Julie Bell Lindsay is CEO of the Center for Audit Quality.
High-quality audits are essential to capital market operations. These audits are planned and executed by highly skilled, independent auditors in consultation with independent audit committees.
In turn, these types of audits make it possible to invest with the confidence that a company’s financial statements were analyzed and verified by an independent third party. This type of assurance is a critical component of our economic engine.
The consequences of wrong information can be severe: Damage to corporate reputations, unpredictable stock price fluctuations and a hit to your portfolio, to name just a few. Even unintentional and seemingly minor inaccurate information can rock markets. Think of the turmoil caused by Lyft’s inadvertent press release typo that briefly sent the stock up by more than 60%.
Just as the way businesses operate and the information needs of investors continuously evolve, so must auditors as they deliver assurance to capital markets when it comes to corporate information. There will always be areas where we can improve. Identifying growth opportunities is how auditors continue to drive audit quality higher after decades of improving results.
When evaluating audit quality, these are just a few of the factors I consider and encourage you to consider as well.
Public Company Accounting Oversight Board Inspections
For the last two decades, inspecting the work of public company auditors has been an important review process in the U.S. corporate reporting system. These “audits of the audit” are performed by the Public Company Accounting Oversight Board (PCAOB).
The audits chosen by the PCAOB for inspection are largely those with a higher risk of material financial statement misstatement and greater complexity. Put more simply, the PCAOB inspection process focuses on the toughest audits to perform. The inspectors review audits to evaluate adherence to standards, and as a result, identify opportunities for further improvement.
This is important because the inspection results provide valuable information to auditors on how they can improve their work. Because of the complexity of the audits being reviewed, it is not surprising to see inspection findings or issues identified each year. Looking beyond the PCAOB’s most recent inspection results, a few things stand out to me that indicate that audit quality remains strong.
The Current State Of Affairs
The first thing that stands out is restatements. While deficiencies went up, restatements remain rare. This is important because unlike deficiencies, which could indicate many easily fixable design or control flaws, restatements indicate that an audit had a material error significant enough to warrant reissuing a company’s financial statements. We know, based on my organization’s past research, that the market understands the complex decision-making that goes into an audit and that the utility of the information they have available continues to improve.
Second, inspection findings have narrowed in recent years as the overall severity of deficiencies has dropped. Essentially, as the PCAOB’s inspection staff have gained experience, auditors have also improved their performance, and the job of the inspector has gotten harder. The “low-hanging fruit” no longer exists as the corporate reporting ecosystem drills down on improving the most challenging aspects of the audit.
In a recent conversation, former PCAOB Member and one of the two CPAs on the Board during his tenure, Duane DesParte, said that while inspection deficiencies have recently increased, “I do not believe there is enough evidence yet to suggest a serious industry-wide quality problem.” He further mentioned that a positive sign is the actual financial statement restatement rates, which are still at or near record-low levels. And he’s right; according to our own analysis, less than 1% (two out of 386) of the 2022 inspections for annually inspected firms identified a deficiency that resulted in a restatement. This is in line with past years.
Firm Reported Metrics
Public company auditors take pride in their work, and many see it as their responsibility to provide investors and other stakeholders with additional context on what goes into an audit. To that end, many audit firms voluntarily disclose information about their quality improvement investments annually.
These measures include, but are not limited to:
• Audit quality measures such as restatements, which, as noted above, remain at historic lows and have declined in severity over the past decade.
• Commitments to factors that contribute to audit quality, such as accountability, independence and transparency, and the steps they are taking to meet those commitments (see PwC’s most recent audit quality report for a great example of this).
• Use of technology such as artificial intelligence and other digital audit methodologies to strengthen audit processes.
• Investments in people from both a training and development perspective as well as progress on efforts to increase diversity.
Stakeholder Views
All the above measures are important to consider when assessing audit quality. However, the PCAOB and the profession’s views on audit quality mean nothing if they do not consider the views of investors and other stakeholders who rely on high-quality financial reporting.
By that measure, we’re encouraged by what we hear from those who rely on audited corporate information. According to the earlier cited research from my organization, among institutional investors, the majority have an overall positive view of corporate reporting in the U.S., believing that our system of checks and balances delivers reliable information. Investors tend to trust audited financial statements due to the strong reputation of the firms conducting audits.
Perhaps due to this strong foundation of trust, investors also want public companies to have other company-reported information, such as climate-related disclosures, audited and assured.
The Bottom Line
Even with restatements at historic lows, we know that we must be relentless in performing high-quality audits. Assuring corporate financial data is critical to our economy, and we must get it right. Failing to do so puts at-risk investor trust and, with them, the functioning of regulated capital markets that make so much of our day-to-day lives possible.
Auditors will continue their investments in continuous improvements of their people and their processes, protecting trust in the markets and keeping restatements low.
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