Attestation Update – A&A for CPAs

Technical stuff for CPAs providing attestation services

Why does PCAOB definition of ‘audit failure’ overstate audit failures? Perhaps because saying ‘audits that should have done better which we found after intentionally looking for audits that might have deficiencies’ doesn’t sound as severe.

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The PCAOB’s self-created definition of audit failures overstates the severity of issues found during inspection, according to a board member of the PCAOB.

Journal of Accountancy reports on 3/21 a PCAOB member suggesting Stop using “audit failure” term in PCAOB reports, Hanson says.

Mr. Jay Hanson says the definition used by the PCAOB is causing confusion about the severity of issues identified during inspections. Here’s the range of definitions of that phrase:

Casual description of PCAOB usage, according to the article:

…cases in which the auditing firm failed to obtain sufficient appropriate evidence to support its audit opinion

In a paper at the PCAOB website, board member Jeannett Franzel explains the board has made up their own definition of the term:

PCAOB uses its own definition of audit failure in inspection reports. It is a deficiency of such significance that the firm, at the time it issued its audit report, failed to obtain sufficient appropriate evidence to support its audit opinion on the financial statements and/or on the effectiveness of internal control. Under the definition, deficiencies include instances where a firm did not identify or address appropriately financial statement misstatements or improper disclosures, as well as failures by the firm to follow auditing standards.

The definition used by accountants for the last many decades is summarized by Mr. Hanson as follows:

In other contexts, “audit failure” is understood to mean that the company’s financial statements are misstated, and that the auditor did not identify relevant problems during the audit, Hanson said.

That is the definition that comes to mind for most people when they hear the phrase ‘audit failure.’ Essentially, the auditors missed a really big misstatement in the financials.

He goes on to cite the definition used by the GAO, which has..

defined the term “audit failure,” in part, as “audits for which audited financial statements filed with the SEC contained material misstatements whether due to errors or fraud.”

Mr. Hanson also criticized media reports that divide the number of deficient audits by the number of inspections to calculate an audit failure rate.

Using a self-defined term when most people would use a different term overstates the severity of issues. Are there problems? Yes. Are one-third of all financial statements you see an audit failure? No. For multiple reasons.

He also reminds us that the PCAOB uses a risk methodology for selecting engagements for inspection. That means they pick reports that they perceive might have a problem.

Perhaps a better term than

  • audit failure

would something like

  • audits that with hindsight we think should have done better when we intentionally selected audits that might have deficiencies.

Previously discussed this idea in my post More good stuff for auditors – 3-12-14

Written by Jim Ulvog

March 24, 2014, 10:52 am at 10:52 am

Posted in Audits

Tagged with ,

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