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  • Jennifer M Mueller-Phillips
    A Decade after Sarbanes-Oxley: The Need for Ongoing...
    research summary posted July 21, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB 
    Title:
    A Decade after Sarbanes-Oxley: The Need for Ongoing Vigilance, Monitoring, and Research.
    Practical Implications:

    This paper provides views on many areas within the auditing profession that would benefit from further research and analysis, as well as opportunities for research that could be useful to the PCAOB as it considers current and future regulatory priorities.

    Citation:

    Franzel, J. M. 2014. A Decade after Sarbanes-Oxley: The Need for Ongoing Vigilance, Monitoring, and Research. Accounting Horizons 28 (4): 917-930. 

    Keywords:
    auditing quality, audit research, PCAOB, Public Company Accounting Oversight Board, Sarbanes-Oxley Act
    Purpose of the Study:

    After more than a decade since passage of the Sarbanes-Oxley Act and the creation of the Public Company Accounting Oversight Board (PCAOB), it is appropriate and necessary to ask questions about the present state of audit quality and evaluate the impact and effectiveness of PCAOB’s oversight programs. Written from the viewpoint of a current PCAOB Board member and former Managing Director of the U.S. Government Accountability Office (GAO), this paper discusses the warning signs of serious auditing problems in the years preceding the Act, and the role that the GAO played in analyzing those risks and calling for greater oversight of the accounting profession’s auditing public companies.

    Design/Method/ Approach:

    This paper provides the perspective of the author, a current PCAOB Board member, on the major issues debated during the development and passage of the Sarbanes-Oxley Act, specifically related to the oversight of the auditing profession and the creation of the PCAOB.

    Findings:

    The interrelated nature of corporate governance, accounting and financial reporting, the auditing of financial statements, and oversight of the accounting profession call on all stakeholders to work vigilantly to ensure the integrity of each aspect of this system. All participants need to be alert to warning signs and red flags and respond appropriately to maintain integrity and the public trust. Failure in any of these areas places a strain on the entire system and could threaten the capital markets and greater economic well-being. The successful functioning of this system also relies on academic researchers. The academic community plays a key role in this system of vigilance by conducting research and analysis, monitoring the strengths and weaknesses of the system at any given time, evaluating performance, across the financial system, studying the impact of specific actions, and generating recommendations for change. In addition, success of the entire system relies on educators preparing future members of the profession to successfully assume and carry out their responsibilities in maintaining integrity and public trust, while protecting investors and the public interest.

    Category:
    Standard Setting
    Sub-category:
    Impact of PCAOB
  • Jennifer M Mueller-Phillips
    A Former PCAOB Board Member Looks to the Past...and to the...
    research summary posted July 21, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB 
    Title:
    A Former PCAOB Board Member Looks to the Past...and to the Future.
    Practical Implications:

    Bill Gradison believes that an appropriate and effective way to protect the investor would be to share its wealth of data with protections of confidentiality with outside group, especially of those in academia, to foster research that might shed light on the importance of investor protection and how best to protect investors in the future.

    Citation:

    Gradison, B. 2014. A Former PCAOB Board Member Looks to the Past...and to the Future. Accounting Horizons 28 (4): 931-935.

    Keywords:
    auditing standards, Public Company Accounting Oversight Board
    Purpose of the Study:

    The Public Company Accounting Oversight Board (PCAOB) is still a relatively new entity, compared with most government agencies. The author of this paper, Bill Gradison, was a Founding Member of the PCAOB with many insights on the workings and challenges of the Board. The world has changed since 2002 when Sarbanes-Oxley became law with almost unanimous Congressional support. It would be most unlikely to be passed into law today. Thus, the Board not only has the challenge and the responsibility to carry out its Congressional mandate but also to champion the cause of investor.

    Design/Method/ Approach:

    Bill Gradison, a Founding Member of the Board, shares his perspectives on the work of the PCAOB during its early years.

