Help Wanted: Audit Quality Considerations in Light of the Great Resignation

Dane Dowell, JGA Director • Sep 20, 2022

As a millennial, I was told that the 2008 global financial crisis was a “once-in-a-lifetime” economy. Many firms went on hiring freezes and some even had layoffs, rescinding offers previously extended to new college graduates. As a young 20-something-year-old, I was happy to know that the “exceptional” economy was early in my career and that the rest of my life would be smooth sailing. Or so I thought.


Then the pandemic of 2020 came around and yet again, the headlines proclaimed the unusual nature of the pandemic and the “once-in-a-lifetime” economic repercussions. Overnight it seemed, more than 10 million people lost their jobs and the world appeared to spiral out of control. Fast forward to August of 2022 and the economy has now fully recaptured the 10 million lost jobs. But surprisingly, there is suddenly a labor shortage. The Great Resignation. What? How is that possible?


Almost every industry is feeling it, whether the medical profession struggling with burnout from two-years of pandemic stress or the transportation industry struggling to find drivers to keep up with home deliveries. The audit industry is no exception; every client we work with is feeling it. We’re feeling it.


In a recent study published by McKinsey & Company, at the end of May 2022, there were 11.3 million job openings. And to make matters worse, “Despite significant changes in the economy since the onset of the Great Attrition (or what many call the Great Resignation), the share of workers planning to leave their jobs remains unchanged from 2021, at 40 percent. That’s two out of five employees in our global sample who said that they are thinking about leaving in the next three to six months.”


Talk with an economist and there are any number of reasons why there is a labor shortage in the current economy. But answers to “why” rarely provide practical solutions to “what do we do?”


For firms that are struggling with resources, we hear you. Within the audit and accounting profession, we know of many firms that have resorted to using part-time employees and independent contractors to help fill needs. Some firms have leveraged staff from various departments such as IT consulting or internal audit. While all these approaches fill the seats and provide resources to execute the audits, the question remains, what procedures are firms putting into place to ensure quality audits?


Firm QC Considerations


Acceptance and Continuance: Paramount to any audit, the firm process starts first and foremost with engagement acceptance and continuance. This process is already in place for firms, but how much thought is put into the careful completion of these checklists? The critical consideration here is capacity and competence. I know when I was an associate, I was charged with rolling forward the A&C forms from prior year; the senior then officially completed the form and the approval process started with the manager, then partner and up the chain depending on the type of client and the risk profile. In light of the current resource constraints, how are A&C forms capturing considerations around capacity and competence? And how do staff know whether the firm has the right resource capacity and competence? These are often higher-level discussions held at regional and national management levels, but how are those considerations being evaluated and documented? The reality is, if the firm doesn’t have the capacity or the right competence, it needs to either decline engagements or hire the right knowledge base/skill sets to execute a quality audit. 


Independence: Once an engagement has been accepted, the firm then needs to determine the proper staffing. While it may be easy to pull from internal resources, such as leveraging IT consultants to come perform IT controls testing, the Firm needs to be intentional in making sure all engagement team members understand the independence implications of working on the audit. For instance, consulting has very few independence limitations, so an IT consultant may not be aware of the strict nature of SEC independence rules for a public company audit. Similarly, the use of contractors external to the firm is another viable solution to resource constraints, but the question still stands, despite completing an independence checklist/confirmation, has the consultant been educated on the specific nature of independence requirements for the audit?


Technical Knowledge: Assuming the borrowed staff and/or consultants are independent, what is the firm’s process for evaluating competence of these resources? Sure, firms know to review the CV and certifications, but we all know there is a distinction between an accountant and an auditor and yet both often have the same degree and may even both be CPAs. Or take an IT consultant for example. The IT consultant likely has a strong understanding of information systems and could easily perform a walkthrough and execute tests of operating effectiveness over automated controls and/or information technology general controls (ITGCs). However, mere execution is not the same as truly understanding the audit risks and implications of findings. For instance, in performing a walkthrough, the IT consultant may obtain an understanding of the change management process and as with all processes, there are always exceptions to the rules. The question is, would an IT consultant understand the audit implications for various exceptions? Or if the IT consultant is testing an automated control, would they know to test more than the mere functionality as described in the walkthrough? Would they know to test all possible scenarios to demonstrate that the system can only process information as described in the automated control?


Regardless the area, whether IT, valuation, tax or some other specialty knowledge, understanding audit risks is critical. After all, risk is what drives an audit. So, what does management do to ensure that resources have the proper audit understanding? While a three-hour training on PCAOB audit standards may help provide some insight and may placate the PCAOB from a “checklist” mentality, let’s be frank, audit risk is learned over time. There is a reason managers and partners perform reviews, having years of audit experience, slowly learning the risks and implications of various scenarios that emerge in audits. A three-hour training cannot replace years of experiential learning. The question remains, what are firms doing to bridge this gap? This points to consideration of the staffing mix and the need for appropriate review and supervision, as discussed below.


Monitoring: Current QC standards require various monitoring programs at a firm level. These programs are often executed for all internal resources, but what about external resources or resources from different divisions? Take independence monitoring and/or training/CPE/licensure monitoring, are “fill-in” resources subject to these same processes? While performing an independence check for an occasional contractor may be easy enough, as firms embrace more part-time workers and engage more contractors, firm QC processes will need to be amended to ensure appropriate checks over this emerging resource pool.


Tone at the Top: It’s worth emphasizing the importance of creating a culture of curiosity over conviction. Employees and teams should feel encouraged to ask questions, to seek for better understanding, and to not hesitate to consult with national office / upper management. Considering a lot of cumulative audit knowledge and experience is being lost through the great resignation, promoting a culture of knowledge sharing is even more important to ensuring employees feel comfortable raising their hand when they don’t understand something and feel supported by all levels of management so they can perform quality audits.


Engagement Team Considerations


Team Assignments: At the engagement team level, it’s important that firms consider the staffing mix on audit teams. While firms may have no choice but to use contractors and borrow staff from other departments, audit teams should still have “core audit members” who can share the audit knowledge and keep audit risks front of mind. Maybe that means the firm will need to rotate clients for some of its core assurance staff so that every team has core assurance members. As well, as audit areas are assigned, managers and partners should be thinking through risks at the financial statement level and ensuring higher risk audit areas are completed by stronger, core assurance members.


What about areas like IT or taxes where the area is specialized and may present a pervasive or significant risk? Firms need to be conscientious of these areas and if their resources do not themselves have the requisite audit knowledge and/or experience, then perhaps firms should consider specific coaching programs or targeted in-flight review programs that can compliment the use of contractors and/or borrowed staff. For instance, perhaps the firm uses an IT partner with years of in-depth audit experience to coach less experienced IT contractors across multiple engagements. As the workforce and employment model is changing, so too will the structure and makeup of engagement teams. Be creative. 


