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PCAOB Board Member Reveals Why 46% Audit Deficiency Rate Is Misleading

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When Senator Elizabeth Warren publicly accused PCAOB Board Member Christina Ho of “downplaying atrocious findings” about audit quality, it got me thinking: Do these alarming statistics about audit deficiencies really tell the full story?

The numbers definitely grab attention: Audit deficiency rates rose from 29% in 2020 to 46% in 2023. These figures from the Public Company Accounting Oversight Board (PCAOB) suggest that nearly half of all audits reviewed contained deficiencies so severe that “the audit firm had not obtained sufficient appropriate audit evidence to support its opinion.” At face value, these statistics paint a troubling picture of the accounting profession.

In a conversation on the Earmark Podcast, I asked Christina to help me understand these numbers. Christina explained the gap between headline statistics and meaningful measures of audit quality.

Understanding the PCAOB’s Role

Before getting into deficiency rates, it’s essential to understand what the PCAOB does. Christina explains, “The PCAOB is responsible for making sure auditors who check the publicly traded companies’ financial disclosures are doing their job well.”

The PCAOB fulfills this mission by registering audit firms, inspecting their work, and enforcing standards through sanctions when necessary. The inspection program represents the largest part of the PCAOB’s operations, with different firms facing different inspection frequencies:

  • The “Global Network Firms” (Big Four plus Grant Thornton and BDO) are inspected annually, with about 50 audits reviewed for each of the largest firms.
  • Firms with more than 100 public company clients are inspected annually, with about 10% of their audits reviewed.
  • Firms with fewer than 100 public company clients are inspected every three years.

The Misleading Mathematics of Deficiency Rates

When the PCAOB announced that 46% of audits reviewed in 2023 contained significant deficiencies, it received considerable attention. In our discussion, Christina pointed out several critical issues with how these numbers are presented and interpreted.

First, these audits aren’t randomly selected. The PCAOB uses a “risk-based approach” that deliberately targets audits they believe are likely to have problems. 

This selection bias fundamentally changes how the statistics should be interpreted. Christina pointed out, “We really can’t extrapolate the deficiency rate to the entire population of all audits because we did not take a statistical sample.”

Even more revealing is what these deficiencies actually mean. Despite the alarming definition, the PCAOB’s own reports include a critical disclaimer that Christina highlighted: “It does not necessarily mean that the issuer’s financial statements are materially misstated.”

In fact, less than 5% of these so-called deficient audits resulted in incorrect audit opinions—the outcome that would truly matter to investors. This stark contrast between the headline figure (46%) and the rate of consequential errors (under 5%) reveals how statistics without proper context can give the wrong impression.

Another significant issue is the PCAOB’s failure to differentiate between levels of deficiency severity. “Our deficiencies… we put everything in the same bucket,” Ho explained. “And in reality, not everything is the same in terms of impact and materiality.”

Unlike internal control evaluations, which distinguish between material weaknesses, significant deficiencies, and minor deficiencies, the PCAOB’s inspection reports do not make such distinctions. This makes it nearly impossible for investors to understand which deficiencies truly matter.

The Disproportionate Burden on Smaller Firms

Christina argued that the current inspection approach unfairly burdens mid-sized audit firms. While the largest firms have a smaller percentage of their audits inspected, firms just above the 100-client threshold face much more scrutiny.

“I personally think that our inspection program is disproportionately burdensome on these firms,” Christina said. This burden is so significant that some firms are intentionally reducing their client base: “They are trying to get rid of their audit clients to get under 100” to qualify for inspections every three years instead of annually.

This creates a troubling situation where firms avoid growth to escape regulatory burden. “I just don’t think it’s good for a very important part of an ecosystem to try to not grow,” Christina said. “We need to make sure we have resilience in the audit marketplace.”

The impact extends beyond individual firms to affect market competition and, ultimately, the capital markets themselves. When mid-sized firms deliberately avoid growth, it concentrates the market among the largest firms—limiting options, especially for smaller public companies.

