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    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 
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    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)