Review and Supervision: In addition to the staffing mix, firms should consider review and supervision at the engagement team level. Though the standard around engagement team review and supervision has not changed, the expectations may be evolving. For areas performed by less experienced staff, whether new hires, borrowed staff, or independent contractors, managers and partners should be performing more in-depth reviews. For areas of higher risk, teams should consider whether additional levels of review are necessary. And for areas of specialized risk, as mentioned above, firms should consider whether there is a need for targeted in-flight reviews. Perhaps the most important factor for quality review and supervision is workload. What metrics is the firm using to monitor manager and partner workload? What are firms doing to relieve overworked managers and partners? This ties directly into the capacity discussions that management is having at the acceptance and continuance level.


Consultations: Finally, in conjunction with firm management setting the correct tone-at-the-top at the firm level, engagement teams should leverage firm-wide resources and not be afraid to consult when needed. Too often, teams only focus on required consultations, but nothing says that a team can’t consult when questions arise in other non-mandatory scenarios. Knowledge is power and firms have vast sums of cumulative audit knowledge and experience at the management levels, so don’t be afraid to reach out to national office with questions. Chances are, you aren’t the first to have that question.


Use of Other Firms Considerations


So far, we’ve focused mainly on the use of independent contractors and borrowed staff, but there is also a movement to using other audit firms to also assist with audits. Sometimes the other firm will issue an opinion and sometimes the other firm only performs audit procedures on behalf of the principal auditor. Currently, China comes to mind; given various restrictions due to COVID and regulatory concerns, many US firms are leveraging other audit firms in China to assist in executing audits. In our recent article of use of other auditors, we provide factors to consider, but the general theme points to review and supervision. So what procedures are firms implementing to ensure appropriate review over the work performed by other auditors? A mere review of the reporting package is likely not sufficient given the new PCAOB standards/amendments.


Technology Considerations


Given the digital age, we would be remiss not to mention technology. In our joint webinar on ISQM 1, Dayshape CEO, Andrew Bone, said: “For those already struggling to fill their current vacancies, the obvious question is where will this extra capacity come from? Unable to simply recruit and reluctant to scale back fee earning work, firms are looking to technological resources for answers. What firms are finding is that technology can help in a number of different ways.” 


For instance, using technology for resource management will help firms easily identify available employees, what skills and experience various resources have, and potentially even reduce administrative burdens on resources, such as finding ways to automate administrative processes. “Technology can be used by firms to track and evidence that the right skills and competencies have been assigned to a project and that independence criteria have been met. When doing this at scale, technology can be extremely useful to help firms track skills firm-wide and demonstrate a robust and standardized process.” 


In addition, technology can automate various Firm QC processes or monitor QC metrics (i.e. partner or manager workloads, as mentioned above). Bone continued, “technology can be used to implement automated project controls to provide assurance that the right quality measures and checks are in place and that these are followed consistently. These can be set at a firm level to ensure that the right people review and approve work at the right stage. Or at the engagement level where engagements failing certain quality criteria can also be automatically escalated.” 


Finally, as we all know, big data can be incredibly powerful, and technology combined with data analytics could transform future audits. Already, technology is being used to help perform many non-subjective functions such as account reconciliations, cash proofs for revenue, various roll forwards for investments or equity or journal entries, etc. Technology requires an investment, but as we approach a more and more automated world, it will soon be inevitable, and thanks to software-as-a-service models, technology resources are becoming more and more accessible to the masses.


Key Takeaways


The Great Resignation is proving to be a challenging time for everyone. Whether flight cancellations or poor service in restaurants (if the restaurant stayed open), we’re all feeling the effects of staff shortages. For those who didn’t resign, it seems there is more to do with less (yet again). While use of contractors and borrowed staff is a temporary fix, firms should incorporate the following:


  • Acceptance and continuance decisions need to be thoughtfully considered, taking into account a firm’s capacity and competence.


  • Independence and ethics requirements should be clearly explained and understood by all staff working on audit engagements, regardless of whether they are internal or external.


  • Competence is more than just technical ability and should incorporate an element of understanding audit risk. This could be accomplished through trainings, but firms could also incorporate other elements such as engagement team coaching (either by team mangers and partners or through designated coaches), in-flight reviews, and consultations.


  • Engagement team staffing should be thoughtfully evaluated to ensure there is a mix of core assurance and other staff such as contractors or borrowed staff.


  • Review and supervision are becoming increasingly important, especially as the use of alternative resources increases. Ensure workloads allow for adequate time for coaching and review during an audit.


  • When using other audit firms, keep in mind the new PCAOB amendments and standards, largely pointing to increased responsibility around review and supervision for lead engagement teams.


  • There are tools, technology and services available to help. Firms must assess the gaps whether intellectual, human, or technological, and make investments now for the future.


No one knows how long the labor shortage will last. In the long term, the economy and the markets will adjust. My grandfather worked at one company his entire life. At the time, that was normal. Today, that’s exceptional. In the 90’s, companies complained about lack of loyalty when the younger generations began to change jobs more frequently, but sure enough, the workforce adjusted. Now with the Great Resignation, once again, companies are feeling the strain and in particular, the employees who didn’t resign. But, as has always been the case, the markets will adjust in time. Perhaps this is truly the emergence of the “gig economy” en masse. Perhaps this is creating the impetus needed for firms to more rapidly adopt technology, making audits more efficient. Whatever the outcome, in the short term, we can’t lose sight of audit quality. Filling seats isn’t the same as engaging the right resources with the appropriate firm QC protocols in place to enable teams made up of contractors, borrowed staff, and traditional assurance staff to perform high quality audits.


Dane Dowell is a Director at Johnson Global Accountancy who works with PCAOB-registered accounting firms to help them identify, develop, and implement opportunities to improve audit quality. With over 12 years of public accounting experience, he spent nearly half of his career at the PCAOB where he conducted inspections of audits and quality control. Dowell has extensive experience in audits of ICFR and has worked closely with attorneys in the PCAOB’s Division of Enforcement and Investigations. Prior to the PCAOB, he worked with asset management clients at PwC in Denver, Singapore, and Washington, DC.

JGA Sponsors MSP’s 45th Anniversary Event

By Randall Thompson • 22 Apr, 2024
Johnson Global is proud to sponsor My Sister's Place (MSP) 45th Anniversary Celebration on May 15, 2024 in Washington, D.C. MSP has been providing services to the D . C . community to empower survivors of domestic violence and their children, while fostering leadership and education to build a supportive community. MSP's experienced team provides training, case consultation, and advocacy to engage communities to prevent violence and abuse. Click here for more details.

Allinial Global Executive Team Conference

By Randall Thompson • 02 Apr, 2024
Johnson Global Advisory (“JGA”) is pleased to sponsor the Allinial Global Executive Team Conference 2024. This four-day event will be from May 19–22 at The Westin Kierland Resort & Spa in Scottsdale, AZ. This premier event for firm management, strategy and growth, and leadership, with a focus on Driving Success and Accelerating Possibilities through collaboration, knowledge sharing, and networking. PROGRAM HIGHLIGHTS A keynote session entitled The Time to Win - Grow Your Firm by Exceeding Clients’ Need for Speed by Hall of Fame speaker and New York Times best-selling author Jay Baer Inspiring sessions focused on how firms can evolve their internal operations and management to facilitate a seamless client experience through lean processes and innovative approaches to talent and technology Half-day virtual programs on Monday, May 20 and Tuesday, May 21 To learn more and register click here. About Johnson Global Johnson Global partners with leadership of public accounting firms, driving change to achieve the highest level of audit quality. Led by former PCAOB and SEC staff, JGA professionals are passionate and practical in their support to firms in their audit quality journey. We accelerate the opportunities to improve quality through policies, practices, and controls throughout the firm. This innovative approach harnesses technology to transform audit quality. Our team is designed to maintain a close pulse on regulatory environments around the world and incorporates solutions which navigates those standards. JGA is committed to helping the profession in amplifying quality worldwide.

