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What We Talk about When We Talk about Audit Quality

Joanne S. Barry, CAE

In the fall of 2007, a year before what former Federal Reserve Chair Ben Bernanke called the worst financial crisis in global history, the United States Treasury Department formed the Advisory Committee on the Auditing Profession. Cochaired by former SEC Chair Arthur Levitt Jr. and former SEC Chief Accountant Donald T. Nicolaisen, this group was charged with reviewing the profession's current “condition” and recommending steps that would need to be taken to ensure its sustainability.

Among the series of recommendations the advisory committee suggested in its final report (released October 6, 2008) was that the PCAOB should “determine the feasibility” of developing audit quality and effectiveness indicators and require audit firms to publicly disclose them. To determine whether developing audit quality indicators was feasible, the PCAOB was told to seek the input of anyone affected by these indicators—such as auditors, investors, boards of directors, public company management, audit committees, academics, and others. If everyone were in agreement that this goal was indeed feasible and the indicators established, the PCAOB would be charged with monitoring them.

An Elusive Goal

Fast-forward to today, and we are still waiting on the PCAOB's report. But don't laugh at the prolonged timetable. The quest to define audit quality didn't begin six years ago, and it didn't begin with the PCAOB. In remarks made last year, PCAOB member Jeanette M. Franzel noted that a recently published research paper determined that after more than two decades of research, we still haven't determined what audit quality is.

While the definition of audit quality may be elusive, we seem to have made some progress on defining what happens when an audit lacks quality—the audit failure. This definition came so easily that we have more than one. The PCAOB's definition, which Franzel included in her January 2013 remarks, is that an audit failure 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.”

But Jay D. Hanson, one of Franzel's fellow board members, pointed out in a March 2014 speech that the Government Accountability Office, in a survey of public accounting firms with SEC firm clients, public company CFOs and their audit committee chairs defined “audit failure” as an “audit for which audited financial statements filed with the SEC contained material misstatements whether due to errors or fraud [emphasis Hanson's].” He added that he would like to see the PCOAB eliminate the use of the phrase “audit failure” in its inspection reports, unless the auditor's failure relates to misstated financial statements.

But even this definition raises questions. It reminds me of the philosophical thought experiment: “If a tree falls in the forest and no one is around to hear it, does it make a sound?” If an auditor failed to fully follow U.S. GAAS and apply a minimum of professional skepticism, is the audit a failure—even if the financial statements do not contain material misstatements? Even if the audit failed to do what it is intended to do?

So the PCAOB is attempting to define what audit quality is but is not seeking to establish specific benchmarks or formulas for audit quality—instead, the board says it hopes to provide insight into audit quality for stakeholder decision making and policy making, as well as provide firms with additional incentives to compete based on audit quality.

At the Crossroad

What to make of all of this? To provide some context and analysis on the subject, The CPA Journal and Pace University's Lubin School of Business are sponsoring “Audits at the Crossroad: A Symposium on Evolving Standards and Practices,” a panel discussion to be held at the NYSSCPA's offices on January 12, 2015. The debate will be moderated by Leslie F. Seidman, former FASB chair and current executive director of Pace's Center for Excellence in Financial Reporting at the Lubin School of Business, and will feature panelists Gregory J. Jonas, director of the PCAOB's office of research and analysis; Cynthia M. Fornelli, executive director of the Center for Audit Quality; and Rita Piazza, director of Marks Paneth LLP's professional practice group and former chair of the NYSSCPA's SEC Committee. For more information about this event, see page 33.

Joanne S. Barry, CAE. Publisher, The CPA Journal, Executive Director & CEO, NYSSCPA, jbarry@nysscpa.org.

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