The Public Company Accounting Oversight Board (PCAOB) in a non-profitmaking body created by Congress in the year 2002 upon the passing of the Sarbanes-Oxley Act into law. The board began operations in the year 2003 and was mandated to superintend the audits of public companies with the aim of protecting the welfares of investors and the general public (Hill, McEnroe & Stevens, 2005). PCAOB promotes precise and informative audit reports while ensuring the independence of the reports. This paper discusses the circumstances under which PCAOB was created, the changes in the board's quality control and auditing inspections, and the impacts of these changes on the accounting profession and the general business community. The responses of stakeholders on changes in PCAOB are also addressed and a personal view given on the positive effect of the changes.
What brought about the change or changes?
The board was formed in the wake of accounting scandals and frauds implicating corporations like Xerox, Enron, Adelphia, WorldCom, and Tyco. The scandals provoked concerns regarding independence, effectiveness, and governance of the auditing profession. During that time, these concerns caused a great deal of uneasiness among investors concerning capital markets in the United States. In a bid to address the investors' concerns, the Congress assigned the PCAOB responsibilities to register firms engaged in public accounting, conduct inspections on such registered firms, set auditing standards for broker, dealers and public companies as well as carry out investigations on their own or on request and take disciplinary actions against auditors found to violate laws or auditing standards (Hill et al., 2005). The activities of the board are embedded on a five-step premeditated design encompassing improvement of audit services through combined efforts to prevent and deter non-compliance, anticipating and promptly responding to rapidly changing business environment, proactive stakeholder engagement for enhanced transparency, excellent pursuance of operations through efficient utilization of resources and technology and empowerment of human capital to achieve the shared goals (Hermanson, Houston & Rice, 2007).
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Since its formation, PCAOB has brought several inspections and quality control changes in the auditing and accounting professions occasioned by the seven trillion US dollars loss experienced by investors in the late 1990s and early 2000s (Fung, Raman & Zhu 2017). The losses were a result of audit failures coupled with accounting restatements and scandals in big companies, including those mentioned earlier. The board has changed the conventional system where auditors would set working standards themselves and determine the efficiency of those standards through peer reviews. Subject to Securities and Exchange Commission’s (SEC) oversight, PCAOB took over critical regulatory functions such as inspections and standard-setting from the auditors (Fung et al., 2017).
Over the years, PCAOB, through its strategic planning initiative, has conducted organizational assessments resulting in transformation changes in its operations. For instance, the board made it compulsory for all auditing firms dealing with brokers, and public company audits to be registered with the board. Another change was that audits steered by the registered firm were subject to inspection by PCAOB. The most recent PCAOB changes touch on quality control standards, disclosure of Critical Audit Matters (CAM), inspection reports, and staffing.
Concerning changes in quality control standards, the board has moved from the standards it adopted in 2003 after its formation. With the rapidly changing auditing environment, PCAOB has established a risk-oriented framework that accommodates the use of IASSB recently amended quality control standards (Hermanson et al., 2007). In addition, PCAOB has adopted the audit quality indicator technique whose concepts relate to audit inputs, the process of auditing, and the results of the audit. Audit inputs describe the auditors' traits and resources set aside to manage audit personnel while auditing process entails independence, incentives, remediation, and monitoring. The concept of results deals with the quality of reports, including timely reports on weaknesses of internal control, frequency of fraud and restatements, and trends of PCAOB's proceedings and litigations. The board continues to seek public comment on approaches that should be incorporated in their systems to improve quality control in the future. New quality control systems will help the board keep up and remain relevant in its interaction with companies that have adopted technology and automated their auditing, accounting, and data analyzing processes.
On critical audit matters, the board has introduced changes that require audit reports for firms registered with the board to include critical audit matters. The critical matters make financial audit reports more meaningful as they contain additional information that is relevant to users of the reports. Critical audit matters inform users of the auditing risks encountered and how the auditor addressed them. The board requires that critical audit matters be principle-based, relate to account, be objective, challenging, and involve critical judgment by the auditor (Hermanson et al., 2007).
With regard to inspections, the board continues to change the inspection strategy. Inspectors often redefine and polish the risk-oriented strategy to select approaches to addressing risks that keep evolving, including firm-specific risks. The board has transitioned to the use of a random selection of firms to inspect and application of statistical methods of disseminating findings of firm audits. It is projected that PCAOB's inspection approaches will continue to evolve, with more firms investing in quality control systems. The new approach provides that inspectors report both the nature and severity of deficiencies found in audits rather than just the nature of these insufficiencies like in the past year (Hill et al., 2005). This change ensures that deficiencies are addressed based on their severity, unlike in the past, where they were dealt with equally despite the recognition that audit deficiencies are differentiated by severity.
In addition to changes in the inspection approach, the board has changed the language used in inspection reports making it less boilerplate. This is a result of complaints that the board's inspection reports are hard to read and comprehend, thus failing to meet the need of users, particularly investors and members of the audit committee (Hill et al., 2005). To address the problem, the board has established a new report design and format that uses simple language allowing comprehensive communication with targeted end-users.