JGA Team Perspectives: Navigating the PCAOB Inspection Process

By Geoffrey Dingle, Managing Director, Shareholder • 27 Mar, 2024
Editor's note: This article is part of a series to highlight the unique experience that JGA professionals possess and deliver to our clients. As busy season winds down, it is an opportune time to reflect on challenges in ensuring audit quality and preparing for a successful outcome to the PCAOB inspections process. There are a myriad of obstacles to audit quality such as time constraints and the complexities of client engagements. Amidst these demands, audit quality remains the utmost priority. Geoff Dingle an author of JGA’s guide, Navigating PCAOB Inspections, Second Edition shares his insights on how firms can effectively prepare for the entire process. The Purpose Registered firms that issue at least one public company audit opinion are subject to inspection at least every three years. Every inspection is different based on the firm, its clients, and PCAOB priorities, but the overall process is the same. It is a long process that takes planning and coordination, and this guide addresses the main phases and pain points. “Through our work at JGA, supporting firms on PCAOB inspections, we are able to witness first-hand the struggles that some firms encounter as they work through the inspection process with the regulator. Although some of this information is available on the PCAOB’s website, we have been able to consolidate our own experiences having supported over 100 firms during their inspections. JGA has a team of alumni from the regulator that have led inspection teams and quality management initiatives, with over 139 years of combined experience at the PCAOB and SEC,” says Dingle. The Process The inspection process often takes more than two years (sometimes as long as four years) from initial notification of an inspection to the final remediation determination. It can take weeks to months to issue comment forms after the inspection week. Report finalization is getting faster but it can still take more than six months to issue an inspection report to a firm. If there are few issues, the PCAOB can respond quickly, but with multiple findings the process oftentimes takes longer. After report issuance Firms have 12 months to remediate Part II findings and provide these remedial plans to the PCAOB for evaluation. Pre-Inspection The PCAOB provides the dates for its intended inspection week. The notification letter includes the period being inspected, questions, and requested documentation about the firm and its clients. There are not many pain points at this stage, but there is typically a four-week deadline to respond. The PCAOB contacts the firm two to three weeks before the inspection starts with the names of the issuers selected for inspection and requests specific information and access to the workpapers for these audits. “We always recommend that firms hold internal meetings to assign responsibilities between the engagement teams and the national office and plan for the inspection. Prep week - the week before the inspection, can be stressful. We suggest that engagement teams go back through their audit files to re-familiarize themselves with the workings of the audit file,” Geoff continues . Key Points About The Process Before COVID, inspections were conducted in-person. Now the majority of the inspections are performed virtually. “With the engagement team and the inspection team not being in the same room, we have observed inefficiencies in getting matters resolved because of the need to coordinate firm personnel and inspection personnel, across various time zones, locations, and schedules,” he mentions. During the inspection week, the PCAOB provides detailed questions to the engagement team regarding the audit file. It’s a mix between written questions sent to the firm and asked questions during meetings. All questions are answered in subsequent meetings. With the remote process, meetings are scheduled to address and answer these questions. “Our own experience is that if a particular line of questions continued for the week (i.e. the engagement team’s response is not satisfying the inspector), then chances are there will probably be an issue that will result in a comment form,” Geoff adds. Be ready for multiple layers of questions on the same subject by providing details based in the working papers and show a deep understanding of the audit. Inspection issues are usually riskier areas involving judgements. Audit documentation should “tell the story” of how auditors came to their conclusions, not just what the conclusion was. Audit documentation should describe in detail what considerations were made by the engagement team in coming to their judgment (i.e. how any contradictory evidence was addressed; why the engagement team went with one model over another, etc.). If judgments are not well documented, the PCAOB has no alternative but to conclude that sufficient procedures were not performed. Comment Forms A few weeks after fieldwork is completed, the inspection team provides comment forms that include a summary of the deficiency and the facts related to the issue. Firms have 10 business days to respond. The Inspection Report Part I inspection findings are in the report’s public portion. Part I.A deficiencies indicate the firm had not supported its opinion on the financial statements, ICFR, or both. Part I.B findings are compliance issues which do not specifically compromise the audit opinion. Part II findings are related to the firm’s system of quality control and are in the report’s nonpublic section and these are not shared with the public. Firms have 12 months to remediate Part II findings before they can become public if the PCAOB concludes that the firm did not adequately remediate. Frequent Part I.A findings in an integrated audit relate to testing controls, testing estimates, and use of service auditor reports. Part I.B findings may result in enforcement cases and include incorrect opinion language, independence breaches, audit committee communication issues, and incomplete or late filing of Form AP. Responding to Findings in Part II of the Inspection Report Ultimately, the firm has 12 months to communicate to the PCAOB how it plans to remediate quality control findings. Geoff provides his insights on the importance of root cause analysis, “In our experience, firms do not do a great job of root cause analysis to identify the remedial action needed for deficiencies because they do not dig deep enough. We review comment forms and related workpapers to understand why the PCAOB issued the comment, and then we interview the engagement teams about root causes, to understand whether the issue was related to areas like staffing, partner workload, supervision and review, technical competence, audit methodology, or firm tools. In fact, firms will soon be compelled to do a rigorous root cause analysis as the proposed quality control standard (QC 1000) requires root cause analysis.” A proactive approach to remediation, specifically quality control findings allows for firms to make corrective actions based on their root cause evaluation and provide time to see the updates work their way through the firm’s audit cycle. Showing examples of the new process goes a long way. See our contribution to Journal Of Accountancy, Quality Management Standards: How to Perform a Root Cause Analysis . “We advise firms to address Part II remediation findings early. If they wait until they receive the report to start remediation, another inspection could start, and a repeat finding could result.” PCAOB guidance details five relevant criteria they use to conclude on the sufficiency of remedial actions. Every firm’s quality control processes are different, so we work with clients to apply the guidance to their own remedial actions and avoid repeat criticisms,” Geoff mentions. In conclusion, the PCAOB has made it clear both through its speeches and its enforcement actions that they will be tougher on enforcing regulation and audit quality. Firms need to plan in advance to make sure the inspection process is as issue-free as it can be. That starts with making sure audits are completed in accordance with the PCAOB auditing standards, not when you get notified of an inspection. Firms should enhance their practice monitoring by engaging firms like JGA to perform in-flight reviews while the audit is happening. In that way, quality is achieved prior to the signing of the audit opinion. Interested in learning more about the PCAOB inspections process and how to prepare? Navigating PCAOB Inspections, Second Edition is a roadmap for firm management and engagement teams through the entire PCAOB inspection and remediation process, to help prepare for inspections and implement continuous audit quality improvements. Geoff Dingle, JGA Managing Director, Shareholder With more than 20 years of experience in the accounting and auditing industry, Geoffrey Dingle works with public accounting firms to help them achieve the highest level of audit quality. Geoff brings a diverse set of experiences to JGA. As an Associate Director for almost 10 years, in the Division of Registrations and Inspections at the PCAOB, he conducted inspections of quality control and issuer audits. In addition, he played a senior role in planning, executing and reporting on the annual inspections of Global Network Firms, including, but not limited to, quality control procedures, review of comment forms, development of the inspection report criticisms and quality control themes, and evaluation and review of Firm root cause analysis and remedial actions. To learn more about Geoff and the JGA Team visit the Meet Our Team page.

