PCAOB chief slams auditors for 40% error rate

By Jim Tyson for CFODive.com

• Inspectors this year at the Public Company Accounting Oversight Board will probably report flaws in 40% of the 2022 audits they review, PCAOB Chair Erica Williams said Thursday, noting that many auditors fail to back up their opinions with solid evidence.

• “We are seeing audit quality for both domestic and international firms trend in the wrong direction for the second year in a row,” Williams said in a speech. Inspection reports this year will probably show that the proportion of flawed audits surged 6 percentage points in 2022 after rising 5 percentage points in 2021.

• “Audit opinions were signed without completing the audit work required to verify the accuracy of financial statements,” Williams said. “That is a serious problem at any rate, and 40% is completely unacceptable.”

Backed by Securities and Exchange Commission Chair Gary Gensler, Williams has led a push for expanded inspections, tougher enforcement and stricter standards since January 2022, when she took the top post at the agency that oversees the accounting firms auditing publicly listed companies.

“The PCAOB has not hesitated to bring enforcement cases against auditors when appropriate,” Williams said. Last year it doubled the number of enforcement orders compared with 2021 and imposed a record total in penalties, she said.

Board inspectors annually vet 800 audits in more than 30 jurisdictions worldwide. Last year the PCAOB for the first time secured access for inspections in China.

Audits by units of KPMG and PwC in China showed “high rates of deficiencies,” the PCAOB said in May after an inspection of audits focused on China-based companies listed on U.S. stock exchanges.

The board identified weaknesses in all four audits it reviewed last year by KPMG Huazhen, which is headquartered in Beijing, and three of four audits performed by PwC in Hong Kong. The flaws encompassed controls testing, goodwill, revenue, journal entries and independence.

The PCAOB findings were the culmination of a successful multi-year effort by the U.S. to overcome obstacles posed by regulators in Beijing.

Under a U.S. law enacted in 2020, more than 200 companies headquartered in China faced the prospect of delisting from U.S. stock exchanges if the PCAOB was barred from reviewing their audits for three straight years.

“We are continuing to demand complete access with no loopholes and no exceptions,” Williams said.

Indeed, the PCAOB is on track by the end of this year to audit 99% of the total market share of the U.S.-listed companies audited by Hong Kong and mainland China firms, according to Williams.

“Should the People’s Republic of China authorities obstruct or otherwise fail to facilitate the PCAOB’s access — in any way and at any time — the board will act immediately,” she said.

Meanwhile, the board has “laid out the most ambitious standard-setting and rulemaking agendas in PCAOB history,” focusing on more than half of its rules, Williams said. Nearly all of the standards under review were set on an interim basis in 2003 soon after creation of the PCAOB.

For example, the PCAOB on Sept. 28 unanimously approved the replacement of a 20-year-old interim rule with a standard tightening the requirements for auditors when verifying with a third party assertions made by a client in a financial statement.

The new standard requires an auditor to confirm with a client’s lenders, customers or other third parties the amounts of cash and cash equivalents reported by the client.

An auditor will no longer be able to assume accuracy of the numbers based on “negative confirmation,” or the lack of a response or objection from third parties.

Subject to SEC approval, the standard will take effect for audits of financial statements for fiscal years ending on or after June 15, 2025.

“To keep investors protected, our standards must keep up,” Williams said. “Capital markets don’t stand still. They evolve constantly. Practices change. Technology advances relentlessly, and new risks emerge.”