The Public Company Accounting Oversight Board has released Spotlight: Staff Update on 2023 Inspection Activities (2023 Inspections Spotlight). This publication presents the results of the 2023 inspection program and provides staff observations on those results. The 2023 Inspections Spotlight is generally similar to the inspection “preview reports” the Board has released in prior years. See 2022 PCAOB Inspections Preview Says 40 Percent of Audits Reviewed Had Deficiencies, July 2023 Update. However, the 2023 Inspections Spotlight is more comprehensive than the prior reports and includes new information to facilitate comparisons between categories of inspected firms and an understanding of inspection findings.
The 2023 Inspections Spotlights begins with a discussion of trends and key findings. Following that discussion, the report consists of five sections – 2023 Inspections Approach; Common Deficiencies Found by 2023 Inspections; Observations Related to Quality Control Systems; Trends in Areas with Recurring Deficiencies, 2021 to 2023 Inspections; and Good Practices and Important Reminders.
Trends and Key Findings
In 2023, the PCAOB inspected 227 registered public accounting firms and reviewed portions of 793 public company audits and 103 securities broker-dealer audits. Forty-six percent of the public company audits reviewed in 2023 had at least one Part I.A deficiency, up from 40 percent in 2022. (A Part I.A deficiency is an audit deficiency of such significance that it appeared to the PCAOB that the firm did not obtain sufficient evidence to support its opinion.) Regarding the increase in Part I.A deficiencies in recent years, the 2023 Inspections Spotlight offers several observations:
Although the overall negative trend in deficiencies continued in 2023, the staff states that it has “begun to see the aggregate deficiency rate at the Big Four firms level off, as well as improvements in the deficiency rates at several of the other annually inspected firms.”
Audit firms have told the PCAOB staff that remote work and the lack of in-person training for new hires during the pandemic “negatively affected audit quality and resulted in a surge of inspection deficiencies in 2021 and 2022.”
Some firms have suggested other factors contributed to rising deficiencies, including challenges with firm technology; over-reliance on prior year results; ineffective timing and project management; and insufficient testing of significant transactions.
The 2023 Inspections Spotlight also identifies and discusses ten “key findings” arising from the 2023 inspections:
Signs of “Leveling Off” at the Largest Firms. For the U.S. Big Four firms as a group, the Part I.A deficiency rate was unchanged at 26 percent of inspected engagements in 2023 after increasing from 12 percent in 2020 to 16 percent in 2021 and to 26 percent in 2022. Similarly, the percentage of these four firms’ audits reviewed by the PCAOB that had more than one audit deficiency was nearly flat at 20 percent in 2023, after rising from 9 percent in 2020 to 13 percent in 2021 and to 21 percent in 2022. (Each engagement in Part I.A of an inspection report may have one or more audit deficiencies.) In addition, aggregate Part II criticisms in Big Four inspection reports fell in 2023 for the first time in three years. (Part II of an inspection report includes PCAOB criticisms of the inspected firm’s system of quality control.)
Outliers Heavily Influence Averages. For the six U.S. firms that are affiliates of global networks (including the Big Four), the aggregate Part I.A deficiency rate was 34 percent. The staff states that this rate was substantially affected by two “outliers.” The two global network firms with the highest Part I.A deficiency rates were BDO (86 percent) and Grant (54 percent).
Audit Quality at Triennially Inspected Firms Is Not Improving Quickly Enough. Over half of the triennially inspected firms (i.e., those with 100 or fewer public company audit clients) had no notable changes in their Part I.A deficiency rate compared to prior inspections.
First-Time Firm Inspections Typically Have Higher Deficiency Rates. An increase in the share of firms inspected for the first time in 2023 was a factor in the increase in Part I.A deficiencies.
Different Engagement Selection Criteria Produce Similar Results. Although most engagements are selected for inspection based on the PCAOB’s perception that the audit involved elevated risk, in 2023, 39 percent of engagements in Part I.A were randomly selected, an increase from 26 percent in 2022 and 19 percent in 2021. The PCAOB staff states that this “demonstrates that the risk-based selection of engagements for review is not the sole factor driving” the increase in deficiency rates. All other things being equally, one would expect that randomly selected engagements would be less likely to result in Pat I.A deficiencies, compared to engagements selected based on risk.
Signs of Potential Improvements in Quality Control Findings. Big Four firm 2023 Part I.A audit deficiencies “appear to represent more isolated incidents than in the past, where we often saw the same or related types of deficiencies on multiple audits. The more isolated nature of the incidents in 2023 means the deficiencies are less likely to indicate QC system concerns.” The staff also states that it is “hopeful” that the isolated nature of 2023 deficiencies and the decrease in the number of Part II quality control system criticisms “signals improvement in [the Big Four] firms’ QC systems, which in turn could lead to declines in their audit deficiencies going forward.”
Market Volatility and Iterative Risk Assessment. Macroeconomic events, such as inflation and interest rates, affected the nature of deficiencies, particularly those related to auditing estimates.
Recurring and Pervasive Deficiencies Continue. Many 2023 Part I.A deficiencies are similar to those in prior inspections. Two common recurring deficiencies are (1) insufficient testing of estimates or of data and reports used to support audit conclusions, and (2) insufficient testing of controls that include a review element, specifically insufficient testing of whether such controls operated at a level of precision sufficient to prevent or detect material misstatements.