JGA Team Perspectives: Navigating the PCAOB Enforcement Landscape

By Matthew Rogers, CFE, CFF, Managing Director • 29 Feb, 2024
Editor's note: This article is the first in a series to highlight the unique experience that JGA professionals possess and deliver to our clients. What is top of mind for the Public Company Accounting Oversight Board (PCAOB)? The PCAOB has made it clear that it intends to carry out an aggressive inspection program to identify and correct the high rate of audit quality deficiencies it continues to find and refer matters to its Division of Enforcement and Investigations (“DEI”). “ As a consultant, I work with audit firms to establish or enhance their policies and procedures so they deliver audit services at the highest quality level and hopefully avoid regulatory scrutiny from the PCAOB and SEC .” When an auditor or firm has become subject to a PCAOB or SEC investigation, JGA can assist in a number of ways including in their responses to informal document requests, Accounting Board Demands, and subpoenas for workpapers, emails, and other documents. Our consultants also perform workpaper review, provide case assessments and strategy guidance, assist with witness preparation, and help in preparing white papers, Statements of Position, and Wells responses. We also serve as expert witnesses by providing expert reports and expert testimony. Johnson Global professionals consult firms on timely remedial and corrective actions and other activities to obtain PCAOB extraordinary cooperation credit to substantially reduce or eliminate monetary penalties and sanctions. Once there is a PCAOB enforcement inquiry, before a case is brought, we review audit workpapers and documents and evaluate the firm’s quality control system to identify the potential violations, assess the significance of the violations, provide a root cause analysis, and propose remedial solutions. Existing or new clients include individuals and firms who have received a letter from DEI or the SEC’s Enforcement Division announcing an informal inquiry, or that a formal order of investigation has been initiated. “Our vast network, includes attorneys that I know from doing forensic accounting for so many years.” As needed, we assist firms in obtaining counsel with experience working with the PCAOB and SEC, if they do not have one. We work with counsel closely in these matters for counsel to provide legal advice and correspond with the regulator directly on behalf of the firm. Recent Trends PCAOB Reporting - Form AP and Form 3 Compliance We have seen an increase in the number of PCAOB enforcement actions related to PCAOB Form AP (Auditor Reporting of Certain Audit Participants) and PCAOB Form 3 (Special Events). The general requirement for Form AP is to file it within 35 days from the date the firm’s audit report is first included in a Form 10-K or 20-F filed with the SEC. For Form 3, the form must be filed within 30 days after the event. Firms are not filing these on time, commonly because they are not aware of the requirements or forget to file. Once the audit is over, attention can get diverted from Form AP. Form 3 is particularly burdensome because there are 18 specified events to report and monitoring these can be a challenge. Also, these forms may not be filled out correctly. For Form AP, it is easy for the PCAOB to determine whether a firm has timely filed it by comparing SEC filings to the Form AP filing, and the inspections group will routinely do that. It is harder for the Board to identify Form 3 compliance issues because their special events are unique to each firm, but we see instances of that occurring and enforcement matters as a result. When compliance failures occur, we have observed that the DEI will send a letter to the firm with a draft order that will propose a settlement, without even discussing the matter with the firm. We discuss the options with the client and client’s counsel, including the costs associated with litigation, so they can decide. Most clients do not challenge the Board and agree to the censure and fine, which can be $5,000 or more per violation, along with the requirement for a self-review and self-certification of the firm’s quality control policies and procedures relating to PCAOB reporting. The consequences of any compliance failure on these forms can be harsh, even though it was just a mistake. Form compliance is an area where we can help firms to make process changes and put policies and procedures in place to timely file and avoid a repeat failure. We recommend annual training on PCAOB reporting and the implementation of an annual certification process for Form 3 events. For Form AP, we help firms institute tracking and monitoring controls by the designated head of quality. For example, we designed a Form AP tracker that includes the relevant required information for all the firm’s PCAOB clients, along with the estimated filing dates and calendar reminders so there is a process to monitor engagement teams to proactively follow up. We also developed a Form 3 checklist that includes the trigger events and can be used at monthly meetings or by email requiring affirmative responses, so firms are able to proactively identify the events that require a filing. Communications with Audit Committees This is an area where the PCAOB is using sweeps, presumably from information gathered at the audit inspection level. Participation of other auditors in the audit must be communicated to the audit committee, but the PCAOB has noted failures to communicate which firms and individuals were involved and what they did. Another common problem area in audit committee communications is the lack of required preapproval of non-audit and audit related services. Firms may need training to understand the requirements, along with additional quality control policies and procedures. There should be audit program steps in the tools firms use that apply to audit committee communication in PCAOB audits, not those under AICPA or international standards, because the rules are not the same. The PCAOB continues to bring cases in this area, even if it is for one single violation of this PCAOB standard. There is an apparent zero tolerance policy at the PCAOB for violations of this nature. Engagement Quality Review EQR is a hot area now. Firms may not have done one at all, or the quality is not there - either on the front end for risk identification and planning, or at the back end when the audit is done. Our firm has developed and provides an EQR mentoring program , which is a collegial one on one approach to help firms get better, and it includes retraining as partners rotate on engagements. Documentation There are a number of inspection findings relating to AS 1215, Audit Documentation, including firms adding, backdating, or altering workpapers after the report release date. There is a process under the standard for adding documents that includes documenting who made the change, when, and why. We advise firms that have documentation issues to follow the standard because it is not advisable to make it look like a workpaper was always there when it was not. Quality Controls The PCAOB is very focused on this area. When the PCAOB finds a number of violations, firms should consider whether they have quality control issues, including whether there is a strong ‘tone at the top’ related to audit quality. Most PCAOB enforcement actions issued in 2023 either cited a QC failure or required the firm to enhance its QC system as part of the sanction. It can be challenging for firms, especially those with fewer than ten or so PCAOB clients, to determine how much financial and personnel resources to commit to the firm’s system of quality control. The notion of scalability seems to have gone by the wayside resulting in a high fixed cost for entering the PCAOB audit market and maintaining a presence in that space. Some firms are hesitant to invest in compliance measures because of the high costs, but better quality likely will lead to getting more clients and the potential for less trouble down the line. There is a new PCAOB auditing standard on quality control coming soon, and it includes a requirement that assigns individual responsibility and accountability for the QC system. There is awareness, but we are encouraging our clients to get ready for this now. We offer quality control review services and can serve as a quality control confidant, especially for small firms that do not have a QC leader. PCAOB Inspections of China and Hong Kong Firms Last year, the PCAOB published inspection reports of PCAOB-registered firms in China and Hong Kong and announced enforcement actions and a record high level of penalties as a result of violations of PCAOB rules and U.S. securities laws. These included auditors cheating on ethics and other internal examinations, and extensive quality control deficiencies. By 2023, the PCAOB will have inspected up to 99 percent of these firms’ audits. Inspection reports are expected to come out in April 2024 showing more of the same deficiencies. The 2024 PCAOB budget includes resources to continue inspections in this region. U.S. firms should look at these inspection results and enforcement cases to be aware of what the PCAOB found and is continuing to look for. Conclusion PCAOB Chair Williams and the current board continue to deliver a tough message about audit deficiencies and enforcement. The PCAOB is filing enforcement cases not only against firms that pose potential danger for not doing anything right but also for compliance failures, including those relating to PCAOB reporting. Auditors need to invest in audit quality and keep on top of changes in audit standards to avoid PCAOB scrutiny and potential sanctions. Matt has more than 30 years of experience in financial reporting, auditing, and fraud detection and prevention. He held enforcement roles at the SEC and PCAOB, along with leadership roles at national consulting firms where he provided clients with solutions in accounting, auditing, financial reporting, forensic accounting, and litigation support.