    Findings:

    The five major challenges facing the Board as of January 2011.

    1. Current inability to conduct inspections in the EU, Switzerland, and China;
    2. Major changes in accounting standards;
    3. New authority to inspect and if necessary discipline auditors of broker-dealers;
    4. Ongoing recruiting challenges; and
    5. Fee pressures being experienced by public company auditors.
    Category:
    Standard Setting
    Sub-category:
    Impact of PCAOB
  • Jennifer M Mueller-Phillips
    A Perspective on the PCAOB - Past and Future.
    research summary posted July 21, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 01.06 Impact of PCAOB 
    Title:
    A Perspective on the PCAOB - Past and Future.
    Practical Implications:

    The quality of the firm performing the audit is important but must be viewed through the perspective of a specific engagement team and a specific set of circumstances. Information supplied by the PCAOB is one component of the evaluation of the likelihood that an engagement team will perform a quality audit and of specific areas of audit practice where deficiencies have been identified. In the end, however, issues of independence, auditor rotation, industry competence, attention to the work, and all the other important aspects of audit quality must be monitored by the audit committee at the engagement level in the context of the specific engagement.

    Citation:

    Wedemeyer, P. D. 2014. A Perspective on the PCAOBPast and Future. Accounting Horizons 28 (4): 937-947.

    Keywords:
    internal auditing, auditing standards, PCAOB, Sarbanes-Oxley
    Purpose of the Study:

    The passage of Sarbanes-Oxley (SOX), the creation of the Public Company Accounting Oversight (PCAOB), and subsequent developments have substantially increased the political visibility of auditors and audits of financial statements. These same events have substantially decreased the role of the auditing profession in establishing audit standards and standards of audit performance; auditing is now an industry regulated primarily by persons who are not professional auditors. The perceived interest of each of the parties involved in the political process is often in conflict with those of any, or all, of the other parties.

    The author’s primary concern is the quality of the audit performed on a specific engagement.

    Design/Method/ Approach:

    This paper summarizes and synthesizes information on the PCAOB and its effect on the business model of an audit firm.

    Findings:

    SOX requirements for PCAOB inspections of audit firms substantially increased the possibility that an audit will be subsequently evaluated despite the absence of identified errors in audited financial statements. The SOX requirement for an auditor's opinion on internal controls over financial reporting (ICFR) immediately increased audit costs. The net effect of these changes has been to increase the cost of audits, particularly as a result of increased review, other quality control activities, and the performance of audits of ICFR, where required. In return, the quality of audits in terms of compliance with audit standards has improved significantly. However, the business models of audit firms and the processes for education and certification of accountants have remained substantially unchanged and are major influences on the quality of audits.

    Category:
    Standard Setting
    Sub-category:
    Impact of PCAOB, Impact of SOX
  • Jennifer M Mueller-Phillips
    Are PCAOB-Identified Audit Deficiencies Associated with a...
    research summary posted November 10, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 09.0 Auditor Judgment, 09.04 Going Concern Decisions 
    Title:
    Are PCAOB-Identified Audit Deficiencies Associated with a Change in Reporting Decisions of Triennially Inspected Audit Firms?
    Practical Implications:

    Our findings seem to support statements made by the PCAOB regarding the usefulness of the inspection process in changing audit firm behavior.

    The change in GC reporting decisions that we find suggests either (1) an increased conservatism following a PCAOB inspection, of the audit firm on important reporting issues, and/or (2) an increased level of competence brought to the reporting decision.

    It is important to note that we find no change in the accuracy of the GC opinions, as measured by the future bankruptcy (or not) for clients that received a GC opinion.

    For more information on this study, please contact Jayanthi Krishnan.

    Citation:

    Gramling, A.A., J. Krishnan and Y. Zhang. 2011. Are PCAOB-Identified Audit Deficiencies Associated with a Change in Reporting Decisions of Triennially Inspected Audit Firms? Auditing: A Journal of Practice and Theory 30 (3): 59-79.

