On November 1, the PCAOB released the 2020 inspection reports for the U.S. affiliates of the six global network audit firms. The overall percentage of these firms’ inspected audits that the PCAOB found deficient fell from 24 percent in 2019 to 16 percent in 2020. The drop in aggregate deficiencies was largely driven by a major improvement in PwC’s inspection results. In 2019, the Board found deficiencies in 18 out of 60 (30 percent) of the PwC audits it inspected. In 2020, the Board found only one deficient audit (2 percent) out of 52 engagements inspected – a record low for any Big Six firm. Like PwC, Deloitte’s deficiency rate also dropped into the single digits at 4 percent. In contrast, the Board found deficiencies in over half of inspected BDO engagements, up from 42 percent last year.
This item presents a summary and analysis of the 2020 inspection reports. As discussed in the Comments section below, the 2020 reports suggest five observations:
Overall, large firm audit quality appears to have improved modestly in 2020.
Changes in the inspection process do not appear to have significantly impacted deficiency findings.
There are pronounced differences between the inspection results of the six large firms.
ICFR audit deficiencies seem to be leveling off.
Assumptions underlying estimates and use of information provided by the entity are stumbling blocks in financial statement audits.
2020 Inspection Cycle Report Synopses
Part I.A of a firm’s inspection report describes audit deficiencies of such significance that it appeared to the PCAOB that the firm had not obtained sufficient appropriate audit evidence to support its opinion on the financial statements and/or internal control over financial reporting (ICFR) of the issuer (i.e., the public company under audit) at the time the opinion was released. Part I.B of an inspection report describes instances of non-compliance with PCAOB standards or rules that do not relate directly to the sufficiency or appropriateness of the evidence supporting the firm’s opinions.
Below is an overview of Part I.A and Part I.B the 2020 inspection reports for the six U.S. affiliates of the global network firms:
BDO USA, LLP. The PCAOB reviewed 24 BDO issuer audits, 17 of which were integrated audits of both the financial statements and ICFR. In 13 of the 24 audits (54 percent), the PCAOB staff identified deficiencies of such significance that it appeared that the firm had not obtained sufficient appropriate audit evidence to support its opinion. This compares to BDO’s 42 percent deficiency rate in 2019. Seven of the 13 engagements in Part I.A included deficiencies related to both the audit of the financial statements and of ICFR; four included only a financial statement audit deficiency; and two included only an ICFR audit deficiency. The PCAOB described 61 deficiencies, associated with 64 auditing standard violations, in the 13 engagements in Part I.A. In Part I.B of the inspection report, the PCAOB identified 16 instances of noncompliance with PCAOB standards or rules that did not relate directly to the evidence the firm obtained to support its opinion.
Deloitte & Touche LLP. The PCAOB reviewed 53 Deloitte issuer audits, 50 of which were integrated audits of both the financial statements and ICFR. In two of the 53 audits (4 percent), the PCAOB staff identified deficiencies of such significance that it appeared that the firm had not obtained sufficient appropriate audit evidence to support its opinion. This compares to D&T’s 10 percent deficiency rate in 2019. One of the two engagements in Part I.A included deficiencies related to both the audit of the financial statements and of ICFR; one included only a financial statement audit deficiency. The PCAOB described nine deficiencies, associated with ten auditing standard violations, in the two engagements in Part I.A. In Part I.B of the inspection report, the PCAOB identified 19 instances of noncompliance with PCAOB standards or rules that did not relate directly to the evidence the firm obtained to support its opinion.
Ernst & Young LLP. The PCAOB reviewed 52 EY issuer audits, 47 of which were integrated audits of both the financial statements and ICFR. In eight of the 52 audits (15 percent), the PCAOB staff identified deficiencies of such significance that it appeared that the firm had not obtained sufficient appropriate audit evidence to support its opinion. This compares to EY’s 18 percent deficiency rate in 2019. Four of the eight engagements in Part I.A included deficiencies related to both the audit of the financial statements and of ICFR; four included only a financial statement audit deficiency. The PCAOB described 18 deficiencies, associated with 21 auditing standard violations, in the eight engagements in Part I.A. In Part I.B of the inspection report, the PCAOB identified two instances of non-compliance with PCAOB standards or rules that did not relate directly to the evidence the firm obtained to support its opinion.