More Opportunities to Improve: The PCAOB’s Latest Report on Broker-Dealer Audit Quality

By Don Melody, JGA Director • 29 Feb, 2024
On January 31, 2024, the PCAOB Staff (the “Staff”) released its first ever Spotlight, Insights Into the PCAOB’s Interim Inspection Program Related to Audits of Broker-Dealers . I commend the Staff for this Spotlight. It provides new insights and more context than their typical annual reports on the broker-dealer inspection program results. To provide some brief background, the broker-dealer inspection Program was created as result of the Dodd-Frank Act, which was enacted into law in 2010. Inspections started in 2011, and the revised Securities Exchange Act Rule 17a-5 was effective in 2013. The most recent Annual Report published in August 2023 reported a 58% deficiency rate for broker-dealer firm inspections conducted in 2022, and stated that the rate was, “unacceptably high.” That compares to a 40% deficiency rate for issuer firm inspections in 2022, so the difference is considerable. See our September 2023 article that talks about the report - Broker Dealer Reruns: Haven’t I Seen This Before? (jgacpa.com) Auditors have, understandably so, argued that they need more guidance from the PCAOB to correct these deficiencies. It looks like the Staff has heard the pleas based on this Spotlight. Here are a few of the key observations by the staff in the report, and our recommendations for firms. PCAOB Finding: Insufficient Understanding of the Broker-Dealer Industry “In addition, broker-dealer specific training for auditors is not widely available. Typically, only larger audit firms offer in-house training and have acquired extensive broker-dealer audit experience that is shared with audit firm personnel. While there are a few vendors who offer quality training, course offerings are limited throughout the year.” The point is that the broker-dealer industry is specialized; you can’t simply be a good auditor and conduct a quality broker-dealer audit without obtaining the requisite understanding of the rules and regulations. For example, the auditor of a broker-dealer also provides an opinion on the supplemental information (e.g. Net Capital Computation, Reserve Formula Computation, etc.), and evaluates whether the supplemental information, including its form and content, is presented in conformity with 17 C.F.R. §240.17a-5 . That involves determining whether the broker-dealer's net capital computation is complete and accurate. Net capital includes assets that are “allowable” or “non-allowable” in the computation. And sometimes an otherwise allowable asset per Rule 15c3-1 may actually be non-allowable if, for example, there isn’t a particular clause in a clearing agreement. And sometimes an asset that is otherwise non-allowable per Rule 15c3-1 can be allowable if certain other conditions are met. The nuances exist in various SEC interpretations released over the last 50 or so years. These nuances are difficult enough for audit professionals with decades of broker-dealer audit experience. If engagement teams don’t gain that specialized knowledge, they won’t know what they don’t know, and will not be set up for success. We continue to see opportunities for engagement teams to have more BD-specific experience on the team. Training is one way to raise the bar, but that leads to the next problem – there simply isn’t a lot of high-quality broker-dealer audit training out there! While providing broker-dealer audit training to our clients, we have found that general training is often not sufficient to meet their needs and/or remediate PCAOB findings. For example, a general training on auditing a common broker-dealer that claims a (k)(2)(ii) exemption and introduces customer transactions to a clearing broker-dealer, will not help an engagement team audit a broker-dealer that specializes in mergers and acquisitions. As the Staff also emphasizes in the Spotlight, there is also an overreliance on standardized audit programs. We don’t look at these topics separately. We work with auditors to tailor their audit programs to the types of broker-dealers they audit and train their engagement staff to apply the programs to the facts and circumstances of their audits. PCAOB Finding: Overreliance on Standardized Audit Programs Inspectors found that standardized audit programs “may not be all encompassing, may reflect only certain criteria in the standards, and may be limited in the scope of procedures to be completed…these programs typically must be tailored to reflect the nature of the broker-dealer’s business operations, internal controls, and financial reporting and attestation risks.” In my time as a PCAOB Inspection Leader, I saw this time and time again. Audit firms subscribe to “off-the-shelf” audit methodology providers and rely on the audit programs they provide. Engagement teams follow the programs, fill them out completely, and still, they don’t conduct sufficient procedures. How can that be? Said differently, the audit programs are a good resource and a great foundation, but they are a guide and simply cannot account for every risk in the audits of your client portfolio. That holds true for any audit, but especially so for unique, complex broker-dealer industry audits. The audit programs are not a substitute for understanding the complexities of the broker-dealer industry (see above regarding the need for industry-specific training). In our work performing practice monitoring reviews for BD audits, we have seen cases where methodology doesn’t get down to the level necessary to force the understanding and documentation of a robust workflow to identify the risks at the assertion level necessary to sufficiently design test procedures. Based on our work with firms, the best path to success is to start with the standardized programs and then tailor them to the types of broker-dealers they audit. For example, if a firm audits broker-dealers that are involved in contractual revenue streams, such as the private placement of securities, we add in steps to address the key elements of revenue recognition within those transactions, such as obtaining evidence of the closing of the transaction, reviewing the contracts for possible claw backs, etc. These are specific considerations that are unlikely to be covered by a standardized audit program. PCAOB Finding: Low-Cost Providers and the Pace of Auditor Changes The staff reported that about a third of all broker-dealer audits have budgets of 40 hours or less and fees of $10,000 or less. These small audits, we believe are the root cause of many audit deficiencies. In the Spotlight, they said everything that is possible without saying it. Take into consideration these points mentioned above : the need for high-quality, broker-dealer industry specific training the need to go beyond the standard audit programs the need to conduct a rigorous risk assessment process that includes obtaining a sufficient understanding of the broker-dealer’s operations revenue transaction cycles related controls that will enable auditors to tailor their planned audit procedures more effectively Now do all of these points in 40 hours or less and collect $10,000. You can start to see why this doesn’t work. Conducting quality audits under that model is not sustainable, especially when the PCAOB levied a record amount of fines in 2023. Auditors would be wise to consider whether retaining a $10,000 audit client under these circumstances is worth the risk of being sanctioned and fined considerably higher dollar amounts. The Spotlight also highlights that about a third of broker-dealers audited by firms inspected during 2022 changed audit firms in the last three years. There are a variety of reasons for changing auditors, but in my experience, cost is the most common reason. Many of the low-cost providers that did not conduct audits in accordance with PCAOB Standards have been sanctioned and shut down by the PCAOB. But there are still some out there. My advice is to enhance your client acceptance and continuance process. The Staff touches on this in the Spotlight as well. Determine whether your firm has the expertise and tools to complete the audit in accordance with the standards. Specifically, when assessing the skills of the potential engagement team personnel, in my previous roles as SEC examiner and PCAOB inspector, I often saw that audits would be accepted and staffed with personnel with a range of broker-dealer industry experience. But not all broker-dealers are the same. Just because a firm has a team that has audited introducing broker-dealers doesn’t mean it should or could accept an engagement of a clearing broker-dealer, or even another exempt broker-dealer that engages in complex trading activities and hold difficult-to-value securities. It’s important to understand the detailed activities of the broker-dealer prior to accepting it as a client to ensure that your firm has the staff with the requisite expertise to complete the audit. In addition, use the acceptance process to set reasonable budgets and charge a fee that will allow you to conduct audits that meet PCAOB Standards. I even recommend sending the PCAOB Spotlight to your clients to start a conversation about the need to invest more time (and money) on audit quality improvements. I’ve been there and understand the challenge – many smaller broker-dealers don’t understand why it takes so many hours to do a quality audit, so show them. If the client refuses to pay the reasonable fee, let the client go to a low-cost provider that will be out of business in a couple years. That will keep you from becoming one of those firms that are out of business in the next couple of years. Other Findings and Next Steps There is a lot more in the Spotlight that can lead to higher quality broker-dealer audits, including applying professional skepticism, gaining experience with PCAOB Standards, having an effective EQR, and establishing a robust client acceptance and continuous process. I recommend spending time reviewing the Staff’s insights and consider how you can use them to increase your firm’s audit quality related to broker-dealer audits. Don has more than 23 years of regulatory examination, audit, and audit regulation experience, focusing on the broker-dealer industry. He previously served as an Inspections Leader in the Broker-Dealer Firm (BDF) Inspection Program at the PCAOB. His key activities as Inspection Leader included transforming the inspection approach, leading inspection teams, assessing auditor and examination procedures, and reviewing comment forms. He also served as Risk Assessment and Selections Leader for the BDF Program, where he was responsible for selecting audit firms/broker-dealer audits for inspection and served as a liaison between BDF Program and the SEC. During his 12-year tenure at the SEC, Don served as Examination Manager / Branch Chief, Broker-Dealer Examinations, in the Chicago Regional Office.