As regards changes in staffing, the board has created new positions such as principal information security officer, principal risk officer, compliance staff, among other experts in portfolio management. With the staffing change, the board has launched an enterprise risk management plan and has established programs to address concerns of business continuity and security threats. The board established a learning and skill development system to help staff in personal growth, acquisition of new skills, and refresher causes. The board is currently looking into a philosophy for career progression.
Impact the change have or would have on the business community as a whole and the accounting profession specifically
PCAOB's regulations and inspections have had direct impacts on accountants, auditors, and the general business community, particularly the investors. It is the duty and responsibility of the board to ensure that auditors of brokers, dealers, and public companies faithfully carry out their obligations to investors and business communities. Through ensuring reliability and accuracy in corporate disclosure and providing oversight over public company audits, the board has managed to fulfill its legal role of protecting investors and the interests of the entire business community (Aodia, 2018). Besides, investor protection is a core part of the board's mission, making it the goal of the board to guard the investors' interest by holding public companies' auditors accountable to objectivity, standards, and professional independence.
Accounting firms have been impacted by the board, both positively and negatively. On the negative side, the accounting firms are charged with meeting the bills for the board's activities. These firms are required to pay registrational and annual fees to cover their filings with the board. Moreover, the PCAOB striped off auditors the key regulatory function to set their own working standards and checking compliance through peer reviews (Hermanson et al., 2007). Since the creation of the board, auditors are obligated to register with the board, subjected to inspections and disciplinary actions, and required to follow the set auditing standards by the independent board. On the positive side, changes brought by the creation of the board have directly dealt with the quality of audits (Fung et al., 20170. The board has played a significant oversight role in improving the quality of financial audits, bookkeeping, and reporting. PCAOB has also enhanced independence of auditors, internal controls, and corporate governance all that have strengthened the financial information systems.
Another impact of the changes brought by the formation of PCAOB is the restoration of business communities' confidence and trust in the United States' capital market. Working in collaboration with SEC, which oversees and governs the flow of financial information within capital markets, the board has resolved the accounting scandals and frauds of the 1990s while preventing their reoccurrence (Fung et al., 2017). The board is vigilant in adopting operational changes and assessing the profession's activities as well as the regulatory regimes to ensure that financial auditing, accounting, and reporting are not put under duress given the rapid changes in the business environment.
The creation of PCAOB has also impacted on market shares for registered auditing firms. Firms that are inspected by the board tend to have a bigger market share compared to those that are not subjected to PCAOB inspections. On average, forms inspected by PCAOB increase their market shares by 3.5 to 6.4 percent (Aobdia, 2018).
Also, PCAOB activities and resultant changes have impacted on auditors of penny companies. The board has prioritized going after auditors of companies that operate outside the main stock markets are highly vulnerable to manipulation and fraud. The board has successfully eliminated from the market several penny companies and their auditors who essentially abetted fraud by neglecting their audit responsibilities.
How the various would affected groups respond or have responded to the changes
Auditing professions, policymakers, investors, financial organizations, and other stakeholders have responded to the creation of PCAOB by engaging constructively with the board on policy initiatives, developing changes in internal controls, inspections and standards, and giving views and comments about these changes before they are approved. Investors have responded to the auditing changes effected by the board by increasing their investments in companies that are audited by firms registered under PCAOB (Gramling, Krishnan & Zhang, 2011). The board has faithfully taken up its responsibility to carry out audit inspections encouraging auditors to quit aiding their clients to conduct financial frauds. This practice has improved the quality and reliability of audits by investors who, in turn, have restored their faith in capital markets.
Policymakers have supported the board in fulfilling its mandate by providing commentaries on proposals and advocating for practical standards-setting and formulation of regulations. Pursuant to the SOX Act of 2002, the stock exchange commission has responded to some of the changes proposed by PCAOB by approving them and declaring them law. Case in point, the commission approved PCAOB's proposed rules and economic analysis strategy upon reviewing the attached letters of comments and confirmation that the proposals are consistent with requirements of the SOX Act. The commission has also approved several other change proposals by PCAOB upon a conviction that the changes were for public interests, protection of investors and that the changes promote capital formation, efficiency and fair competition (Gramling et al., 2011).
Public auditing firms responded to the formation of PCAOB by registering with the board and giving independent opinions about their clients' financial status based on their audits. In response to changes proposed by the board, auditing firms conduct audits in compliance with standards set by PCAOB and in harmony with the generally accepted auditing standards in the United States. These standards necessitate that auditing firms conduct audits that give rational assurance that their clients' financial reports and statements are safe from misstatement either due to swindles or errors.
Accounting bodies such as CAQ and the AICPA have responded to PCAOB and its proposed operational transformations by mobilizing resources and guidance to aid auditors of public corporations in enhancing professional skepticism. The bodies also ensure that public company auditors operate objectively and enjoy their independence from their clients. An example of how accounting bodies have responded to PCAOB is the recent member alerts by CAQ that address the role of an auditor in cybersecurity and the high-risk areas for auditors (Nagy, 2014).