    Keywords:
    PCAOB inspection reports; going-concern; audit deficiencies.
    Purpose of the Study:

    At a broad level, we are obtaining evidence on whether the PCAOB inspection process is associated with changes in auditor behavior. More specifically, we examine whether PCAOB-identified audit deficiencies are associated with a change in triennially inspected audit firms’ going concern (GC) reporting decisions for their financially distressed clients. 

    Design/Method/ Approach:

    We obtained PCAOB inspection reports, dated between 01/01/2005 and 12/31/2007, from the PCAOB website. These reports covered PCAOB inspections of audits completed by the audit firms during 2004-2007. For the audit firms included in the sample, we read the inspection reports to identify those that indicated audit deficiencies. Data on GC opinions were obtained from Audit Analytics. The final sample on which we base our results consists of 202 audit firms and 1,648 client-year observations. The sample clients are distributed across a wide spectrum of industries, with over 50 two-digit SIC industries represented.

    Findings:
    • Firms with PCAOB-identified audit deficiencies were more likely to issue GC opinions for financially distressed clients subsequent to their PCAOB inspection than prior to their inspections.
    • While there was a change in behavior, the change does not suggest an improvement in reducing Type I errors (i.e., issuing a GC opinion to clients that subsequently remain viable) or Type II errors (i.e., failure to issue a GC opinion to a client that subsequently declares bankruptcy). Additional analysis indicates no systematic change in Type I and Type II errors following the issuance of a PCAOB report.
    • We find limited evidence of a change in the likelihood of issuing a GC opinion for audit firms that had no PCAOB-identified audit deficiencies. This finding suggests that the inspection reports without identified audit deficiencies have some, but limited, impact on changing audit firm behavior.
    Category:
    Auditor Judgment, Standard Setting
    Sub-category:
    Going Concern Decisions, Going Concern Decisions, Impact of PCAOB
  • The Auditing Section
    Auditor Standard Setting and Inspection for U.S. Public...
    research summary posted April 13, 2012 by The Auditing Section, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 01.06 Impact of PCAOB 
    Title:
    Auditor Standard Setting and Inspection for U.S. Public Companies:
    Practical Implications:

    The authors hope to generate discussion and reform of accounting and auditing regulation, specifically with respect to the PCAOB, based upon the observations and points below. 

    • The authors believe that the audit “profession lost sight of its core values such as independence, high-quality audits, and responsibility to the public trust.  …in many ways, SOX led to a justified back-to-basics focus within the largest international accounting firms.”
    • Under the Auditing Standards Board (ASB), the United States was the global leader in auditing standard-setting.  There are currently three sets of auditing standards that may govern an audit:  the ASB, the PCAOB and the International Auditing and Assurance Standards Board (IAASB). 
    • Auditors of publicly held companies will continue to audit against audit standards sponsored by several different standard setters in efforts to conduct high quality audits. Audit quality will continue to be a high priority of regulators and the firm’s quality control functions.  Coordinating the various standard setters’ requirements into a single quality control system for firms will be a challenge.
    • In an effort to increase independence of standard-setting from the audit profession, the PCAOB has adopted a non-expert model.  The resulting standards may be costly and of poor quality.
      • PCAOB inspections are not able to conduct risk-based inspections.
      • Inspection reports do not adequately distinguish between trivial and significant findings for the public to understand whether the audit itself is of adequate quality.
      • Inspection reports are issued so late as to be of little value in the subsequent audit.
    • The PCAOB should reconsider its standard-setting and inspection processes.
      • Standard-setting should be better aligned with the process of financial accounting standards.  Specifically, the standards should be set by the profession with oversight by the PCAOB.  The analogy is that FASB sets the accounting standards with oversight by the SEC.  Alternatively, the PCAOB should adopt the IAASB/ASB standards.  Either approach utilizes the expertise not currently resident in the PCAOB and reduces the complexity and number of standards a firm must follow in conducting a quality audit.
      • Although the AICPA peer inspection process has weaknesses, it leverages industry and technical expertise that is currently lacking in the PCAOB process.   The authors recommend a “peer enhanced” federal inspection.  With direction and scope provided by the PCAOB, and inspections by industry expert peers, the inspections would improve at a reduced PCAOB cost.
      • Transparency should be a priority of the PCAOB in standard-setting as well as reporting of inspection findings.  In addition, a resolution process should be implemented so disputes between the inspection team and the firm can be resolved.
    Citation:

    Glover, S.M., D. F. Prawitt, and M. H. Taylor. 2009. Auditor standard setting and inspection for U.S. public companies:  A critical assessment and recommendations for fundamental change.  Accounting Horizons 23 (2): 221-237.

    Keywords:
    auditing standards, PCAOB
    Purpose of the Study:

    The purpose of this study is to provide commentary on the PCAOB’s ability to achieve its mission given its standard-setting and inspection models, incentives, organizational composition, and structure. The authors also provide recommendations to policy makers, regulators and leaders in the accounting and audit profession in developing improved approaches to audit standard-setting, inspection and enforcement.

    Design/Method/ Approach:

    This paper is structured as a commentary organized under the following sections: auditing standards, inspection and enforcement, and recommendations to improve standard-setting and inspection.

    Findings:

    As this paper is a commentary, there are no findings.  The summary of discussion points is included below.

    Category:
    Standard Setting
    Sub-category:
    Impact of SOX, Impact of PCAOB
    Home:
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  • Jennifer M Mueller-Phillips
    Balancing the Costs and Benefits of Auditing and Financial...
    research summary posted April 1, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 01.07 Impact of SEC Actions, 15.0 International Matters 
    Title:
    Balancing the Costs and Benefits of Auditing and Financial Reporting Regulation Post-SOX, Part II: Perspectives from the Nexus at the SEC
    Practical Implications:

    The study provides helpful insight on auditing and financial reporting public policy issues and initiatives. The report focuses on the roles of the SEC and PCAOB in the setting of standards, convergence of standards, and the formation of a new public oversight regulating body. The author provides her personal perspective on the complications and thought processes behind many of the tasks taken on by the SEC from 2006 - 2008.

    For more information on this study, please contact Zoe-Vonna Palmrose (zv.palmrose@marshall.usc.edu).

    Citation:

    Palmrose, Z.-V. 2010. 2010. Balancing the Costs and Benefits of Auditing and Financial Reporting Regulation Post-SOX, Part II: Perspectives from the Nexus at the SEC. Accounting Horizons 24 (3):487-507.

    Purpose of the Study:

    Zoe-Vonna Palmrose served as the Deputy Chief Accountant for Professional Practice in the Office of the Chief Accountant. From August 2006 to July 2008, Palmrose observed the effects of SEC activities in the areas of auditing and financial reporting public policy during her tenure. Palmrose discusses her observations about the following areas:

    • Oversight of the PCAOB by the SEC
    • SEC Federal Advisory Committee on Improvements to Financial Reporting (CIFiR)
    • International Financial Reporting Standards (IFRS)
    • U.S. Department of the Treasury Advisory Committee on the Auditing Profession
    • Auditor Independence
    • Assessing Audit Regulation Under Sarbanes-Oxley 
    Design/Method/ Approach:

    The author relies on personal experiences from her tenure as Deputy Chief Accountant to provide insight about the topics mentioned above.