JGA Pleased To Sponsor 2024 ALI-CLE Accountants' Liability Conference

By Randall Thompson • 29 Feb, 2024
Johnson Global Advisory (“JGA”) is pleased to sponsor the American Law Institute Continuing Legal Education’s two-day event live in Washington, D.C. and virtually online on May 16th and 17th. Join us and gain insights and perspectives on wide range of hot-button issues. The 2024 conference promises to be better than ever. Hear the latest, engage with colleagues, and stay current in your field. This year’s program is still being finalized but planned topics include: Accounting litigation trends New and proposed accounting standards Artificial intelligence in the accounting profession Quality controls and other emerging regulatory issues ESG/climate accounting Strategic considerations in regulatory investigations Beyond the Big Four SEC perspectives PCAOB inspection program Register today at use the code " JOHNSON " to save $250. Click here to register. About Johnson Global Johnson Global partners with leadership of public accounting firms, driving change to achieve the highest level of audit quality. Led by former PCAOB and SEC staff, JGA professionals are passionate and practical in their support to firms in their audit quality journey. We accelerate the opportunities to improve quality through policies, practices, and controls throughout the firm. This innovative approach harnesses technology to transform audit quality. Our team is designed to maintain a close pulse on regulatory environments around the world and incorporates solutions which navigates those standards. JGA is committed to helping the profession in amplifying quality worldwide.

PCAOB Form AP: Do’s and Don’ts of Filing Timely and Accurately (Replay Available)

By Randall Thompson • 29 Feb, 2024
Replay this informative program hosted by JGA’s Managing Director and Litigation and Investigations Practice Leader, Matthew Rogers. With more than 25 PCAOB enforcement actions relating to failures to timely filing of a Form AP, the cost of non-compliance can be high. Hear insights that will enable practitioners to better understand the Form AP requirements through lessons learned from PCAOB enforcement actions. Also, explore topics that will help foster discussion about practical solutions for enhancing firm quality controls to minimize the risk of compliance failure. To watch the replay or for additional details about this program please visit this link . Learning Objectives: Understand Rule 3211 and the Form AP Filing Requirements Discover what can go wrong and what are the penalties from past PCAOB Enforcement actions related to Rule 3211 and Form AP Apply best practices to reasonably ensure compliance with Rule 3211 and Form AP After registering you will receive a confirmation email containing information about watching the webcast. About Johnson Global Johnson Global partners with leadership of public accounting firms, driving change to achieve the highest level of audit quality. Led by former PCAOB and SEC staff, JGA professionals are passionate and practical in their support to firms in their audit quality journey. We accelerate the opportunities to improve quality through policies, practices, and controls throughout the firm. This innovative approach harnesses technology to transform audit quality. Our team is designed to maintain a close pulse on regulatory environments around the world and incorporates solutions which navigates those standards. JGA is committed to helping the profession in amplifying quality worldwide.

Joe Lynch, JGA Managing Director to Speak at AICPA® & CIMA® ENGAGE 24

By Randall Thompson • 15 Feb, 2024
Johnson Global is pleased to announce that Joe Lynch, JGA Managing Director will speak at the AICPA® & CIMA® ENGAGE 24 Conference on June 3–6, 2024, at the ARIA Resort & Casino in Las Vegas, NV and live online. This CPE-eligible event is one of the largest annual gatherings of standards setters, regulators, and accounting professionals to discuss the year’s biggest accounting, auditing, and regulatory developments. Joe will speak during the following sessions: NAA2404. Quality Management for Sole Practitioners and Small Firms NAA24101. Quality Management: Path to Implementation Register today and use the code ENG24 to save $150 at checkout*. *This offer can only be combined with section and credential discounts. It cannot be combined with any other discounts or incentives, not valid on previous purchases. Not valid on group discounts. About Johnson Global Johnson Global partners with leadership of public accounting firms, driving change to achieve the highest level of audit quality. Led by former PCAOB and SEC staff, JGA professionals are passionate and practical in their support to firms in their audit quality journey. We accelerate the opportunities to improve quality through policies, practices, and controls throughout the firm. This innovative approach harnesses technology to transform audit quality. Our team is designed to maintain a close pulse on regulatory environments around the world and incorporates solutions which navigates those standards. JGA is committed to helping the profession in amplifying quality worldwide.

Johnson Global Accountancy Expands to Washington, D.C.

By Randall Thompson • 29 Jan, 2024
Washington, D.C. : Johnson Global Accountancy (“JGA”) is excited to announce our plans to open a new office in the District of Columbia region this year. The new location is slated to be in beautiful downtown D.C., two blocks northwest of the White House. This planned expansion comes at a time when JGA is growing rapidly. With pressure from increased audit regulation and market dynamics, public accounting firms are seeking advice on audit quality issues. “Our new location will provide us with a new home to further engage with stakeholders worldwide, who are committed to audit quality and investor protection,” says Santina Rocca, JGA Managing Director. “I am thrilled to continue planning of a gathering place for our growing DC-based team of directors and managing directors to work together to advise audit firms on actions to transform their practices to meet audit quality initiatives. We look forward to engaging with our clients and stakeholders in the nation’s Capital!” JGA has continued to serve clients and is passionate and practical in supporting firms through their audit quality journey. “Having a place to call home in D.C. allows JGA to further its mission to be the most innovative and technically excellent advisory firm at the intersection of companies, auditors, and regulators, that improves investor decision-making confidence. I look forward to welcoming our JGA staff, clients, colleagues, and other key stakeholders in the audit quality ecosystem to our new office,” says Jackson Johnson, JGA President. About Johnson Global Accountancy Johnson Global partners with leadership of public accounting firms, driving change to achieve the highest level of audit quality. Led by former PCAOB and SEC staff, JGA professionals are passionate and practical in their support to firms in their audit quality journey. We accelerate the opportunities to improve quality through policies, practices, and controls throughout the firm. This innovative approach harnesses technology to transform audit quality. Our team is designed to maintain a close pulse on regulatory environments around the world and incorporates solutions which navigate those standards. JGA is committed to helping the profession in amplifying quality worldwide.

The PCAOB and China: What’s Happened Since the HFCAA Became Law

By Matthew Rogers, JGA Managing Director • 29 Jan, 2024
Since the signing of the Holding Foreign Companies Accountable Act (“HFCAA” or “Act”) into law in December 2020, the Public Company Accounting Oversight Board (“PCAOB”), the accounting firms registered with the PCAOB that are headquartered in mainland China and Hong Kong (collectively, “China”), and their US-listed company clients have been very active. Over the past three years we have seen – US-listed companies based in China change auditors to accounting firms in PCAOB-accessible jurisdictions; A game-changing agreement between China authorities and the PCAOB enabling unobstructed access to inspect and investigate China-based auditors registered with the PCAOB; The completion and publication of the PCAOB’s first full inspections of two China-based accounting firms; and The first enforcement actions of China-based firms as a result of using its full investigative authority. We explore more about what has happened over the last three years, what China-based accounting firms may expect from the PCAOB in 2024, and the challenges they face. The HFCAA and the PCAOB’s Initial Determination it was unable to Inspect and Investigate China Auditors Fully The HFCAA was enacted to address the limitations on the PCAOB’s ability to inspect and investigate PCAOB-registered public accounting firms headquartered in China because of positions taken by authorities in the People’s Republic of China (“PRC”). According to the HFCAA, the PCAOB is required to determine whether it is “unable to inspect and investigate completely because of a position taken by an authority in the foreign jurisdiction” (e.g., China and Hong Kong). This determination is made by the PCAOB Board annually in accordance with the PCAOB’s rules 1 . If the PCAOB does not have complete access for inspections and investigations for two consecutive years, the SEC would be required to prohibit trading in the securities of issuers engaging those audit firms 2 . China-based US-Listed Companies Change Auditors In December 2021, the PCAOB issued a report on its determination (the “Initial Determination”) that it was unable to inspect or investigate PCAOB-registered public accounting firms headquartered in mainland China and Hong Kong because of positions taken by the PRC 3 . In March 2022, the SEC published a list of China-based US-listed companies that SEC staff identified were subject to possible trading prohibitions if the PRC did not permit the requisite access to the PCAOB, as required by the HFCAA. The SEC has continued to update the list on a rolling basis since March 2022, which now encompasses 174 companies (the SEC’s “Conclusive List”) 4 . The reaction by many China-based companies from the PCAOB’s Initial Determination and their appearance on the SEC’s Conclusive List was to change auditors in an apparent attempt to avoid the threat of having their stock delisted in the United States. After the Conclusive List was first published, 24 of those companies changed auditors, according to an article published by NikkeiAsia. 5 Accounting firms in the US and Singapore were the primary beneficiaries of the fallout, according to the article 6 . Accounting firms that were and may continue to be beneficiaries of the reshuffle should carefully consider whether they have the scalability and quality controls in place to take on multiple audit clients over a short duration. Although the PCAOB’s settled enforcement action with Marcum LLP 7 is an extreme example of what can go wrong when accepting too many clients at once, any firm that has taken on multiple China-based clients in short duration is at a heightened risk of a PCAOB inspection, investigation, and possible enforcement action. PCAOB Obtains Access to Inspect and Investigate Completely In August 2022, the PCAOB announced that it signed a Statement of Protocol with the China Securities Regulatory Commission and the Ministry of Finance of the People's Republic of China, marking the first step toward opening access for the PCAOB to inspect and investigate PCAOB registered public accounting firms headquartered in mainland China and Hong Kong completely 8 . This was a game changer for the PCAOB and investors in US-listed companies with China-based auditors. Inspection Results of the First Two Firms As a consequence of the Protocol, the PCAOB was successful in conducting its first two full inspections of China-based audit firms in 2022. In December 2022, the PCAOB vacated its Initial Determination because of the full access it experienced 9 and the SEC followed suit by acknowledging that there are no issuers currently at risk of having their securities subject to a trading prohibition 10 . In May 2023, the PCAOB published the inspection reports of the two firms it inspected in 2022: KPMG Huazhen LLP (“KPMG Huazhen”) in mainland China and PricewaterhouseCoopers in Hong Kong (“PwC HK”). As the PCAOB suspected, there was a high rate of deficiencies, including part I.A deficiencies, which the PCAOB defines as having such significance that the PCAOB believed the firm, (i) at the time it issued its audit report(s), had not obtained sufficient appropriate audit evidence to support its opinion(s) on the issuer’s financial statements and/or ICFR or (ii) in audit(s) in which it was not the principal auditor, had not obtained sufficient appropriate audit evidence to fulfill the objectives of its role in the audit. According to the inspection reports – KPMG Huazhen 11 was the principal auditor of 30 US-listed audit clients and participated in the audits of 77 other US-listed company audits. Of these, the PCAOB selected four audits for inspection, all of which were determined to have Part I.A deficiencies. PwC HK 12 was the principal auditor of three US-listed audit clients and participated in the audits of 27 other US-listed company audits. Of these, the PCAOB selected four audits for inspection, three of which were determined to have Part I.A deficiencies. Deficiencies were numerous and found in the financial statement areas of cash, revenue (and related accounts), inventory, other investments, goodwill and intangible assets, long-lived assets, and significant transactions, and involved departures from the following PCAOB rules and standards: Audit evidence (AS 1105) Audit documentation (AS 1215) Communications with audit committees (AS 1301) Auditing internal control over financial reporting (AS 2201) Responding to the risk of material misstatement (AS 2301) Substantive analytical procedures (AS 2305.16) Audit sampling (AS 2315) Consideration of fraud in a financial statement audit (AS 2401.61) Auditing accounting estimates (AS 2501) Auditor reporting on financial statements (AS 3101) Form AP - reporting of certain audit participants (Rule 3211) The PCAOB acknowledges that it is not unexpected to find numerous deficiencies in jurisdictions that are inspected for the first time and that the deficiencies identified by the PCAOB above are consistent with the types and number of findings the PCAOB has encountered in other first-time inspections around the world 13 . These deficiencies have not resulted in an enforcement action with these firms at this time. These two firms will almost assuredly be inspected again in 2024 or 2025. PCAOB Enforcement Activity The PCAOB was also very active in sanctioning China-based accounting firms since it obtained access to fully investigate China-based accounting firms in the PRC. In 2023, the PCAOB published three settled enforcement actions with PCAOB registered firms based in China. Two of the cases involving PwC were the direct result of information learned in the inspections the PCAOB conducted in 2022 after securing complete inspection access, according to the PCAOB’s press release announcing the settlements 14 . The following summarizes the PCAOB’s findings and corresponding money penalties imposed (refer to the related Orders for other sanctions), according to the PCAOB’s Orders published on its website – PwC China and PwC HK violated the integrity and personnel management elements of the PCAOB quality control standards by failing to detect or prevent extensive, improper answer sharing on tests for mandatory internal training courses 15 . These firms agreed to collectively pay $7 million in money penalties to settle their cases. Shandong Haoxin and four of its auditors falsified an audit report, failed to maintain independence from their issuer client, and improperly adopted the work of another accounting firm as their own. Interestingly, the US-listed company that was the audit client disclosed in the Order (Gridsum Holding Inc.) is not listed on the SEC’s Conclusive List. The firm agreed to pay $750,000 and the four auditors collectively agreed to pay $190,000 to settle the matter 16 . What to Expect in 2024 In a May 2023 news release by PCAOB Chair Erica Williams, she stated, “[t]he two firms we inspected in 2022 audited 40% of the total market share of U.S.-listed companies audited by Hong Kong and mainland China firms, and we are on track to hit 99% of the total market share by the end of this year.” 17 In addition, The 2024 PCAOB Budget includes the resources necessary to continue to drive inspection activities in support of the PCAOB’s mission to protect investors, “including inspecting the remaining firms registered in mainland China and Hong Kong under our mandate.” 18 These statements suggest the PCAOB continues to have unobstructed access to inspect and investigate PCAOB registered firms in China and Hong Kong. Accordingly, it is expected that – The PCAOB will release the inspection reports of the accounting firms that comprise the remaining 56% of the 99% of the total market share of U.S.-listed companies audited by China accounting firms in or about May 2023, and we anticipate those reports to continue to reveal that firms based in China have a lot of work to do to improve audit quality. Any remaining China-based accounting firms that have not been inspected—those making up the remaining 1% of the total market share—and follow-up inspections on those initially inspected are likely to occur this year, in 2024; and The PCAOB’s Division of Enforcement and Investigations will likely have continued to receive referrals from the Inspection Division as a result of the 2023 inspections of China-based accounting firms, and there will be multiple enforcement actions in 2024 or later as a consequence. What Firms in HK and China Should Do Now Prepare for initial inspection: An inspection is an examination of both the firm’s quality control policies and selected applicable client engagements. In essence, the inspection begins before the firm has even started an audit. An effective system of quality control provides the firm with reasonable assurance that its personnel comply with applicable professional standards and the firm’s standards of quality. In addition to reviewing the firm’s quality control documentation, the inspectors will review the audit work papers of the selected audits. Therefore, it is imperative that audit documentation be robust, easy to follow, provide a clear road map from planning and risk assessment to the conclusions reached, and is fully assembled in compliance with PCAOB standards. The achievement of these two objectives will go a long way toward making the firm’s initial inspection a smooth one. Post-inspection: The next step for firms after their initial inspection is to perform a root-cause analysis and remediate. A sound remediation plan that includes (i) focused training (ii) enhancements to policies, procedures, and methodologies; (iii) the adoption of PCAOB-specific audit tools and templates; and (iv) the implementation of pre-issuance reviews on riskier audits and post-issuance reviews of completed audits are just a few of the things firms can do to prevent poor inspection results and avert a referral to enforcement. Conclusion In sum, every audit should be conducted with the highest level of quality and with the notion that your audit will be selected for a PCAOB inspection. The published inspection reports and enforcement actions of the China-based accounting firms should serve as a guide. Read them carefully and revisit the standards cited therein to understand precisely why the firms were criticized and how the standards should be applied. Make audit quality your top priority. PCAOB Rule 6100. This was originally three years in the HFCAA, it was reduced to two years with the singing of the Consolidated Appropriations Act, 2023. PCAOB Makes HFCAA Determinations Regarding Mainland China and Hong Kong. The list is located on the SEC’s website at SEC.gov Holding Foreign Companies Accountable Act. Chinese companies switch auditors to avoid U.S. delisting risk - Nikkei Asia , May 16, 2023. Id. See PCAOB press release: Imposing $3 Million Fine and Requiring First-Ever Changes to Supervisory Structure, PCAOB Sanctions Marcum LLP for Significant Quality Control Violations | PCAOB (pcaobus.org) PCAOB Signs Agreement with Chinese Authorities, Taking First Step Toward Complete Access for PCAOB to Select, Inspect and Investigate in China | PCAOB (pcaobus.org) . FACT SHEET: PCAOB Secures Complete Access to Inspect, Investigate Chinese Firms for First Time in History | PCAOB (pcaobus.org) SEC.gov | Holding Foreign Companies Accountable Act 2022 - KPMG China - Inspection Report 2022 - PwC Hong Kong - Inspection Report PCAOB Secures Complete Access to Inspect, Investigate Chinese Firms for First Time in History | PCAOB (pcaobus.org) FACT SHEET: PCAOB Imposes Historic Sanctions on China-Based Audit Firms In the Matter of PricewaterhouseCoopers and In the Matter of PricewaterhouseCoopers Zhong Tian LLP In the Matter of Shandong Haoxin Certified Public Accountants Co., Ltd., et al PCAOB Releases 2022 Inspection Reports for Mainland China, Hong Kong Audit Firms | PCAOB (pcaobus.org) Chair Williams’ Statement Before the SEC Open Commission Meeting on the PCAOB’s Proposed 2024 Budget | PCAOB (pcaobus.org)
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