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When a regulator says she is being “persecuted” by members of the US Senate finance committee, you know things have taken a dramatic turn in the normally sedate world of audit oversight.
Public criticism of the US audit regulator, the Public Company Accounting Oversight Board, by senators Elizabeth Warren and Sheldon Whitehouse has set off a raging debate, not just in Washington but in the wider US accounting profession, about whether the quality of public company audits is deteriorating alarmingly or is — quite the opposite — improving nicely.
The backdrop is a sharp rise in the number of flaws found in US audit work since Covid by PCAOB inspectors. More than 40 per cent of the audits they looked at had deficiencies in each of the past two years, a situation the PCAOB chair Erica Williams has described as “unacceptable”. She has urged companies to consider a firm’s deficiency rate when choosing an auditor.
Not everyone agrees the deficiency rate is a good guide to audit quality, including one of the PCAOB’s own board members, Christina Ho, a former auditor. She argued in a September speech that an auditor can fail to follow all the required steps to validate every line in a company’s accounts, but that does not usually mean they missed an actual error. The best measure of audit quality, Ho says, is the frequency with which companies have to correct their financial statements.
It was into this somewhat technical debate that senators Warren and Whitehouse lobbed a caustic public letter last month. They criticised Williams for daring to suggest that, even in the past year with its elevated deficiency rate, there were signs of improvement. And they singled out Ho and her September speech for “downplaying and misdirecting attention from these atrocious findings”. The senators’ letter pointed out that PCAOB board members served at the pleasure of the Securities and Exchange Commission, its oversight body.
“Senators, why are you persecuting me?” Ho responded in a highly unusual and personal post on LinkedIn. “Yes, those in charge have the power to fire me without cause; the power to put my daughter’s healthcare, education, and future in jeopardy as I am a single parent . . . Is there anything more abusive than US Senators’ thinly veiled threat to take away the jobs of public servants just because they have different perspectives?”
Ho says she is speaking up in defence of “data-driven government and evidence-based policymaking”, and that the senators are wrong to denounce audit quality. They wrote that the 46 per cent deficiency rate found by PCAOB inspectors last year meant “investors and the public essentially face a coin flip when it comes to whether they should believe and trust the results of public companies’ audits”. But that figure does not tell the whole story.
First, while 46 per cent of inspected audits were flawed in some way, a much smaller percentage contained flaws that meant the auditors actually came to the wrong conclusion and were forced, after the inspection, to get their clients to restate financial results or publish a warning that internal processes were weak. Looking at just the six biggest US audit firms, where the deficiency rate was 34 per cent last year, the percentage of audits found to have reached the wrong conclusion was 5 per cent.
Jeffrey Johanns, a former PwC partner who teaches auditing at the University of Texas, points out that if you look only for an inspection that led to a financial results restatement — the kind of thing that matters most to investors — then the figure is less than half of 1 per cent. And the percentage of US-listed companies restating their financial results has been at a 20-year low in three of the past four years, according to Ideagen Audit Analytics.
But Williams countered Ho in a speech last week arguing that it was “simplistic” to use restatements as a measure of audit quality, and wrong to dismiss the warnings from the deficiency rate. “Poor audits may miss errors that may never come to light,” she said, and “a poorly performed audit does not always mean that the financial statements are erroneous.” By definition, deficiencies are those that could mean an auditor misses an error or material weakness in a company’s accounts.
There was at least one thing in Williams’ speech on which she and Ho would be in complete agreement: “Audit quality is complex, and it escapes simplistic proxies or measures.”
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