    Findings:
    • The Committee on Improvements to Financial Reporting took on an initiative to increase the usefulness of SEC reports. The improvements focused on enhancing the standards-setting process as well as the helpfulness of the standards. The committee also focused on clarifying guidance for restatements and accounting judgments. The author finds that no formal action has been taken on the committee’s recommendations.
    • During the author’s tenure, the leadership of the SEC moved from an advocating role towards IFRS and U.S. GAAP convergence to allowing U.S. companies adopt IFRS. The author noted that the possible costs associated with U.S. companies adopting IFRS standards would be high relative to the costs associated with adopting Sarbanes-Oxley.
    • The U.S. Department of the Treasury Advisory Committee on the Auditing Profession issued a report in 2008 with recommendations for audit firm governance and transparency. The report urged firms to appoint independent members with full voting power to audit firm boards and advisory boards. It also urged the PCAOB to require certain public annual reporting by large audit firms by 2010. The report recommended that the PCAOB develop key indicators of audit quality and effectiveness and require the disclosure of those indicators by audit firms. The report recommended that large audit firms file audited U.S. GAAP financial statements with the PCAOB beginning in 2011. The report also recommended that the PCAOB should monitor catastrophic risk associated with audit quality.
    • The author observes that the co-chairs of the Advisory Committee were concerned primarily with the revenues of audit firms based on type of service. The concern was focused on non-audit services revenue. The author finds that the views of the co-chairs will likely become a part of public policy discussions.
    • The author observes that the convergence of auditor independence standards is becoming very difficult. The author suggests that a compilation comparing independence rules of the SEC and PCAOB would be helpful to initiate the change and convergence of the rules. The author finds that one factor preventing convergence is that international standards use a threats and safeguards approach which is adamantly opposed by investor advocates in the U.S.
    • The author observes that the PCAOB standard setting process does not allow enough meaningful public input. The author finds that the PCAOB has failed to distinguish public company audits enough to warrant the need for auditing standards other than the IASB standards. The author notes that SEC oversight does not mean that is runs the PCAOB. The two bodies have different agendas which can create issues.
    • The author proposes that a new regulatory organization for audits of public entities be formed. The regulatory organization would be subject to SEC oversight. The regulatory organization would be funded by an audit fee surcharge.
    Category:
    International Matters, Standard Setting
    Sub-category:
    Impact of PCAOB, Impact of SEC Actions
  • Jennifer M Mueller-Phillips
    Client Stock Market Reaction to PCAOB Sanctions Against a...
    research summary posted July 30, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 11.0 Audit Quality and Quality Control 
    Title:
    Client Stock Market Reaction to PCAOB Sanctions Against a Big 4 Auditor.
    Practical Implications:

    The authors provide evidence on the PCAOB actions by showing that the PCAOB’s sanctions against Deloitte contain information useful to market participants. When public disclosure of a quality control problem is made by the PCAOB, investors react by discounting their valuation of that audit firm’s clients. Clients value disclosures about control weaknesses found at audit firms.

    Citation:

    Dee, C. C., Lulseged, A., & Zhang, T. 2011. Client Stock Market Reaction to PCAOB Sanctions Against a Big 4 Auditor. Contemporary Accounting Research 28 (1): 263-291.

    Keywords:
    quality standards, auditing standards, sanctions, quality of service, quality assurance
    Purpose of the Study:

    Audits are valued by investors, because they assure the reliability of and reduce the uncertainty associated with financial statements. Any such value derived from the audit is related to its perceived quality, and damage to an audit firm’s reputation can reduce the credibility of financial statements audited by the firm. The authors examine the stock market effects of news of the Public Company Accounting Oversight Board’s (PCAOB) sanctions imposed upon Deloitte and Touche, LLP (Deloitte) on December 10, 2007 for actions related to its 2003 audit of Ligand Pharmaceuticals Incorporated (Ligand). Deloitte was censured and fined one million dollars. The engagement partner responsible for the Ligand audit was banned from association with a registered accounting firm. These sanctions mark the first time the PCAOB has used its enforcement powers against a Big 4 auditor (or any national or international firm), as well as the first time the PCAOB has issued a monetary penalty against any individual or registered accounting firm.

    The PCAOB order against Deloitte contains three potentially value-relevant pieces of information. First, it shows that Deloitte did not conduct a quality audit of Ligand’s 2003 financial statements. Second, it highlights serious problems in Deloitte’s quality control policies and procedures that go beyond the Ligand audit failure. Finally, the PCAOB order reiterates the remedial actions Deloitte took to improve its quality control policies, which may alleviate investors’ concerns and signal improvements in the quality of the firm’s future audits.