Partners and key stakeholders in accounts and audit reporting chains have worked in collaboration since its formation in 2002 to avail information necessary in improving corporate governance, pecuniary reporting, and the integrity of investment markets in the United States and abroad. Some of the collaborative efforts by stakeholders include initiatives like audit committee collaboration and the anti-fraud collaboration (Nagy, 2014). Independent scholars have also added to the board's research thereby expanding knowledge of audit quality, nature, and severity of audit deficiencies and emerging issues among investors and the general business community.
Views as to whether the impact would have positive or negative effects
In my view, establishment of PCAOB and the impacts of its transformational changes since creation have had positive effects on stakeholders. However, this does not declare success since more needs to be done to attain and maintain high-quality audits on a consistent basis, but still, the positive effects are rather evident. Feasibly, the most important effect of PCAOB creation and subsequent changes is the restoration of investors' trust in the United States' capital markets through protecting their interests as per the board's mission. The board's regulations, inspection, and quality controls have contributed in reducing the number of reported audit deficiencies resulting in financial restatements.
Besides, the changes have improved quality of audits through a combination of actions to prevent, detect, deter, and remedy non-compliance, audit deficiencies, and non-professionalism. The changes have also improved investor's confidence in the dependability of public corporation audits through setting auditing standards and enforcing them through striking penalties for violations (Aobdia, 2018). Investor confidence in the effectiveness of public company internal controls has also been enhanced by changes effected by the board. The rigorous independent and high-quality audits on financial statements of public companies have seen the capital formation increase over the years with continuous implementation of more inspections and quality control changes by the board.
Also, the changes have contributed in transforming auditors' behavior and practices. The fact that audits are subject to inspection by the boards keeps auditors on toes and cautious of the kind of audits they approve. Auditors can no longer be used to aid financial frauds as board inspections will always reveal any deficiencies.
In my opinion, the actions of the board have an indirect positive effect on the preparers of financial statements. The inspections conducted by the board highlight audit deficiencies that can only be resolved if auditors obtain additional information from clients. Sometimes addressing the deficiencies force clients to change their method of financial reporting. A good example is the internal control aspect. Addressing deficiencies helps to improve auditors' skills in internal auditing controls making companies make changes in their control environment, internal operations, and documentation of the controls. The overall outcome is a positive development characterized by improved and effective internal controls with decreased number and severity of financial restatements.
Perhaps the most significant effects of PCAOB's changes come from the transformation in reporting of inspection findings. The change requires that auditors report both the nature and severity of inspection results, unlike in the past where deficiencies were reported void of severity differentiation. The weakness with this traditional reporting approach was that all deficiencies were regarded equally while, in actual sense, some were more severe than others, particularly those that resulted in financial restatements (Fung et al., 2017). The new approach of nature and severity reporting has shifted the public’s focus to a more meaningful assessment of the audit’s quality.
Another positive effect is protection of companies audited by PCAOB registered firms from unreasonable burdens which justifies any burden imposed on these companies through the benefits to be gained. In the past years, some auditors would ask their clients for unnecessary, immaterial, and low-risk information and claim to be requirements of the board in reviewing internal controls. The board's changes that introduced rigorous fiscal analysis connected to auditing standards established suitable scrutiny levels, testing, and documentation formats to be used by auditors during internal control audits. The change confined auditors to the set scrutiny levels when seeking financial information from their clients.
The changes that have taken place in PCAOB requires that the board provide guidelines on how auditing firms should comply with its auditing standards. The board gives out published guidelines, practice alerts, staff reports, and consultation processes as a means of informing audit firms on how they can successfully meet the set auditing standards. This eliminates the auditors' and accountants' perceptions that PCAOB's expectations for compliance with their standards were moving targets that increased with each inspection but had no clarity on how to achieve.
References
Hill, N. T., McEnroe, J. E., & Stevens, K. T. (2005). Auditors' reactions to Sarbanes-Oxley and the PCAOB. The CPA Journal , 32.
Hermanson, D. R., Houston, R. W., & Rice, J. C. (2007). PCAOB inspections of smaller CPA firms: Initial evidence from inspection reports. Accounting Horizons , 21 (2), 137-152.
Fung, S. Y. K., Raman, K. K., & Zhu, X. K. (2017). Does the PCAOB international inspection program improve audit quality for non-US-listed foreign clients? Journal of Accounting and Economics , 64 (1), 15-36.
Aobdia, D. (2018). The impact of the PCAOB individual engagement inspection process—Preliminary evidence. The Accounting Review , 93 (4), 53-80.
Gramling, A. A., Krishnan, J., & Zhang, Y. (2011). Are PCAOB-identified audit deficiencies associated with a change in reporting decisions of triennially inspected audit firms? Auditing: A Journal of Practice & Theory , 30 (3), 59-79.
Nagy, A. L. (2014). PCAOB quality control inspection reports and auditor reputation. Auditing: A Journal of Practice & Theory , 33 (3), 87-104.
