What the PCAOB's inspection results mean for your company: many audit and control failures can be attributed to failures of documentation by the public company.

Author:Howell, Joseph
Position:Internal Controls: IN THE CROSSHAIRS - Public Company Accounting Oversight Board

Much has been written about the 2014 results of the Public Company Accounting Oversight Board's (PCAOB) inspections of audits, which showed an average audit failure rate of more than 39 percent of inspected audits for the Big Four audit firms--with two firms reaching 46 percent and 49 percent.

James Doty, the chair of the PCAOB, recently said reports to be released in 2015 will show no significant improvement.

This is a marked contrast from the early days of the PCAOB, which was created as part of the Sarbanes-Oxley Act of 2002 (SOX) to provide oversight of the auditing of public companies.

Each year since its formation, the PCAOB has inspected selected public company financial statement and internal control audits and published its findings. When inspection reports were first published, the board reported problems with about 15 percent of the audits it inspected.

Controls Oversight

Many of the PCAOB's recent criticisms focus on a failure of the auditor to provide persuasive evidence that internal controls over financial reporting (ICFR), and especially management review controls, were operating effectively or at level of precision that would detect or prevent material misstatements.

Audit firms have taken the PCAOB's criticisms seriously, and are responding by changing their audit approach and scope of work. Auditors are performing more extensive, costly and time consuming audit procedures related to internal controls, sometimes even after issuing their audit opinion.

As a result, some companies had to amend previously filed Form lOKs to report previously undisclosed material weaknesses. This resulted in significant increases in related audit fees. In most instances, however, these actions did not result in changes to the financial statements.

Increased SEC Scrutiny

Adding to the pressure, the Securities and Exchange Commission (SEC) has increased its focus on whether companies are in compliance with their internal control requirements. In recent public statements, the SEC staff has expressed concern that companies are not fulfilling their responsibility to evaluate their internal controls, and to identify and disclose material weaknesses without the help of their auditors.

As Brian Croteau, the SEC's Deputy Chief Accountant for Professional Practice, remarked last December, "It is surprisingly rare to see management identify a material weakness in the absence of a material misstatement." He suggested these results could either stem from...

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