    Design/Method/ Approach:

    The authors apply the market model to estimate expected returns over the period from 260 days before through 10 days before December 10, 2007  the date the PCAOB made public its sanctions against Deloitte. Using Audit Analytics and COMPUSTAT, the authors build a final sample that includes 707 Deloitte and 2,363 non-Deloitte clients.

    Findings:
    • Deloitte clients have a significantly negative market reaction to news of the PCAOB sanctions over one- and three-day event windows.
    • Non-Deloitte clients show no significant reaction to news of the PCAOB sanctions against Deloitte.
    • The lack of significance for non-Deloitte clients suggests that the results are not driven by uncontrolled factors common to clients of Big 4 auditors. There is no evidence of spillover effects to clients of other Big 4 auditors.
    • The negative effects of information contained in the PCAOB order against Deloitte outweigh any possible remedial effects coming from news of Deloitte’s corrective actions taken after the sanctions.
    • Deloitte clients had no reaction to other events specifically related to the Ligand audit failure that predate the sanctions. Thus, the evidence shows that the PCAOB sanctions revealed value-relevant information about Deloitte’s reputation or insurance value that was not contained in the other Ligand events.
    • The negative market effects observed are most likely the result of the news of the control weaknesses at Deloitte rather than events specific to the Ligand audit.
    • There is more negative reaction to news of the PCAOB sanctions against Deloitte for firms that are financially distressed.
    Category:
    Audit Quality & Quality Control, Standard Setting
    Sub-category:
    Impact of PCAOB
  • Jennifer M Mueller-Phillips
    Did the 2007 PCAOB Disciplinary Order against Deloitte...
    research summary posted July 27, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 11.0 Audit Quality and Quality Control 
    Title:
    Did the 2007 PCAOB Disciplinary Order against Deloitte Impose Actual Costs on the Firm or Improve Its Audit Quality?
    Practical Implications:

    The results suggest that the PCAOB censure imposed actual costs on Deloitte by adversely affecting its switching risk and lowering audit fees. However, Deloitte’s audit quality appears to be no different from that of the other Big 4 firms during a three-year period either before or after the censure. Thus, the findings suggest that PCAOB censure can inflict actual harm on a Big 4 auditor by adversely impacting audit committee perceptions of the firm’s audit quality, but without an observable improvement in the firm’s audit outcomes as reflected in the audit quality metrics.

    Citation:

    Boone, J. P., Khurana, I. K., & Raman, K. K. 2015. Did the 2007 PCAOB Disciplinary Order against Deloitte Impose Actual Costs on the Firm or Improve Its Audit Quality? Accounting Review 90 (2): 405-441.

    Keywords:
    audit fees, Big 4 audit quality, PCAOB censure, switching risk
    Purpose of the Study:

    The December 2007 disciplinary order of Deloitte was unprecedented for a Big 4 firm, representing the first-ever public censure of a Big 4 firm by the PCAOB. These disciplinary proceedings followed up on a prior-year inspection report by publicly censuring Deloitte for violations of auditing standards in connection with the 2003 audit of Ligand Pharmaceuticals. Notably, the December 2007 censure came about more than three years after Deloitte’s resignation from the Ligand engagement in August 2004, and more than two years after the audit failure became public information in May 2005, when Ligand restated its financial statements for 20032004.

    The authors investigate the nature of the actual costs imposed on Deloitte by the December 2007 disciplinary order issued against the firm by the Public Company Accounting Oversight Board (PCAOB). That is, the authors examine whether Deloitte’s switching risk in terms of the likelihood of losing existing clients to other Big 4 firms or attracting new clients and audit fees changed following the PCAOB censure. They also examine whether the PCAOB censure improved Deloitte’s audit quality relative to that of the other Big 4 firms during the three years following the PCAOB censure.

