Impact of PCAOB on auditing profession and fraud prevention
US accounting profession was blotted with the whirlwinds of corporate scandals like Enron and Worldcom during 2002. Investors lost billions of dollars as they were duped by these companies through accounting fabrication, which deceptively showed the shallow side of the companies to the whole investment community. Accordingly, the financial markets were suffering from the tapered investor confidence and it was important for the US government to restore that confidence by bringing in some strict legislations for the corporate community, and this lead to the passing of landmark legislation, Sarbanes-Oxley Act in 2002 and one of the most important aspect of this act was the creation of Public Company Accounting Oversight Board (PCAOB) which finally brought accounting profession under federal regulations and also with the authority to set standards for auditors of publicly traded companies. Important to note, before the creation of PCAOB, auditing was a self-regulating profession, however, following the discovery of financial reporting and auditing improprieties in some of the largest companies such as Enron, Worldcom, Xerox, Tyco and with certified role of either participation or negligence by the auditors, the need for the enhancement of internal control and regulation of auditing profession was at peak. Accordingly, the creation of Public Company Accounting Oversight Board (PCAOB) was a milestone step taken by US Congress relating to the federal securities laws since 1934.
Now, with more than a decade of the establishment of PCAOB, it is important to access the impact of PCAOB on auditing profession and how effectively it has been able to prevent the occurrence of fraud amongst the US companies. Therefore, in this paper, we analyze those impacts and the effectiveness of PCAOB, as a whole.
Public Company Accounting Oversight Board (PCAOB)
Before we start assessing the impact of PCAOB on the audit profession and how the board is taking steps toward fraud prevention, it is important that we first learn about the PCAOB and the authorities it hold.
PCAOB is a non-profit organization that regulates the auditory procedures of public limited companies. Created as part of Sarbanes Oxley Act, 2002, PCAOB works with the objective of protecting the interest of the investors and other stakeholders of public limited companies by ensuring that the auditors follow a strict guideline set by the board. Moreover, in July 2010, with the amendment of Sarbanes Oxley (SOX) Act according to Dodd-Frank Act, PCAOB has also been endowed with an additional authority of overseeing the audit of broker-dealers including timely filing of compliance report according to set regulations.
SOX requires that public accounting companies, both based in US and overseas, but provide audit services to US based companies, should get themselves registered with PCAOB and pay a mandatory fee. In addition, the act requires PCAOB to conduct annual inspections for audit firms that provide audit services to more than 100 issuers, and triennially for audit firms that provide audit service for 100 or fewer issuers. In case PCAOB finds any violation relating to audit standards, performance of audit, issuance of audit report, audit logs or any other aspect against the regulatory order, the Board can fine the auditor, suspend or revoke an auditor’s registration and can bar public companies from associating with the auditor in any professional form.
In the nutshell, the board has four main responsibilities:
Ensuring registration of accounting firms
Inspection of registered firms
Performing investigations of accounting firms
Establishing audit standards
Impact of PCAOB on auditing profession
-Issuance and enforcement of standards
PCAOB is responsible for issuance of standards relating to auditing, quality control, ethics, independence and any other standards which the board may seek necessary for protecting the public interest and to promote transparency and fairness in the auditing profession. In addition to the responsibility of setting up of the standards, the board also has the authority to enforce the standards on public accounting firms. Since its inception in 2003, the board has issued fifteen(15) auditing standards relating to audit documentation, internal control, audit planning and risk assessment. The board has also amended a number of accounting standards such as AU 325, AU 411, AU 508, AU 350 and AU 329.
Important to note, this feature of PCAOB has endowed a crucial impact on the auditing profession. For instance, even before the passing of SOX act and setting up of PCAOB, auditors of public companies were required to review the internal control measures adopted by their client and determine the extent they could rely on those control measures while conducting the audit. However, Section 404 of SOX act now requires the auditors to be more broader in their review and cite whether the internal control measures have any weakness and if they found any weakness, they must describe that weakness and issue an adverse opinion for internal control measures. On the other hand, PCAOB is directed under section 404 to adopt a standard that tells the auditor how it should conduct the review of internal control measures and requires the auditor to issue an opinion on the internal control measures adopted by their client.
Therefore, the standard setting and enforcement feature of PCAOB has brought more transparency in the auditing profession.
