers and authorities in the subject in recent years has been the motivation of the study. Bibliometry was chosen as a method in the study because it provides the opportunity to look at the literature of the area studied from a broad perspective. The study aims to make a bibliometric analysis of studies published in English in the field of social sciences in the Scopus database on audit quality (AQ). This analysis covers 1419 articles from 1981 to March 2020. It has been determined that academic research on AQ has increased dramatically since the 2000s. ‘Audit quality’, ‘audit fees’, ‘earning management’ issues are up-to-date in the studies carried out; Researches on ‘Public Company Accounting Oversight Board' (PCAOB), ‘financial reporting’ and ‘audit committee’ turned out to be on the rise. The country that gets the most citation on the subject is USA. It was also concluded that numerous non-authors frequently collaborated amongst them to contribute to the development of the field. In addition, although there are publications using a qualitative research method with the increasing number of publications with AQ, it is the first bibliometric and social network analysis in the study area. While this study helps to create the conceptual framework that still causes controversy in the field of AQ; It can be a guiding resource in determining future studies and regulations.JEL Codes - C00; M42