Grant Thornton LLP. The PCAOB reviewed 29 Grant issuer audits, 27 of which were integrated audits of both the financial statements and ICFR. In five of the 29 audits (17 percent), the PCAOB staff identified deficiencies of such significance that it appeared that the firm had not obtained sufficient appropriate audit evidence to support its opinion. This compares to Grant’s 23 percent deficiency rate in 2019. All five of the engagements in Part I.A included deficiencies related to both the audit of the financial statements and of ICFR. The PCAOB described 23 deficiencies, associated with 27 auditing standard violations, in the five engagements in Part I.A. In Part I.B of the inspection report, the PCAOB identified three instances of noncompliance with PCAOB standards or rules that did not relate directly to the evidence the firm obtained to support its opinion.
KPMG LLP. The PCAOB reviewed 53 KPMG issuer audits, 47 of which were integrated audits of both the financial statements and ICFR. In 14 of the 53 audits (26 percent), the PCAOB staff identified deficiencies of such significance that it appeared that the firm had not obtained sufficient appropriate audit evidence to support its opinion. This compares to KPMG’s 29 percent deficiency rate in 2019. Nine of the 14 engagements in Part I.A included deficiencies related to both the audit of the financial statements and of ICFR; one included only a financial statement audit deficiency; and four included only an ICFR audit deficiency. The PCAOB described 50 deficiencies, associated with 57 auditing standard violations, in the 14 engagements in Part I.A. In Part I.B of the inspection report, the PCAOB identified 6 instances of noncompliance with PCAOB standards or rules that did not relate directly to the evidence the firm obtained to support its opinion.
PricewaterhouseCoopers LLP. The PCAOB reviewed 52 PwC issuer audits, 50 of which were integrated audits of both the financial statements and ICFR. In one of the 52 audits (2 percent), the PCAOB staff identified deficiencies of such significance that it appeared that the firm had not obtained sufficient appropriate audit evidence to support its opinion. This compares to PwC’s 30 percent deficiency rate in 2019. The engagement in Part I.A included deficiencies related to both the audit of the financial statements and of ICFR. The PCAOB described five deficiencies, associated with six auditing standard violations, in the engagement in Part I.A. In Part I.B of the inspection report, the PCAOB identified 18 instances of noncompliance with PCAOB standards or rules that did not relate directly to the evidence the firm obtained to support its opinion.
Comparisons of Firm Performance
The table below summarizes the results of the 2020 inspections of the six firms. A similar table, which appeared in 2019 PCAOB Large Firm Inspection Reports, January-February 2021 Update, showing results of the 2019 inspections, follows the 2020 table.
The tables above focus on the percentage of inspected engagements found to have at least one audit deficiency. Other indicators of the relative performance of the six firms are the number individual audit deficiencies in each report and the number of auditing standards violations associated with those deficiencies. These metrics differ from the percentage-of-deficient engagements measure because an engagement included in Part I.A may involve more than one deficiency and a deficiency may be associated with a violation of more than one auditing standard. The following table compares the performance of the six firms based on the number of audit deficiencies in each inspection report and the number of auditing standards associated with those deficiencies.
Aggregate Deficiency Data
The auditing standards most frequently cited as the basis for audit deficiencies in Part I.A of the 2020 inspection reports of the six firms are listed in the table below. The table also shows the percentage of all deficiencies in the six reports that were based on each auditing standard. The same auditing standard may have been cited more than once in an engagement described in Part I.A if the inspectors found more than one deficiency based on that standard.
In each inspection report, the PCAOB lists the most frequently identified audit deficiencies, divided between the most frequent deficiencies in financial statement (FS) audits and the most frequent deficiencies in ICFR audits. The table below aggregates these frequent deficiencies lists for the six firms. The table also indicates what percentage of the engagements in Part I of the six reports included these deficiencies. Only deficiencies that were identified more than once are included.