The Political Fallout

Christina experienced firsthand how deficiency statistics can become political weapons when Senators Elizabeth Warren and Sheldon Whitehouse publicly accused her of “downplaying atrocious findings” after she questioned these metrics in a speech.

“I was very upset about being accused of lying,” Christina told me. “I thought it was very hypocritical of the senators, especially Senator Warren, to essentially bully me because I had a different view from her.”

Rather than reaching out for discussion, the senators sent a letter to the PCAOB Chair, which Christina said left her without “a proper avenue to respond.” This prompted Christina to respond via LinkedIn, where she received significant support from accounting professionals.

This incident highlights how statistics without context can be weaponized in ways far beyond academic disagreements about methodology.

The Search for Better Measures of Audit Quality

Given the problems with the PCAOB’s deficiency rate figures, how should audit quality be measured? Christina suggested several approaches that might be more meaningful:

  1. Look at trends rather than isolated annual statistics. Christina said, “The best way to look at the deficiency rate is not by each year. The best way to look at that data is to be looking at a trend.”
  2. Focus on restatements. Christina said, “Restatements is a much better metric…because that really measures the true impact to investors.” Restatement rates have declined over the past decade, suggesting improvement rather than deterioration in audit quality.
  3. Consider greater transparency. When asked if revealing the names of companies whose audits contained deficiencies would be beneficial, Christina was open to the idea, though she acknowledged the need for broader stakeholder input.
  4. Develop severity ratings. Creating a framework distinguishing between technical violations and substantive errors would provide context for interpreting deficiency findings.

Christina noted that measuring audit quality has been challenging because “audit quality is not quantitatively easily measurable.” And yet, the PCAOB’s approach to deficiencies is to treat all issues identically—regardless of severity or impact.

The PCAOB has been exploring “audit quality indicators” for approximately 15 years but has yet to develop more meaningful metrics. This lack of meaningful data makes it difficult to evaluate the effectiveness of the PCAOB’s oversight or the true state of audit quality.

Has Audit Quality Improved?

Christina believes the PCAOB has helped improve audit quality over the past two decades despite the challenges in measurement. When asked about evidence for improvement, she pointed to declining restatement rates and feedback from audit committee chairs and controllers who report improvements in audit and financial reporting quality.

“If you look at the data on the number of restatements and you look at the last ten, twenty years… restatement has been on the decline,” Christina said. “If you look at the AICPA/CAQ study that they released last year… if you talk to [audit committees], they feel that the audit quality has been improving.”

This more nuanced perspective indicates that, despite the worrying headlines about deficiency rates, the overall reliability of financial reporting might be improving.

Looking Ahead: The Future of Audit Oversight

As artificial intelligence and other technologies transform audits, Christina argues for “a more agile approach” to quality measurement—one that can adapt to technological change and focus on outcomes rather than inputs.

After talking with Christina, it’s clear to me that to move forward, we need to find a balance between regulatory oversight, an understanding of how audits work, and what affects the reliability of financial statements. If we don’t, the profession will get bogged down by misleading metrics that only check compliance boxes rather than enhancing what counts: protecting investors through trustworthy financial reporting.

Want to hear the entire conversation with Christina Ho about PCAOB deficiency rates, audit quality measurements, and her experience with political criticism? Listen to the complete episode of the Earmark Podcast.

Audit Crisis: How Flawed Incentives and AI Are Reshaping the Accounting Profession

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In a recent episode of The Accounting Podcast, we explored alarming trends in audit quality shaking the foundations of our profession. The numbers are stark: the Public Company Accounting Oversight Board (PCAOB) found that Ernst & Young (EY), one of the Big Four firms, has a staggering 37% deficiency rate in its audits. Even PricewaterhouseCoopers (PwC), the “best” performer among the Big Four, has an 18% deficiency rate. These deficiencies are so significant that, according to the PCAOB, the auditors should not have issued their opinions.

