PCAOB inspections: An analysis of entity-level and application-level control audit deficiencies

Abstract

The Public Company Accounting Oversight Board (PCAOB) inspection process identifies deficiencies related to how firms conduct audits. Our work extends prior research by examining the type of internal control audit deficiencies (entity-level or application-level). Internal control audit deficiencies of both types may increase the risk of material misstatement, so the PCAOB is concerned with whether audit firms are performing appropriate procedures to identify entity-level and application-level internal control audit deficiencies, including those involving information technology general controls (ITGCs). Using text analysis to examine audit deficiencies by internal control type and firm size, we find that PCAOB inspection reports identify significantly more application-level than entity-level control audit deficiencies. Application-level control deficiencies generally involve revenue, inventory, and accounts receivable accounts whereas entity-level deficiencies often involve lack of centralized controls or controls over period end financial reporting. The number of application-level deficiencies identified for both Big 4 and second-tier firms varied between inspection years 2010 and 2015. However, the number of entity-level deficiencies, including ITGCs for both Big 4 and second-tier firms, held nearly steady during the period. Our findings should be of interest to practicing accountants, regulators, and other users of PCAOB inspection reports.

The impact of the precision of accounting standards on the expanded auditor’s report in the European Union

“…In a study on the implications of internal control on financial reporting, Feng, Li, McVay, and Skaife (2015) explore the effect of inventory-related material weaknesses in internal control on firm operations, because inventory is a critical component of firm strategy and risk. Mascha, Lamboy-Ruiz, and Janvrin (2018) find that Public Company Accounting Oversight Board (PCAOB) inspection reports identify higher internal control audit deficiencies regarding revenue, inventory, and accounts receivable. Based on a review of 23 studies on audit pricing published between , Wu, Wan, and Yan (2018 conclude that following conventional audit pricing theory 74% of these studies include the inventory variable to control for audit risk and/or audit complexity.…”

Narratives of the Big-4 transparency reports: country effects or firm strategy?

“…In other research, word clouds are studied. For example, Mascha et al (2018) study audit deficiencies by internal control type and firm size, finding that PCAOB inspections detect more application-level than entity-level control audit deficiencies (Mascha et al , 2018). Along similar lines, this paper uses LSA and hierarchical clustering.…”

PCAOB international inspections: Updates and extensions

“…Like DeFond and Lennox (2017), Mascha et al (2018) examined deficiencies in internal control audits cited in PCAOB inspection reports. Focusing on Big 4 and second‐tier U.S. audit firms inspected by the PCAOB between 2010 and 2015, Mascha et al (2018) extended the DeFond and Lennox (2017) study by identifying whether the deficiencies were related to application‐level controls or entity‐level controls. Inspection reports revealed deficiencies in 35% of the internal control audits performed by Big 4 firms and a higher deficiency rate for second‐tier firms (45%).…”