Takeaways from the 2022 PCAOB inspection reports

Usually, the PCAOB publicly releases their inspection reports on the annually inspected filers in December, but for some reason this year’s batch was delayed. Well, we’re happy to report that the 2022 PCAOB inspection reports were finally released at the end of February 2024 and there were certainly some surprises. This post summarizes five key takeaways based on our initial review of the reports. Over the coming weeks, we plan to publish further posts based on our review of the PCAOB inspection reports, culminating in the release of the 6th Edition of our PCAOB eBook scheduled for mid-May 2024.

Background

In the 2022 inspections of the annually inspected firms, the PCAOB assessed the firm’s compliance with laws, rules, and professional standards applicable to the audits of public companies with fiscal years generally ended in 2021. Per review of the PCAOB website, the 2022 annually inspected firms were:

• Baker Tilly Virchow Krause, LLP
• BDO USA, LLP
• BF Borgers CPA PC
• Cohen & Company, Ltd.
• Crowe LLP
• Deloitte & Touche LLP
• Ernst & Young LLP
• Grant Thornton LLP
• KPMG LLP
• Marcum LLP
• Moss Adams LLP
• PricewaterhouseCoopers LLP
• RSM US LLP
• WithumSmith+Brown, PC

In this post, we are going to discuss Part 1.A deficiencies and the related firm deficiency rates. Part 1.A deficiencies do not mean that the financial statements were materially misstated, but rather that the auditor did not provide sufficient audit evidence to support their opinion. A firm’s deficiency rate is calculated simply by dividing the number of audits with deficiencies by the total number of audits inspected. For example, if the PCAOB looked at 10 audits and 4 of them were found to have deficiencies, that firm would have a 40% deficiency rate, which by the way is the deficiency rate that Chair Erica Williams says she’s seeing and is “completely unacceptable.”

Ground rules: We (generally) don’t shame or name! 

We’ve been reviewing the PCAOB inspection reports and the related firm deficiency rates since 2009. Well, when we published our first blog on the topic in 2015, we listed the firms, by name, and their corresponding 5-year deficiency rates. However, these firms are either our clients or we want them to be, so since then we decided to not to provide the firm names.

Therefore, the firms will be referred to as either:

• GNF #1-6 (Global Network Firm) – one of the six global network firms.
• Firm #1-8 – one of the other eight annually inspected firms

However, we sometimes make an exception to this rule, and we do so in this post. With that, let’s get into our key takeaways!

Takeaway #1: The good, the bad, and the ugly

Here are the deficiency rates for past three inspection cycles for the 14 annually inspected firms (from first to worst based on 2022 inspections):

Here’s where we break our rule about naming names. Congratulations to Crowe LLP (Firm #1) for having the lowest deficiency rate at 7% and for their improvements in each of the last three years. Also, a shout out to PwC (GNF #1) for having three years of deficiency rates in the single digits! That is truly exceptional, especially when you look at the deficiency rates of the firms below them. Yikes! For the record, the industry is really trying to get audit deficiency rates to 25% or below and, unfortunately, only 5 of the 14 annually inspected firms are hitting the mark based on the 2022 inspection reports.

It's obvious that the deficiency rates are up year over year. 8 of the 14 firms have seen their deficiency rates increase in 2022 as compared to 2021, and basically that number is 10 if you count GNF #3 whose 2022 deficiency rate was redacted (see below) and Firm #8 (they really can’t go any higher). That’s 70% of the annually inspected firms that have seen their deficiency rates increase this inspection cycle.

Are audits really getting worse or is the PCAOB getting more nitpicky?

Takeaway #2: Does the PCAOB have a death penalty?

