Report shows decrease in audit deficiencies among certain U.S. firms

A new PCAOB report appears to signal improvement in audit quality among U.S. firms that audited 100 or fewer public companies.

The rate of significant audit performance deficiencies identified in audits conducted by such firms declined from 2007 to 2010 compared with the 2004–2006 period tracked in a previous PCAOB report. The PCAOB defines significant audit performance deficiencies as those that result in the audit firm’s lacking sufficient evidence to support its audit opinion.

U.S. firms that audit 100 or fewer public companies must be inspected at least once every three years by the PCAOB.

Forty-four percent of the audit firms inspected from 2007 to 2010 had at least one significant audit performance deficiency, according to the PCAOB. That’s down from 61% from 2004 to 2006. Although the overall rate for 2007 to 2010 was 44%, it was 51% in 2010 alone. In 2011, the rate declined to 45%.

Among individual audits inspected, 28% had at least one significant audit performance deficiency between 2007 and 2010, compared with 36% from 2004 to 2006.

Despite the decrease, the persistence of deficiencies concerns the PCAOB, according to the report.

“The board has issued this report to highlight areas where audit firms can focus their attention to enhance the quality of their audits,” PCAOB Chairman James Doty said in a news release. “We also encourage firms to identify and address the root causes of any audit performance deficiencies identified during the inspections process.”

The PCAOB report is based on observations from 748 inspections of 578 firms conducted from 2007 to 2010 and encompasses reviews of aspects of 1,801 audits.

Areas that saw frequent deficiencies in audits related to:

• Auditing revenue recognition.
• Auditing share-based payments and equity financing instruments.
• Auditing convertible debt instruments.
• Auditing fair value measurements.
• Auditing business combinations and impairment of intangible and long-lived assets.
• Auditing accounting estimates.
• Auditing related-party transactions.
• Use of analytical procedures as substantive tests.
• Audit procedures to respond to the risk of material misstatement due to fraud.

Lower rates of significant audit performance deficiencies also were reported from 2007 to 2010 when the PCAOB conducted second inspections of firms. Thirty-six percent of the firms that underwent second inspections had at least one deficiency in their second inspection, compared with 55% in their initial inspection.

—Ken Tysiac (ktysiac@aicpa.org) is a JofA senior editor.