“Audit Deficiency Syndrome” – IFIAR and the PCAOB Would Call It a Global Epidemic

In the panoply of clumsily identified affinity groups, the acronym for the awkwardly named International Forum of Independent Audit Regulators – IFIAR -- would surely be a top candidate for well-deserved obscurity.

IFIAR came together in 2006, one of the offspring of the Public Company Accounting Oversight Board – the American audit regulator known for short, and no more poetically, as the PCAOB.

That agency was itself born in 2002, in the post-Enron spasm of legislative righteousness that begat the Sarbanes-Oxley law and marked the end of the accounting profession’s exercise of self-inspection and quality oversight. Audit regulators were spawned around the world – the PCAOB and its children in 50 more countries now gather under the IFIAR banner with the mission of “knowledge sharing and collaboration in pursuit of its members’ shared objectives of high quality audit performance.”

That comes from the group’s press release, issued at its assembly in London earlier this month, which was led by current chair Lewis Ferguson, a member of the aforesaid PCAOB.

Bidding for media attention to its inspection and oversight programs, Ferguson’s press briefing announced the results of IFIAR’s latest survey of its members’ sampling of the work of large-company auditors:

“We continue to see high levels of inspection deficiencies in vital areas of public company audits. This is a problem for investors and stakeholders around the world.”

Numbers came with the words -- appropriate for this sector of the capital markets: the survey reported deficiencies in fully 47 % of the 948 public company audits inspected, and 41 % of the inspected audits of 148 financial institutions.

Splashed across the business and trade press, the attribution of persistent, recurring high levels of inspection deficiencies in vital audit areas was characterized as “staggering” and “chronic” in outlets such as Forbes, Economia, CFO Magazine, Financial Director, the Journal of Accountancy, Accounting Today and Accountancy Live.

Hold on a second. What of this alarmist message – a forty-plus percent deficiency rate in “vital areas of public company audits”?

On the one hand, while the IFIAR cautions against extrapolating, its findings of deficiencies:

“indicate that the audit firm did not obtain sufficient appropriate audit evidence to support its opinion … and that the audit failed to provide the level of assurance about the financial statements that it purported to do and that is required by professional standards.” (Emphasis added.)

Pass for a second the litigation implications of such charges of sub-standard performance, under the threatening regimes of legal liability in the world’s large economies. Such a failure rate in any other sector would – if credible – also be intolerable to the interested parties.

Some examples: New car warranties are now in place above and beyond 100,000 miles. Airline casualties are measured per hundred million passenger miles. Food safety and environmental pollution standards are expressed in parts per billion. Such dangerous activities as construction sites and chemical plants advertise their accident-free periods over months and years.

Even at the hands of the most casual food-safety agency, such a pervasive rate of “deficiencies in vital areas” would cost the operator’s license of a neighborhood coffee shop or a curbside taco truck in a heartbeat.

And yet – every securities trade on every stock exchange in every IFIAR country is based on financial statements audited by a firm subject to inspection by an IFIAR member. And the very raison d’être of those members is, as they put it (press release, page 3), their “mandate to improve audit quality.”

Which leads to this choice: Is the quality of the Big Audit model so fundamentally degraded that large-firm performance deserves the headline-grabbing assertion of persistent, recurring serious deficiencies?

Or – perhaps – is this global aggregation of audit regulators choosing to devise and apply the proper standards of measurement and evaluation in the first place? In other words, what counts? Who is doing the counting? And what’s the point?

After all – take the case of Andre Drummond, the 6’11” center for the Pistons, Detroit’s professional basketball team. He has the NBA’s worst current career free-throw shooting record, at less than 40 % – well below half the rate of the league’s leaders. Yet he is in his third successful year, based on his skills in rebounding and defense.

The same in professional baseball, where a batter failing to hit safely three times out of four can still achieve Hall of Fame status (see the career batting averages of Bill Mazeroski -- .260 -- Ozzie Smith -- .262 -- and Harmon Killebrew -- .256).

Properly defined measures of performance quality and rates of failure and error are not designed or intended, if legitimate, to be evaded or eroded. So IFIAR’s assertion, as Ferguson put it, that its finding of deficiencies “does not necessarily mean that the audited financial statements themselves were materially misstated,” bangs hard up against its own inability to give affirmative comfort that its findings are consistent with good reliable audit practice.  

IFIAR’s promotional efforts confront the dangerous inanity of “managing what you can measure.” So it is left not only unable to find a satisfactory answer to the wrong question – it is blinkered from even asking the right one.   

Lest we forget, there are two lessons in the legend of the shepherd boy who cried “wolf”:

The publicity-seeking little boy was met with public rejection and the lack of respect that his over-reaching deserved.

And also, when the wolf actually did show up, the villagers really did lose their sheep.

 

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Comments

[Bob Hirth]

Thanks Jim
Remember this too - the inspections cover a risk based sample about 60 of each firms US LLP US listed clients and then they take a subset of complex, subjective, difficult areas within each of those audits to look at.

So, the headlines of "47%, etc." - are very misleading.

(I am the chairman of COSO and also on the SAG at the PCAOB- the SAG deals with audit standards and not the inspection process- while documentation deficiencies can be important, they can be very subjective and hypothetical in terms of actual correctness)

[Jim Peterson]

Bob --

Thanks for your comment. This modest reaction - while extrapolations and extensions are of course to be done only with great care, in part for the reasons you cite, the approach of risk-based selection has a couple dimensions. Selection for complexity and difficulty might be expected to throw up performance challenges. On the other hand, recognition of those issues by the firms themselves ought to mean the deployment of best-quality talent, expertise and consultation. Put another way, might it not be expected that deficiency rates would be lower on the tougher jobs because better executed than those average or below? Further adult dialog on issues like this would seem to be very much called for.