If they don’t, they should, and BF Borgers (Firm #8) should be a candidate. We’ve been analyzing these reports for over 15 years, and we’ve never seen a 100% deficiency rate associated with an annually inspected filer, let alone for two consecutive years. This means that not even one of the audits inspected by the PCAOB over the last two inspection cycles had enough audit evidence to support its opinion. Plus, each one of the audits inspected had multiple deficiencies. Here’s just a sample of some of poignant findings from the PCAOB:

• The firm did not perform any substantive procedures to test certain receivables related to revenue. In addition, the firm did not perform any substantive procedures to test the issuer’s allowance for doubtful accounts.
• The firm did not identify and select journal entries and other adjustments for testing to address the potential for material misstatement due to fraud.
• The firm did not perform any substantive procedures to evaluate whether the issuer’s accounting for, and presentation of, convertible notes payable, including warrants, were in conformity with relevant GAAP.
• The firm did not perform substantive procedures to test revenue beyond comparing it to a schedule provided by the issuer.

I could have gone on all day, but you get the picture. I know I shouldn’t name names, but c’mon man. They audit over 100 public companies and have a gatekeeper responsibility. We’ve talked about their problems before in this podcast and this one.

Takeaway #3: What does it mean to have the deficiency rate redacted?

Redacted means to obscure or remove (text) from a document prior to publication or release and when the 2022 PCAOB inspection reports were released we noted that 2022 deficiency rate for KPMG (GNF #3) was redacted. However, the strange part is that nobody seems to know why. And we asked around! Therefore, until either KPMG and/or PCAOB release further information to clear up the matter, people will be left in the dark and their imaginations might lead them to think the worse.

For the record, you can calculate the 2022 deficiency rate. Their inspection report goes up to Issuer P and Issuer N was the one that was redacted. Assuming that Issuer N’ audit was deficient (in other words, let’s go ahead and count it), that’s 16 of the 54 audits that are deficient yielding a 2022 deficiency rate of 30%. That’s not great, but it is only slightly higher than the previous two years, and it could have been worse!

Takeaway #4: Does the size of the firm matter?

In short, yes. The overall 2022 deficiency rate for the six global network firms was 30%, compared to a 51% deficiency rate for the other annually inspected firms. We’ve been highlighting this gap between the Big 4 and other annually inspected firms for number of years. It went away in the 2017-2018 inspection cycles but has been widening ever since. Furthermore, for the audits with deficiencies, smaller firms tend to have more with multiple deficiencies. Specifically, for the audits with deficiencies for the global network firm, 68% of those audits had multiple deficiencies, whereas that number was 88% for other annually inspected firms.

For the global network firms, the auditing standard with the highest number of deficiencies was AS 2201, An Audit of Internal Controls over Financial Reporting That Is Integrated with an Audit of Financial Statements, and it wasn’t even close! For other annually inspected firms, this was only the fourth noted auditing standard for deficiencies, which makes sense given the size of the companies that they audit (i.e., not as many large accelerated filers subject to ICFR).

The types of differences noted between the two categories of firms was different as well. For example, the finding related to not evaluating the appropriateness of the issuer’s accounting method or disclosure (i.e., not evaluating the GAAP), was much more prevalent with non-global network firms (noted in 5 out of the 8 firms) as compared to the global network firms (only 1 out of 6).

Takeaway #5: The CPA profession has a problem, and this isn’t helping!

As we noted in this blog about the 2023 AICPA & CIMA Conference, the number of student’s earning an accounting degree was down 7.8% last year, a trend that has been happening over the past several years. People have different opinions as for the reasons for the decline, but I can tell you from firsthand experience, that the pressure of auditing a public company subject to PCAOB inspections doesn’t help.

Now “dial up” the regulatory regime, which many believe as gone a bit over the top, disclose these less-than-optimal deficiency rates in the Wall Street Journal and Bloomberg for the world to see, and add the very real possibility of getting fired if a deficiency is found on your audit. No wonder college kids are choosing other majors over accounting. Perhaps the regulators should also be involved as the industry tries to solve the “lack of CPAs” issue!

That’s all for now. In the coming weeks, look out for more posts as we dig deeper into these inspection reports.

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This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.