-Prohibition to extend non-audit services by the auditors
Another influential impact by the PCAOB on the auditing profession is to prohibit accounting firms from rendering non-audit services to their clients. Important to note, before the passing of SOX act, audit firms were also earning revenue from non-audit services such as tax planning, system design, data processing and many other advisory services to their clients. In many cases, revenue earned by the audit firms from the non-audit services significantly exceeded the revenue earned from audit of financial statements. Therefore, citing a doubt on the auditor’s independence and their willingness of not issuing adverse opinions for the client’s financial statements because of the risk of losing consulting business also, SOX act reversed the trend altogether. SOX act finally prohibited the auditors from offering some specified non-audit services to their clients and PCAOB was made responsible for overlooking other non-audit services that can be added to the prohibited list.
This is yet another important area of development in the auditing profession as auditors are now made focused on performing their audit functions only. No public audit firm registered with PCAOB is now allowed to provide prohibited non-audit services to their client. However, audit firms can still provide services that are not on the prohibited lists,but doing so, they will first need to seek approval of the audit committee along with the public disclosure by the auditors. PCAOB chairman, in his annual speech cited that ‘’ Audit committee restraint in approving non-audit services, especially the acquisition of aggressive tax products’’. Henceforth, this feature has also added transparency in the auditing profession as rather than thinking of earning significant revenue from non-auditing services, auditing firms are now being realized of their core responsibilities of performing a prudent financial audit.
-International Inspection
One of the most distinguished features of PCAOB is the authority to inspect non-US audit firms that provides audit services to US based clients and mandatory registration of even non-US audit firms with PCAOB. Expanding its scope international authority, PCAOB clearly cites that any foreign accounting firm that prepare or furnish an audit report for a company that is registered with PCAOB, is subject to the board inspection. Moreover, even if a US registered accounting firm is relying on the opinion of a foreign based accounting firm, even then, all the audit related work-paper of the foreign firm must be supplied to PCAOB on request.
Important to note, even when under SOX section 106, US Congress exempted non-US firms from registration with PCAOB, the board resented the decision to exempt non-US firms citing that investor community needs high-quality audits and professional commitments by the auditors, regardless of the location of the auditor.. Therefore, non-US audit firms are subject to the PCAOB’s inspections in the same manner as the U.S. auditors. It is considerable that despite of numerous challenges involved with the inspection of audit firms based overseas, PCAOB remains committed to its objective of protecting public interest and has thus successfully entered into 17 cooperative arrangements with audit regulators in foreign countries as of the end of 2013.
Therefore, the ability of the PCAOB to enforce mandatory registration and inspection of even non-US firms indicates that the board leaves no stone unturned to promote an ethical working environment amongst the entire auditing community. The following figures validate the fact: By the end of 2012, 911 audit firms(39% of the total) registered with PCAOB were located in foreign countries and as of June, 2013, the board has conducted inspections of 41 non-US firms.
-Corporate Governance
Another area where PCAOB has endowed an impact on auditing profession is the governance practices. Important to note, while SOX act has strengthened the role of the audit committee as auditors are now required to report to the audit committee and not the management. In addition, the auditors will also be responsible for seeking approval from the audit committee for providing services to the respective company. However, the major role is rather played by PCAOB. It is considerable that it is the responsibility of the PCAOB to oversee the activities of the auditors, including their relationship and communications with the audit committee. Therefore, it is inevitable that such standards and inspections by PCAOB will affect the way audit committee and auditors work.
For instance, while PCAOB is responsible for setting prudent standards relating to internal control and requires auditors to express their opinion on the materiality of internal control measures, the board also states that an ineffective audit committee is a part of ineffective internal control measures and a strong indicator of the material weakness in the company. Therefore, at times when auditors are required to report to the audit committee, forming an adverse opinion on the audit committee will be challenging for the auditors. However, by overlooking all the communications between the auditors and the audit committee, PCAOB ensures that the auditors perform an independent professional performance in accordance to the ethics of corporate governance and thus ensure independence and transparency in the auditing profession.
Henceforth, with this proposal, the auditors will soon be seen, not only as accounting principle experts, but also as a source of infusing corporate governance practices within an organization.
-Promoting disciplinary regime amongst the auditors
Unlike previous corporate regulatory boards, PCAOB has been authorized by the SOX act to administer a strict and disciplinary regime in the auditing profession. POCAB has repeatedly said that while its main objective is to foster public interest and helping the accounting firms to raise their work standards and strengthen their quality controls, however, at times when a serious violation of law or professional standards are discovered, it may impose fines and bar individuals and accounting firms from auditing the public companies in the United States.
-Preparing better and ethical auditors for the future
Apart from rejuvenating the whole audit environment and related standards in order to protect the public interest, PCAOB is also making an influential impact on the new and younger generation of auditors. It is considerable that unlike their predecessors, recent and future graduates of accounting programs will be receiving their training in post Sarbanes-Oxley world and under the stringent rules of PCAOB. Henceforth, these graduates will be taught the importance of performing ethical practices at the workplace and how the regulatory bodies will be overseeing their activities. Therefore, PCAOB is also doing an abstract job of preparing better and ethical auditors for the future.