    Design/Method/ Approach:

    The authors use four samples to test their hypotheses using ordinary least squares regression models. They used Audit Analytics and Compustat data with fiscal years between 2005 and 2010, resulting in a sample of 10,013 firm-year observations. Within this sample the authors derived three smaller samples to run further tests.

    Findings:
    • The 2007 PCAOB disciplinary order against Deloitte imposed significant actual costs on the firm, as measured by a subsequent change in Deloitte’s switching risk in the form of an increase in the firm’s existing client loss rate to other Big 4 firms and a drop in the client gain rate.
    • Deloitte reduced the rate at which they were escalating fees over a three-year period following the censure to stem the tide of client defections to other Big 4 auditors.
    • Deloitte’s audit quality was no different from that of the other Big 4 firms during either the pre-censure (20052007) or the post censure (20082010) time periods.
    • Collectively, these results are consistent with the notion that PCAOB oversight during the 20052010 period of the study was focused more on documentation and substantiation compliance than on a holistic assessment of a Big 4 auditor’s brand name service quality.
    • It is possible that Deloitte’s audit quality improved after the censure, but the authors were unable to detect the improvement based on existing methods.
    Category:
    Audit Quality & Quality Control, Standard Setting
    Sub-category:
    Impact of PCAOB
  • Jennifer M Mueller-Phillips
    Did the PCAOB’s Restrictions on Auditors’ Tax Services Imp...
    research summary posted September 13, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 04.0 Independence and Ethics, 04.03 Non-Audit Services 
    Title:
    Did the PCAOB’s Restrictions on Auditors’ Tax Services Improve Audit Quality?
    Practical Implications:

     This study serves the purpose of examining the PCAOB’s role as overseer of public company auditing, while separating from previous studies by targeting the PCAOB’s restrictions on auditors’ tax services, which have not been examined in the past. This study also examines whether APTS pose a threat to audit quality but again differentiates itself from previous literature by focusing on only the tax services that the PCAOB chose to ban and by utilizing the difference-in-differences design to address the limitation of the cross-sectional approach utilized by other studies in the past. After reviewing these findings, it is possible that the PCAOB restrictions did not fully accomplish their objective.

    Citation:

     Lennox, C. S. 2016. Did the PCAOB’s Restrictions on Auditors’ Tax Services Improve Audit Quality? The Accounting Review 91 (5): 1493-1512.

    Keywords:
    PCAOB, audit quality, and auditors’ tax services.
    Purpose of the Study:

    In 2005, the Permanent Subcommittee on Investigations of the U.S. Senate reported that audit firms were selling potentially abusive or illegal tax-planning strategies to audit clients and their top executives on a contingent fee basis. This concerned regulators for many reasons; consequently, the PCAOB adopted three new rules to address these potential threats to audit quality. First, Rule 3521 reaffirms the ban on contingent fees that existed under Rule 302 of the American Institute of Certified Public Accountants’ Code of Professional Conduct. Second, Rule 3522 bars audit firms from selling aggressive tax services to audit clients. Finally, Rule 3523 forbids audit firms from selling tax services to executives in a financial reporting role. These three rules became effective from October 31, 2006 onward. The PCAOB stated that the rules were intended to improve audit quality, and, by extension, the quality of financial reporting. The purpose of this study is to test whether the restrictions met this objective.

    Design/Method/ Approach:

    Because audit quality is not directly observable the author focuses on accounting misstatements, both misstatements that are tax-related and other types, and the issuance of going-concern opinions. The author separates companies into groups based upon the reduction of APTS purchases between July 26, 2005 and October 31, 2006. He then compares the differences in misstatements and going-concern opinions between the treatment and control groups and tests whether these differences change after the PCAOB imposed the restrictions on auditors’ tax services. 