In each inspection report, the PCAOB lists the financial statement accounts or audit areas in which deficiencies in Part I of that report most frequently occurred. For the six firms, on an aggregate basis, these areas were:
Revenue and related accounts – 24 deficiencies
Business combinations – 5 deficiencies
Investment securities – 4 deficiencies
Inventory – 4 deficiencies
Allowance for loan losses – 3 deficiencies
Expenses – 2 deficiencies
Income taxes – 2 deficiencies
Goodwill and intangibles – 2 deficiencies
Part I.B Deficiencies
As noted above, Part I.B of an inspection report describes auditing standard or PCAOB rule violations discovered in the inspection that did not directly affect the auditor’s opinion. It appears that the PCAOB does not review all inspected engagements for every type of Part I.B deficiency. Therefore, the number of Part I.B violations in a firm’s inspection report is not directly comparable to the number in other firms’ reports or to the number reported in prior years.
In 2020, the PCAOB found an aggregate of 64 such violations (based on a review of 431 engagements). These violations related to:
AS 3101, The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion (requiring the auditor to perform procedures to identify critical audit matters (CAMs) and to discuss CAMs in the auditor’s report) – 25 violations (out of 134 engagements reviewed).
AS 1301, Communications with Audit Committees (requiring the auditor to communicate certain matters to the audit committee) – 13 violations (out of 73 engagements reviewed).
Rule 3211, Auditor Reporting of Certain Audit Participants (requiring the auditor to file Form AP with the PCAOB for each public company audit, identifying, among other things, other audit firms that participated in the engagements and disclosing certain information concerning participating firms) – 11 violations (out of 54 engagements reviewed).
AS 1215, Audit Documentation (requiring the auditor to assemble a final set of work papers) – 8 violations (out of 129 engagements reviewed).
AS 2201, An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements (requiring the auditor to communicate ICFR deficiencies to the audit committee and requiring the auditor’s report on ICFR audit to include certain language and disclosures) – 5 violations (out of 17 engagements reviewed).
Rule 3524, Audit Committee Pre-approval of Certain Tax Services (requiring the auditor to describe in writing to the audit committee certain information concerning permissible tax services and to document the substance of related discussion with the audit committee) -- 2 violations (out of 24 engagements reviewed).
Comments: In its inspection reports, the PCAOB cautions that its “inspection results are not necessarily comparable over time or among firms.” Accordingly, drawing reliable conclusions about firm or profession-wide trends in audit quality from inspections reports is problematic. While that caveat should be kept in mind, below are five observations that seem to emerge from the 2020 reports.
1. Overall, large firm audit quality appears to have improved modestly in 2020. As measured by these PCAOB inspection findings, audit quality seems, at first glance, to have improved significantly, compared to last year. For the six global network firm affiliates as a group, the overall deficient engagement rate fell by one-third -- from 24 percent of inspected engagements in 2019 to 16 percent in 2020. For the Big Four, the deficient engagement rate declined from 25 percent in 2018 and 22 percent in 2019 to 12 percent of all inspected engagements in 2020.
These headline numbers are, however, a bit misleading. As noted earlier, PwC’s deficient engagement rate fell from a 30 percent (18 engagements) in 2019 to a record-setting low of 2 percent (one engagement) in 2020. Most of the performance improvement for the six firms as a group was the result of PwC’s turnaround. However, even acknowledging the impact of the PwC results, the 2020 reports seem to reflect an ongoing trend of audit quality improvement. Five of the six firms had lower deficient engagement rates in 2020 than in 2019. (The exception was BDO; its deficient engagement rate rose from 42 percent in 2019 to 54 percent in 2020.) Like PwC, Deloitte’s deficient engagement rate dropped into the single digits at 4 percent, continuing that firm’s multi-year record of declining deficiencies.
2. Changes in the inspection process do not appear to have significantly impacted deficiency findings. It is of course possible that what is changing is the inspection program, not the performance of the inspected firms. There is no concrete evidence that this is the case. Two inspection-process factors may however have played some role in the improvement in aggregate firm deficiency rates.
First, as discussed in last year’s inspection summary (see 2019 Large Firm Inspection Reports, January-February 2021 Update), during the last several years the PCAOB has increased the percentage of inspected engagements selected for inspection at random, rather than based on risk. In 2018, 18.7 percent of inspection selections were random. In 2019, that figure grew to 23.7 percent. In 2020, 24.7 percent were random selections, slightly more than in 2019. The PCAOB argues that random selection is desirable because it makes it harder for firms to predict which audits will be reviewed. At the same time, deficiencies are presumably less likely to be found in engagements selected at random than in those selected based on an assessment of the engagement’s inherent difficulty or risk.
