Audit Standard Setting and Inspection for U.S. Public Companies: A Critical Assessment and Recommendations for Fundamental Change

Abstract

SYNOPSIS: The Sarbanes-Oxley Act of 2002 (SOX) established the Public Company Accounting Oversight Board (PCAOB) to oversee the accounting firms that audit publicly traded companies in the United States. In this commentary we outline why we believe the PCAOB’s audit standard-setting and inspection models are inefficient and dysfunctional. We assert that the Board’s ability to achieve its mission is limited by its early choices, together with its incentives, organizational composition, and structure. We support our assertions with a number of indicators of serious problems and flaws in the current approach. We also present high-level recommendations for change for policy makers, regulators, and leaders in the profession to consider in developing improved approaches to audit standard setting, inspection, and enforcement.

From peer review to PCAOB inspections: Regulating for audit quality in the U.S.

“…A better and holistic understanding of the different systems seems to be necessary for future reforms and to decrease the risk of producing politically unintended and potentially dysfunctional consequences. As such, this study extends prior assessments of the regulation of public company auditing in the U.S. (Abernathy, Barnes, & Stefaniak, 2013;Glover, Prawitt, & Taylor, 2009;Kinney, 2005;Palmrose, 2013).…”

“…104 (d)). Broadly, the inspection process covers a wide spectrum of activities, from the evaluation of an audit firm's tone-at-the-top, partner compensations, and compliance with professional codes of conduct for the proper application of audit procedures and documentation, to assessing the appropriateness of the audit evidence collected (Glover et al, 2009). For every inspection, the PCAOB prepares an inspection report (SOX Sec.…”

“…Glover et al (2009) found individual cases in which inspectors failed to look at the riskiest areas of an audit, or drew incorrect conclusions, due to the technical complexity or their lack of prior experience in the specific field of engagement. Blankley et al (2012) were then the first who analyzed the comments of the audit firms on the inspection reports.…”

“…Whereas "independence" is more an organizational attribute, "objectivity" relates to the unbiased mental attitude of reviewers and inspectors. Although anecdotal evidence indicates that PCAOB inspectors possess a high level of auditing experience (Glover et al, 2009;Lennox & Pittman, 2010), not much is really known about their background or their rationales for working for a governmental agency. The formal independence of the PCAOB regime might therefore not prevent the inspection process from being influenced by the individual characteristics, experience, and former affiliation of the particular inspector, and other possible process-and outcome-related factors.…”

“…Research that was concerned with the validity of PCAOB inspections focused almost exclusively on questions concerning the technical skills and knowledge of PCAOB inspectors Glover et al, 2009;Newman & Oliverio, 2010). Glover et al (2009) found individual cases in which inspectors failed to look at the riskiest areas of an audit, or drew incorrect conclusions, due to the technical complexity or their lack of prior experience in the specific field of engagement.…”