    Findings:
    • The author finds that in the period before the restrictions, there is no difference in the incidence of going-concern opinions between the treatment and control companies; however, the treatment companies are more likely than the control companies to have accounting misstatements and tax-related misstatements. This supports the premise of regulators that the treatment companies had lower-quality auditing before the restrictions were introduced. 
    • The author finds no significant changes in misstatements, tax-related misstatements, or going-concern opinions subsequent to the APTS restrictions after using a difference-in-differences research design. In fact, the treatment companies continue to have significantly more accounting misstatements and more tax-related misstatements in the period subsequent to the APTS restrictions.
    • The author finds large and highly significant reductions in APTS fees when the restrictions were introduced. 
    Category:
    Independence & Ethics, Standard Setting
    Sub-category:
    Impact of PCAOB, Non-audit Services
  • Jennifer M Mueller-Phillips
    Do Income Tax-Related Deficiencies in Publicly Disclosed...
    research summary posted September 13, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 09.0 Auditor Judgment, 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections 
    Title:
    Do Income Tax-Related Deficiencies in Publicly Disclosed PCAOB Part II Reports Influence Audit Client Financial Reporting of Income Tax Accounts?
    Practical Implications:

     While many studies examine how the Part I inspection report or the PCAOB inspection process as a whole impact the auditor and audit committee decision making, the research on the impact of Part II reports is limited. Furthermore, the PCAOB is publicly issuing Part II inspection reports with greater frequency; thus, an understanding of how the failed remediation of Part II reports influences the audit firm and its clients is of importance to a number of parties.

    Citation:

     Drake, K. D., N. C. Goldman, and S. J. Lusch. 2016. Do Income Tax-Related Deficiencies in Publicly Disclosed PCAOB Part II Reports Influence Audit Client Financial Reporting of Income Tax Accounts? The Accounting Review 91 (5): 1411-1439.

    Keywords:
    PCAOB inspections, auditor scrutiny, valuation allowances, and uncertain tax benefits
    Purpose of the Study:

    The Public Company Accounting Oversight Board (PCAOB) is responsible for overseeing the quality of external audits through a rigorous inspection process that examines both audit engagements and audit firm quality control processes. At the completion of their review, the PCAOB issues their findings to the inspected audit firm via inspection reports. This led the authors to investigate whether a change in auditor scrutiny over income tax accounts, prompted by the failed remediation of a PCAOB Part II inspection report, results in changes in client financial reporting of income taxes. Utilizing the unique situation of Deloitte & Touche LLP’s 2007 Part II inspection report, which identifies concerns about the firm’s quality controls with respect to the audit procedures performed on income tax accounts, the authors delve into whether the failed remediation and subsequent public disclosure of the report led to observable changes in financial reporting for income tax accounts among Deloitte’s client.  

    Design/Method/ Approach:

    The authors focus on the time period beginning with Deloitte’s 2007 Part II report, which was issued privately to Deloitte on May 19, 2008 and ending with the remediation period on May 18, 2009. The sample chosen was annually inspected audit firms between 2006 and 2012. The authors also investigate which components of the annual UTB reconciliation drive the changes in the total UTB balance.

    Findings:
    • The authors find that an increase in auditor scrutiny over income tax accounts in response to PCAOB Part II findings is associated with changes in financial reporting of income tax accounts.
    • The authors find that the changes implemented by Deloitte result in an increase in reported valuation allowances and an increase in the reserve for uncertain tax positions among its clients.
    • The authors find that the UTB result is not driven by changes in tax avoidance but is driven but increases in the reserve related to current-year and prior-year positions.
    • The authors do not find that additional auditor scrutiny influences the income tax accounts when examining non-tax related Part II reports. This suggests that the effect the authors identify is in response to the specific deficiencies identified in the Part II report rather than a general reaction to failing the remediation of a Part II report. 
    Category:
    Auditor Judgment, Standard Setting
    Sub-category:
    Impact of PCAOB, Impact of potential post-audit review (e.g. PCAOB - internal firm inspections)

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