-Improvisation of existing standards
Stringent overseeing procedures of board have also resulted in improvisation of many existing standards while assisting US GAAP in proposing better accounting standards drafts and their related amendments for the future. For instance, an inspection conducted by the board during 2007-2009 found that the auditors were not complying with PCAOB auditing standards in areas such as fair value accounting, fair value measurements, goodwill impairment, write-off of loans, off-balance sheet financing, revenue recognition and many other aspects. For instance, in the context of the violation of regulations relating to fair value accounting, the board found that:
Auditors did not obtain a sufficient understanding of the available valuation methods and assumptions related to it
Auditors did not have considerable importance to differences between independent estimates used or developed by firms and fair value ascertained by the management
Auditors did not sufficiently test the valuation procedures adopted for valuing complex securities
Impact of PCAOB in Fraud Prevention and Detection
Apart from endowing a crucial impact on the auditing profession, PCAOB is also having an influential role in both fraud prevention and early detection. PCAOB has repeatedly confirmed that the auditors often fail to effectively modify their standard procedures when they are confronted to fraud risk. In other words, even though auditors are capable of identifying the heightened risk of fraud, however, rather than changing the nature of their procedure, they only tend to respond by increasing the extend of their audit procedures. For example, in the quest to detect the fraud, auditors generally set a large sample size rather than employing different audit procedures that would be effective in detecting the fraud. Henceforth, in order to assist the auditors, PCAOB has laid down comprehensive details u/s 316- Consideration of Fraud in a Financial Statement Audit.In this section, the board does not require the auditor to interpret existing standards in a different manner nor does the board change any existing standard, rather the board identifies certain observations which might help the auditors in detecting fraud while analyzing the financial statements of their clients.
In addition to guiding the auditors through a comprehensive section, PCAOB has also the authority to take up the task of fraud detection when it may seem that the auditors of a particular accounting firm are not performing their fraud detection procedures appropriately. In this regard, while the authority of the board extends only to the accounting firms, however, in order to unearth the possibility of fraud, the inspection or the investigation can affect public companies also. For instance, citing a possible violation of the standards or regulations by the auditors, PCAOB can possibly investigate auditor’s client’s records and interrogate its personnel. Therefore, the board can unearth the fraud instances by looking at the undocumented communication between the company and their auditors.
Conclusion
At the end of this paper, we can conclude that Public Company Accounting Oversight Board (PCAOB) has endowed an influential and productive impact on the audit profession and also in fraud prevention.
It is considerable that the board was formed by Sarbanes Oxley Act (SOX) with the intend to store the public confidence in the auditing process and financial reporting. Most importantly, the board was formed at the time when not even the companies, but also their advisors, i.e. the auditors were found to have equal participation in the effort to dupe the investors in lieu of short-term profits. Accordingly, the corporate collapses, audit failures, financial statement fabrication bred cynicism and anger amongst the investor community. However, US congress soon realized the critical situation and in order to promote long-term health of the capital market, it finally created the Sarbanes Oxley Act(SOX) and as part of SOX act, PCAOB was created and that too with aggressive authorities to implement on the accounting firms and to restore public confidence in the accounting practices.
Now, after more than a decade, PCAOB has evolved over time from a start-up institution focused on establishing an oversight system on the accounting firms to a successful and mature regulatory organization with both experience and resources to quickly adapt to the changes in the accounting profession and regulate the accounting firms while upholding the public interest at the forefront.
References
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D.G. McDermott Associates LLC. (n.d.). How the Sarbanes-Oxley Act of 2002 Impacts the Accounting Profession. Retrieved February 26, 2016, from http://www.dgm.com/information-center/sarbanes-oxley-information/how-the-sarbanes-oxley-act-of-2002-impacts-the-accounting-profession
PCAOB. (2003, October 31). The Work of the PCAOB: Why Should Public Companies Care? Retrieved February 26, 2016, from http://pcaobus.org/News/Speech/Pages/10312003_GoelzerPublicCompanies.aspx
PCAOB. (2007). OBSERVATIONS ON AUDITORS' IMPLEMENTATION OF PCAOB STANDARDS RELATING TO AUDITORS' RESPONSIBILITIES WITH RESPECT TO FRAUD . PCAOB.
PCAOB. (2012, January 23). Reflections on the State of the Audit Profession. Retrieved February 26, 2016, from http://pcaobus.org/News/Speech/Pages/01132012_HansonAAA.aspx
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