Second, due to Covid, the 2020 inspections were conducted remotely, rather than by in-person visits to firm offices and meetings with engagement team members. Further, the PCAOB has stated that in 2020 it adjusted its “inspection approach to consider the impact of COVID-19 on the audits to public companies.” See Spotlight: Staff Update and Preview of 2020 Inspection Observations. While these steps were certainly appropriate, it is possible that remote inspection procedures and a focus on how firms dealt with the pandemic caused inspectors to be less likely to turn up audit deficiencies that would have been detected in traditional inspections.
3. There are pronounced differences between the inspection results of the six large firms. In 2019, the gap between the global network firm with the lowest deficient engagement percentage (D&T) and the firm with the highest (BDO) was 32 percent. In 2020, that gap rose to 52 percent (2 percent for PwC versus 54 percent for BDO).
There are also stark distinctions between the inspection results for these six firms based on the numbers of deficiencies and auditing standards violations cited in Part I.A of each report. On average, the inspectors found 0.64 deficiencies and referenced 0.70 auditing standards in each engagement they inspected in 2020.However, the averages mask a wide dispersion between firms. In the PwC inspection, five deficiencies with six associated standards violations were found (all in one engagement) out of 52 engagements inspected – an average of 0.10 deficiencies and 0.12 standards per inspected engagement. At Deloitte, 53 inspections found nine deficiencies with ten associated standards (all in two engagement) or 0.17 deficiencies and 0.19 standards per engagement. At the other end of the spectrum, in 24 BDO engagements inspected, the staff found 61 deficiencies and cited 64 standards, an average of 2.54 deficiencies and 2.67 standards per inspected engagement – 25 times more deficiencies per inspected engagement than at PwC. In between these extremes, EY, Grant, and KPMG had total deficiency rates ranging from 0.94 to 0.35 deficiencies per inspected engagement.
4. ICFR audit deficiencies seem to be leveling off. Continuing a decade-long trend, the 2020 inspection results highlight the PCAOB’s focus on ICFR auditing, although ICFR audit deficiencies may be starting to plateau. The inspectors found ICFR audit deficiencies in 14 percent of the integrated audits they inspected, down from 23 percent in 2019 and 26 percent in 2018. This year, 77 percent of all audit engagements in Part I.A included an ICFR deficiency. In 2019 and 2018, 81 percent and 89 percent, respectively, of Part I.A engagements included an ICFR deficiency. In 2019, over half (55.3 percent) of the most frequently cited deficiencies affected the ICFR audit. In 2020, frequent deficiencies affecting the ICFR audit fell to 50 percent. It will be interesting to see whether this trend of declining ICFR violations continues in 2021.
5. Assumptions underlying estimates and use of information provided by the entity are stumbling blocks in financial statement audits. The PCAOB found violations in the financial statement audit in 14 percent of the engagements it inspected, and 86 percent of engagements in Part I.A included a financial statement audit deficiency. In 2019, the Board found financial statement audit deficiencies in 21 percent of the audits it inspected, and 87 percent of all deficient engagements included at least one financial statement audit deficiency. (Deficiencies in the financial statement audit do not, of course, necessarily mean that the financial statements were misstated.)
The most frequent Part I.A deficiency affecting the financial statement audit was a consequence of deficiencies in control testing: “Did not perform substantive procedures to obtain sufficient evidence as a result of overreliance on controls (due to deficiencies in testing controls).” The second most frequent financial statement audit deficiency was “Did not sufficiently evaluate significant assumptions or data that the issuer used in developing an estimate.” Deficiencies related to evaluating assumptions underlying estimates is a perennial audit challenge. This issue topped the 2019 and 2018 lists of financial statement audit deficiencies. The third most frequent financial statement audit deficiency was “ Did not perform sufficient testing of the accuracy and completeness of data or reports used in the firm’s substantive testing.” This presumably refers to auditor use of reports generated by the client’s IT system without adequate testing of report accuracy.
* * *
As noted in past years, the audit deficiency description and auditing standard deficiency tables could be used as a checklist for topics audit committees may want to discuss with their auditor to understand how the auditor addressed, or plans to address, the most challenging areas in the company’s audit.