22 years after Enron’s $63 billion collapse, an audit review board finds the industry ‘completely unacceptable’.

22 years after Enron's $63 billion collapse, an audit review board finds the industry 'completely unacceptable'.

The Troubling State of Audit Industry Revealed by Congressional Watchdog

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Accounting firms play a crucial role in verifying the financials of the companies they audit, providing accurate snapshots of their businesses. However, a recent report by the congressional watchdog, the Public Company Accounting Oversight Board (PCAOB), has revealed a startlingly high number of errors and flaws in audit reports. As the virtual embodiment of the Andersen Effect, the PCAOB was created in 2002 to prevent another Enron-like scandal and protect investors and public interest. Yet, what the report found after 21 years is a state of the audit industry that is “completely unacceptable.”

According to the PCAOB report, a staggering one-third of all audits conducted by U.S. global accounting firms in 2022, including the Big Four (Deloitte, PwC, KPMG, and EY), contained errors. This represents a significant increase from the 21% error rate in 2021. The findings were scathing, highlighting a need for immediate action.

The increase in errors may not solely be a result of auditors’ sloppy work. These mistakes likely existed for years but were only uncovered at a higher rate due to economic instability. As the economy fluctuates, discrepancies and deficiencies become more apparent. This revelation raises concerns about the reliability of financial information provided by companies during periods of growth.

For all accounting firms, including those based overseas and unaffiliated with global networks, the rate of mistakes was even higher. Out of the 710 audits reviewed by the PCAOB in 2022, 40% contained errors. This represented a six percentage point increase from 2021. The report highlighted failures in executing basic audit steps sufficiently and using credible data to support conclusions. With this high deficiency rate, PCAOB Chair Erica Y. Williams labeled the situation as “completely unacceptable” and urged firms to address the problem.

The PCAOB did not disclose the names of the audit clients that received faulty audits. However, the report revealed a large jump in errors in non-U.S. global auditing firms, with the percentage of flawed audits nearly doubling from 17% to 31% in 2022. Some firms attributed this increase to above-average staff turnover, a less experienced staff makeup, and the continued impact of the COVID-19 pandemic and remote work. Nevertheless, Williams dismissed these excuses, emphasizing the responsibility of firms to confront the challenges head-on.

The lack of oversight systems used by auditing firms, in addition to employee error, contributes to the problem. The report indicated that some firms lack quality control systems or monitoring procedures to ensure adherence to professional standards. Even firms with inspection procedures in place were found to be neglecting them. This indicates a systemic flaw within the industry that needs to be addressed urgently.

Historically, economic downturns have exposed more cases of accounting fraud. Dr. Feng Gu, chair of accounting and law at the University at Buffalo School of Management, highlighted the relationship between accounting fraud and audit failure. During periods of economic slowdowns or crises, there is an uptick in accounting fraud because auditors fail to catch these mistakes or problems initially. Mistakes are easier to conceal during periods of growth, when positive reports mask underlying issues. However, during unstable economic climates, accounting errors become more visible.

Despite the absence of a widespread recession this year, regional banking crises and predictions of an impending economic downturn have created a favorable environment for uncovering financial accounting problems. There has been a slowdown in certain industry sectors, and this slowdown provides an opportunity for deficiencies to be exposed.

Williams acknowledged that the deficiencies found in 2022 have been recurring trends in PCAOB reviews and urged auditing firms to identify ways to prevent these errors. The PCAOB aims to address the problem by disseminating its findings to the press, potential customers, and investors. It is clear that the PCAOB does not want the Big Four to further shrink and emphasizes the urgent need for auditing firms to improve audit quality.

In conclusion, the report released by the congressional watchdog highlights the troubling state of the audit industry. The high percentage of errors in audit reports, including those conducted by the Big Four, is “completely unacceptable.” While economic instability and the pandemic may contribute to the increase in errors, they cannot solely explain such deficiencies. The lack of oversight systems within auditing firms and the tendency to bury mistakes during periods of growth also play a role. The PCAOB urges auditing firms to address these issues and reverse the troubling trend.