Essay: Advantages/disadvantages of one of PCAOB’s primary functions, inspection

EXECUTIVE SUMMARY
Following the financial scandals of massive corporate names like Enron and WorldCom that exposed fraud initiated within the organizations by its executives, the Sarbanes-Oxley Act of 2002 was passed in response to the aftermath. The alteration of financial statements to mislead the stockholders under the leadership of company executives, revealed that the laws and regulations at that time were not sufficient. The act included clauses aimed at regaining public trust, credibility on financial records, augmented sanctions to responsible individuals and confidence from shareholders, to name a few.
Financial audit is a requirement to publicly listed companies and the output is a financial report released to the public for reference and information. The public and stockholders use the financial statement to gauge an organization’s financial health for investment. The reports are produced by the companies themselves and signed off by external auditors. These auditors may be small firms or big ones like PricewaterhouseCoopers and Ernst & Young. Companies hire auditing firms to conduct the audits to validate if the financial statement is accurate. The auditors use accounting standards and their technical expertise to confirm the financial reports.
Prior to the implementation of Sarbanes-Oxley Act of 2002, auditing firms were never evaluated if their financial audits were compliant to certain non-accounting standards. This absence of a governing body has been determined to be one of the reasons why executives were able to distort financial data because there were no post-audit reviews. Hence, the Sarbanes-Oxley Act of 2002 created such organization to act as an overseer of the auditing firms called the Public Company Accounting Oversight Board or PCAOB.
This paper examines the advantages and disadvantages of one of PCAOB’s primary functions which is inspection, the methods used in inspection, the recent changes in its leadership and the impact of the re-organization.
PCAOB INSPECTIONS
The Sarbanes-Oxley Act of 2002 created the Public Company Accounting Oversight Board with the goal to provide governance to firms that audit publicly listed companies, particularly compliance. PCAOB’s establishment produced the following outcomes: creation of auditing standards, inspection of auditing firms and assurance of firms’ independence (Abernathy, Barnes and Stefaniak, 2013, p. 1). Since its inception, PCAOB has conducted thousands of inspections among its registered auditing firms.
Among PCAOB’s functions, inspection of PCAOB registered firms is one of its major tasks. Most inspections happen at the firm but some smaller inspections are held at PCAOB premises by reviewing the documents submitted by firms and interviews over the phone (Guide to PCAOB Inspections, 2012, p.3). PCAOB selects firms for inspection by taking into account risk-based factors such as company nature, audit issues, contributions in emerging markets among others. PCAOB also considers the scope of a firm’s engagement to its publicly listed clients and the classifications of it. The selection process may also get PCAOB to review results of past inspections, consult the firm’s “internal risk management and inspection processes” (Guide to PCAOB Inspections, 2012, p. 3). For firms that enlist third party services in their audits, PCAOB may go over the “assignments and inspection history of the partners” (Guide to PCAOB Inspections, 2012 p. 3). Firms that conduct relatively small number of audits, PCAOB may review all the audits but otherwise typically targets “companies with large market capitalizations” (Guide to PCAOB Inspections, 2012, p. 3). Inspection is done extensively by PCAOB as it is one of its core functions.
The inspections done by PCAOB have yielded some disadvantages as reported by studies. The board cannot inspect all audits because there are simply too many. In response to this, they have set a limited but significant number of factors to consider in the selection process. For instance, one of the checks they do in qualifying for inspection is the scope of a firm’s influence in emerging markets (Guide to PCAOB Inspections, 2012, p. 3). Another factor is the identification of audit issues that could be detected by the firm (Guide to PCAOB Inspections, 2012, p. 3). Because the board is selective of its inspections, the results may not cover a comprehensive ground, therefore may not provide significant data with regards to its effectiveness (Abernathy, Barnes and Stefaniak, 2013, p. 21). Other researchers have expressed the unreliability of the effectiveness of inspections because of some factors.
Despite some concerns about the inspections, PCAOB ultimately meets its goals in terms of oversight. Through its function of audit review, it has the authority go over the documents submitted by firms to determine if they have been compliant to PCAOB standards and start a process of remediation if firms are found to be non-compliant (Guide to PCAOB Inspections, 2012 p. 4). PCAOB standards require that firms must maintain independence from their clients and through inspection this can be answered (Pcaobus.org, 2018). Independence of auditing firms is one that the Sarbanes-Oxley Act of 2002 is trying to mandate to address the issues of the past financial scandals. The inspection also attempts to answer how the firm handled alterations in the financial statement (Guide to PCAOB Inspections, 2012, p. 4). Without PCAOB’s inspections, the auditing firm might not have the prerogative to refute the altered report especially if it adheres to accounting standards and if contradicting it may jeopardize the client’s business. The inspections check auditing firms’ level of compliance to standards set by PCAOB and these standards are designed to bring back the public’s trust in financial statements and solidify its credibility. Therefore, since PCAOB has the authority to perform functions such as inspections which can either lead to certification of compliance or further investigations, the advantages are intact.
PCAOB is a relatively younger entity compared to the corporate environment which has been existent since the idea of public listing came forth. It is expected that it will continue to evolve its processes and operations as it copes with the corporate climate. Despite having inadequacies, its functions allow it to provide an extra layer of protection to the truth from corporate misconducts.
BOARD CHANGES
PCAOB is led by a chairman and board members appointed by the SEC. This year there was a complete change in leadership which meant the previous appointees were all relieved of their duties by four new board members and chairman (Sec.gov, 2018). According to presiding Chairman William Duhnke, in his speech at 2018 Deloitte / University of Kansas Auditing Symposium, the new leadership will take the strategies further to support PCAOB’s efforts to maintain its goals and adapt to the future (Pcaobus.org, 2018). This meant that PCAOB will have an entirely new set of strategies to implement in the coming years. Like any new endeavor, there will be an adjustment period which could lead to failures. While the new strategies are designed to produce positive outcomes, the learning curve might produce some undesirable and possibly costly ones.
The new board will seek input outside of the organization through public surveys and one-on-one interviews with external parties (Pcaobus.org, 2018). These two new approaches to gather information will produce substantial, if not massive data, especially the public surveys. The interviews with external experts might collect more quality input because the board can filter who to engage with. The public surveys however, might not be as straightforward because of the sheer quantity and sources may not always be reliable.