Organizations often take it as an article of faith that their auditors are following professional standards—and for good reason. Publicly released peer reviews of auditing firms give 95 percent of them passing grades for their work. In fact, a recent Wall Street Journal analysis found that 99 of the 100 biggest accounting firms in America received top grades from peer reviews.
But the performance of auditing firms may be far less impressive than the peer reviews have shown. According to the same Wall Street Journal report, inspections of the top 100 firms by the Public Company Accounting Oversight Board (PCAOB) found that more than a quarter of audits on average had serious deficiencies. And because many auditing firms aren’t required to publish their peer review results, firms that have received a less-than-stellar grade from their fellow auditors may be able to hide deficiencies from the public.
Private companies and nonprofit organizations are particularly vulnerable. Public company auditing has been monitored more closely by the government since the accounting scandals of the early 2000s. The same is not true of privately held organizations, which, according to government statistics, account for more than 5 million companies in the United States alone.
Auditors for private entities are policed by other auditors.
The upshot: If you suspect your auditors of making significant errors, you would be well-advised to look behind the curtain—no matter what peer reviews of the auditing firm have said. Organizations, particularly those that are privately held, must remain vigilant to ensure their auditors have adhered to professional standards. If the auditors haven’t met those standards, organizations may be well positioned to pursue a malpractice claim.
APPLYING PROFESSIONAL SKEPTICISM
Accounting malpractice claims against auditors have been a growth industry for lawyers in the last several years, and as we have noted previously on this blog, they have led to multi-million judgments (including some as high as nine figures) against some of the biggest names in the accounting industry.
Related Reading: Avoiding Accountant Malpractice Claims: It’s Not Getting Any Easier
One key problem is the fact that many accountants have yet to approach audits with sufficient “professional skepticism.” Professional skepticism is a term of art for auditors. It refers specifically to a professional standard requiring auditors to maintain independence and perform audits objectively and without bias.
In a 2015 article for The CPA Journal, Thomas Ray, the former chief auditor and director of professional standards at the PCAOB, wrote that his former agency, “concerned by the evidence obtained in its inspections of registered public accounting firms,” published Staff Audit Practice Alert 10 (SAPA 10) in 2012. The alert, titled “Maintaining and Applying Professional Skepticism in Audits,” was designed to raise the alarm about the lack of professional skepticism demonstrated by auditors.
“Observations from the PCAOB’s oversight activities continue to raise concerns about whether auditors consistently and diligently apply professional skepticism,” SAPA 10 stated. “Certain circumstances can impede the appropriate application of professional skepticism and allow unconscious biases to prevail.”
The alert also spelled out and further illuminated the PCAOB’s definition of professional skepticism.
PCAOB standards define professional skepticism as an attitude that includes a questioning mind and a critical assessment of audit evidence. The standards also state that professional skepticism should be exercised throughout the audit process. While professional skepticism is important in all aspects of the audit, it is particularly important in those areas of the audit that involve significant management judgments or transactions outside the normal course of business. Professional skepticism also is important as it relates to the auditor’s consideration of fraud in an audit. When auditors do not appropriately apply professional skepticism, they may not obtain sufficient appropriate evidence to support their opinions or may not identify or address situations in which the financial statements are materially misstated.
Ray—who is a CPA, former distinguished lecturer at Baruch College, and former KPMG audit partner—noted that a year after SAPA 10 was released, the PCAOB issued a public report that “identified a lack of due professional care—including professional skepticism—as one of several potential root causes of audit deficiencies.”
Why is it so difficult for auditors to apply this fundamental requirement? In the 2013 report, the PCAOB identified a number of possible reasons.
- Over time, auditors developed an inappropriate level of trust or confidence in management.
- They were pressured by their firms to build and maintain long-term audit engagements. This meant avoiding significant conflicts with clients and avoiding potential negative interactions with management.
- Auditors faced unreasonable scheduling and workload demands.
- Auditors were incentivized to achieve high client satisfaction ratings, keep audit costs low and cross-sell other services to clients. All of these factors diminish the ability of auditors to keep their distance and provide information that a client may not want to hear.
A lack of technological prowess on the part of some CPAs may also contribute to auditing deficiencies—and eventually to accounting malpractice claims. By failing to properly apply the latest technology to comb large data sets for anomalies, auditors may add to their already large workload and reduce their ability to spot financial misconduct.
Related Reading: Technology is Changing Auditing
Auditors can deploy artificial intelligence to analyze transactions and assess them according to their risk. By doing so, they can reduce the use of time-consuming manual samples for transactions, and increase the odds of spotting trends in the data that can point to fraud. (And if they don’t have the internal expertise to deploy technology, firms can engage outside forensic and IT professionals to supplement their work.)
During the engagement process, organizations can and should ask prospective auditors about the technology they use. And companies that have a long-standing relationship with an auditing firm should regularly question the firm about its use of technology. A CPA firm that is lagging behind in its understanding and adoption of technology may be unable to provide the standard of care necessary to conduct a thorough audit.
Forensic Strategic Solutions has substantial experience working with attorneys and clients bringing and defending against accounting malpractice claims. To learn more about our work, contact us for a consultation, or visit: