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    PCAOB Inspections of Smaller CPA Firms: Initial Evidence...
    research summary posted April 13, 2012 by The Auditing Section, last edited May 25, 2012, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 11.0 Audit Quality and Quality Control, 11.11 Impact of Firm and External Inspection Programs 
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    Title:
    PCAOB Inspections of Smaller CPA Firms: Initial Evidence from Inspection Reports
    Practical Implications:

    This study provides a detailed analysis of the deficiencies identified in the PCAOB inspections of small firms, including an examination of firm-specific characteristics. It also provides insights into the PCAOB’s inspection practices, which is useful for regulators, audit firms, public companies and financial statement users to consider.

     

    Citation:

    Hermanson, D. R., R. W. Houston, and J. C. Rice. 2007. PCAOB Inspections of Smaller CPA Firms: Initial Evidence from Inspection Reports.  Accounting Horizons 21 (2):  137-152. 

    Keywords:
    PCAOB inspections, inspection reports, audit quality, quality control
    Purpose of the Study:

    In accordance with the Sarbanes-Oxley Act (SOX) of 2002, the PCAOB conducts periodic inspections of member firms. Firms with over 100 issuer clients are inspected annually, while firms with 100 or fewer issuers are inspected at least every three years. Inspection results for the large firms have been well-documented and publicized, however very little is known about the PCAOB inspections of the small firms. This study analyzes the PCAOB inspection reports for registered accounting firms with 100 or fewer issuer clients to determine whether: 

    •  There is an association between inspection process characteristics and the identified deficiencies. 
    •  There is an association between audit firm characteristics and the identified deficiencies.
    •  There is an association between audit firm characteristics and the year of the inspection (all inspections were conducted in either 2004 or 2005).
    •  There is an association between client portfolio characteristics and the identified deficiencies.
    •  Certain specific audit deficiencies are cited by the PCAOB more than others.
    Design/Method/ Approach:

    The authors gather data from 316 PCAOB inspections of smaller accounting firms (i.e. firms that audit 100 or fewer issuers annually) through July 13, 2006. All inspection data are gathered from the PCAOB’s website and supplemented with data from Audit Analytics. Descriptive analyses on the 189 inspection reports that have audit deficiencies are compared and contrasted with that of the 127 inspection reports without deficiencies.    

    Findings:
    • The length of the inspection (days spent on site) and the report lag (months from completion of the inspection to issuance of the report) are greater for firms with deficiencies.
    • Audit firms with deficiencies are smaller (fewer professionals), have a greater number of issuer clients despite their smaller size, and are growing faster than no-deficiency firms.
    • Audit firms inspected in 2004 are significantly more likely to have deficiencies identified than those inspected in 2005.
    • The PCAOB’s 2004 inspections appear to be focused on smaller, riskier, rapidly growing audit firms.
    • Clients of deficiency firms are smaller, less profitable, and more highly leveraged, suggesting greater risk.
    • Deficiencies are overwhelmingly related to the substantive procedures performed by the audit firms (e.g. failure to perform and document various analyses and procedures)
    • The most commonly cited accounting issues listed in the deficiencies are associated with revenues, receivables, equity, and liabilities

    The authors suggest that their findings provide a caution to smaller audit firms, who have perhaps over-extended themselves, and sacrificed audit quality by serving too many issuer clients. They argue that small firms should carefully consider the costs and benefits of serving multiple issuer clients.  

    Category:
    Standard Setting, Audit Quality & Quality Control
    Sub-category:
    Impact of PCAOB, Impact of Firm & External Inspection Programs
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