Noncompliance With Other Rules and Standards Increased. The 2023 Inspections Spotlight does not provide specific information concerning the rate of noncompliance with other rules and standards, but states that the staff “remain[s] concerned” about compliance with PCAOB standards and rules other than those that affect audit evidence. The Spotlight cites fraud risk, audit transparency (audit committee communications and Form AP), and independence as examples.
Overall, Firms Need To Do Better. “We continue to be concerned about audit quality as reflected in the overall deficiency rates.”
2023 Inspections Approach
This section discusses how the Board selects firms for inspection and how it selects engagements for review. It also provides additional insight regarding the impact of random selections on deficiency rates:
“In 2023, 60% of the randomly selected public company audit engagements resulted in at least one deficiency, and we expect approximately 39% of those randomly selected engagements will be included in Part I.A. In comparison, 62% of our risk-based selections resulted in at least one deficiency, and we expect approximately 47% of those risk-based selections will be included in Part I.A.”
The 2023 Inspection Spotlight includes detailed information concerning the profile of firms inspected in 2023 and of the engagements reviewed (e.g., their industry sectors). Financials was the industry sector that accounted for the highest percentage of inspections in 2023 (19 percent) while the Real Estate sector was the lowest (1 percent).
Common Deficiencies Found by 2023 Inspections
This section discusses examples of common deficiencies in ICFR and financial statement auditing and in complying with other PCAOB standards and rules.
With respect to ICFR, examples include deficiencies in risk assessment, testing of the design effectiveness of controls, testing of management review controls, and consideration of the impact of information technology on controls.
The top five financial statement areas in which inspectors have found deficiencies are revenue and related accounts; inventory; accounts impacted by business combinations; investment securities; and long-lived assets, goodwill, and intangible assets. The 2023 Inspections Spotlight discusses examples of deficiencies in each of these areas, along with examples involving digital asset transactions, allowance for credit losses, and cybersecurity.
The most common Part I.B deficiencies related to fraud, critical audit matters, auditor tenure, and audit committee communications. The 2023 Inspections Spotlight discusses these types of noncompliance, along with an overview of findings regarding Form AP.
Observations Related to Quality Control Systems
Inspections include an assessment of the firm’s system of quality control, including an evaluation of whether audit deficiencies indicate a defect in quality controls. The 2023 Inspections Spotlight discusses three quality control areas in which deficiencies are commonly identified: compliance with SEC or PCAOB independence rules, engagement quality review (EQR -- concurring approval of an audit report by a reviewer not involved in conducting the audit), and monitoring (i.e., ongoing consideration and evaluation of the quality control system).
Quality control criticisms appear in Part II of a firm’s inspection report and are nonpublic when the report is issued. If the firm fails to satisfactorily remediate the deficiency within one year of the report’s issuance, the Board makes the criticism public. In 2023, the Board made remediation determinations related to 92 firm inspection reports and reached a satisfactory determination for approximately 60 percent. Quality control areas with an unsatisfactory determination most frequently related to testing controls, EQR, policies for personal independence compliance testing, and testing revenue.
Trends In Areas With Recurring Deficiencies, 2021 To 2023 Inspections
The 2023 Inspections Spotlight presents three years of data on the ICFR audit and financial statement audit areas with recurring deficiencies. The most frequent ICFR deficiencies during the past three years were “testing controls with a review element” and “identifying and selecting controls to test.” For 2023, the most common financial statement deficiency areas were Other Investments, Loans and Related Accounts, and Leases.
Good Practices And Important Reminders
The 2023 Inspections Spotlight discusses in detail good audit practices that inspectors have observed with respect to three audit areas – Long-lived assets, consideration of fraud, and revenue.
Audit Committee Takeaways
1. As noted in 2023 PCAOB Large Firm Inspection Reports in this Update, the 2023 Inspections Spotlight provides good background information for audit committees seeking to understand their audit firm’s inspection results and how they fit into the overall context of the 2023 inspections. Committees may want to review the Spotlight in conjunction with their auditor’s inspection report and as part of their preparation for discussion of the inspection with their engagement partner.
2. The 2023 Inspections Spotlight suggests five questions audit committee members may want to consider discussing with their auditor:
What are the pros and cons of audit tenure?
How does the firm ensure non-U.S.affiliate personnel, staff from other areas of the firm, and/or other auditors used on the engagement maintain their independence?
How does the firm ensure affiliates outside the U.S. follow PCAOB standards and rules, when required, on referred work related to the group audit?
What were the results of your most recent remediation efforts with the PCAOB?
Does the firm have any new initiatives related to improving audit quality?
While these are not a complete list of the relevant questions regarding an audit firm’s inspection, they would be a useful component of the discussion with the engagement partner. Four additional, more foundational, inspection-related questions that the PCAOB staff has previously suggested are listed in 2023 PCAOB Large Firm Inspection Reports in this Update. See also So Many Questions: PCAOB Suggests Questions Audit Committees Should Ask, July 2023 Update.
3. The 2023 Inspections Spotlight may also provide insight into issues the PCAOB is likely to focus on in future inspections and into the audit areas most likely to generate deficiencies. Audit committees may want to discuss with their auditor how it plans to address these areas. The Spotlight may also aid audit committees in understanding their auditor’s risk assessment and resource allocation decisions.
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