Evidence from the PCAOB's Second Inspections of Small Firms

Driving Improvements in Auditing and Quality Control

Dana R. Hennanson, PhD, and Richard W. Houston, PhD

The Sarbanes-Oxley Act of 2002 (SOX) section 104, “Inspections of Registered Public Accounting Firms,” and the PCAOB's “Rules of the Board” [section 4, Rule 4003(b)] require that smaller auditing firms (those that audit fewer than 100 issuers annually) under the PCAOB's oversight be inspected at least once every three years. The small firm inspections began in 2004, and the first round of inspections revealed a large number of audit deficiencies (problems with individual audits) and quality control defects (broader issues related to firms' quality control practices and procedures). For example, the authors' prior research (“PCAOB Inspections of Smaller CPA Firms: Initial Evidence from Inspection Reports,” by Dana R. Hermanson, Richard W. Houston, and John C. Rice, Accounting Horizons, June 2007) found that, of the first 316 smaller audit firms inspected, 60% had audit deficiencies and 72% had quality control defects. The authors provide a detailed analysis of the types of audit deficiencies found by the PCAOB.