PCAOB Quote Regarding Audit Failure Rate Raises Concerns

Recently, the Wall Street Journal reported the shocking headline “One in Three Audits Fail, PCAOB Chief Auditors Says”.  The PCAOB is the Public Company Accounting Oversight Board, so such a statement certainly has the ability to rattle not only the the audit community, but all users of audited financials.

Reading the context of the quote provides some important details regarding the basis for the statement.  First, the failure rate is not based on all audits, but the subset of audits that the PCAOB inspected because it suspected problems. Therefore the rate cannot be extrapolated to all audits.  Further, the definition of “audit failure” is defined as cases where the PCAOB

“found that auditors did not have sufficient evidence to support their opinions.  That doesn’t necessarily mean the underlying corporate financial statements are incorrect, but the audit failures could start to undermine investor confidence.”

Overall, the five most common problems included:

  1. complex “fair value” measurements for financial instruments
  2. management estimates
  3. revenue recognition policies
  4. internal controls
  5. excessive reliance on data prepared by the company

The appropriate use of company prepared data is the subject of a recent Statement of Accounting Standards (SAS 128) regarding reliance on internal auditors.  In general, audit firms must plan and perform their audits with professional skepticism and ensure effective supervision and quality control.

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