As audit deficiency rates remain stubbornly high and scandals shake investor confidence, the accounting profession must confront systemic issues undermining audit quality—including misaligned incentives, inadequate staffing, and outdated practices—to restore trust in financial markets and secure their future relevance.

The Alarming State of Audit Quality

When we discuss a crisis in audit quality, we’re not exaggerating. The deficiency rates reported by the PCAOB paint a troubling picture of the state of auditing in the United States:

  • EY has a 37% deficiency rate—the highest among its peers.
  • PwC, despite performing “best” among the Big Four, still has an 18% deficiency rate.
  • BDO, a top 10 firm, has an alarming 86% deficiency rate.

But what do these numbers mean? A Part 1.A deficiency indicates that the auditor “had not obtained sufficient appropriate audit evidence to support its opinion(s) on the issuer’s financial statements and/or ICFR.” In other words, it means the auditor should not have issued their opinion, and potentially, investors should not rely on it.

This is not just a minor oversight—it’s a fundamental audit process failure. When nearly four out of ten audits at a Big Four firm like EY are deficient, or when 86% of BDO’s audits fail to meet standards, we’re looking at systemic issues that threaten the foundation of our financial markets.

The most common deficiencies relate to basic audit tasks:

  • Performing substantive testing.
  • Testing controls over data accuracy.
  • Evaluating the effectiveness of internal controls.

In essence, auditors are failing to perform the core responsibilities that investors rely on them to perform. These high deficiency rates directly erode investor confidence. When investors can’t trust the audited financial statements, the entire financial reporting and investment system becomes compromised.

Why are these deficiency rates so high? We need to examine the business models and incentives driving audit firms to answer that.

Misaligned Incentives and Flawed Business Models

At the heart of the audit quality crisis lies a troubling truth: audit firms’ business models are fundamentally misaligned with the goal of producing high-quality audits. Instead, they incentivize practices that prioritize profit over thoroughness and accuracy.

One primary strategy audit firms employ to maximize revenue is understaffing. Having the fewest people work on the audits leads to overworked staff and rushed audits, increasing the likelihood of errors and oversights.

EY provides a stark example of this strategy in action. The firm boasts the highest revenue per employee among the Big Four at $383,900. While impressive from a business perspective, it raises serious questions about the firm’s ability to allocate sufficient resources to each audit.

Another concerning practice is the lack of transparency around materiality thresholds. Auditors use these thresholds to determine what issues are significant enough to report. However, these standards are not publicly disclosed and can be manipulated. It’s possible to cover up something undesirable by deeming it “immaterial.” This lack of transparency allows auditors to ignore or downplay significant issues, further undermining the reliability of their opinions.

However, the biggest problem is that auditors lack the financial incentive to detect fraud or significant issues. They have every incentive to do the audit quickly, even if it means overlooking critical problems.

These misaligned incentives and flawed business models directly contribute to the high deficiency rates. They create an environment where cutting corners is rewarded, and thoroughness is penalized, contradicting the fundamental purpose of an audit.

The Supermicro Scandal: A Case Study in Audit Failure

The recent Supermicro scandal provides a vivid example of how systemic auditing issues can lead to significant market disruptions and erode investor confidence.

Supermicro Computing, a major player in the tech industry, recently announced an accounting delay that caused its stock to plummet 19% in a single day. This followed a report by Hindenburg Research, which alleged dubious accounting practices at the company.

Based on a three-month investigation, the Hindenburg report uncovered glaring accounting red flags, including:

  • Undisclosed related-party transactions involving nearly $1 billion were paid over three years to suppliers partly owned by the CEO’s brothers.
  • Rehiring executives involved in previous accounting scandals less than three months after paying a $17.5 million SEC settlement for widespread accounting violations.

But where was Deloitte, Supermicro’s auditor, in all of this? Despite charging $4.5 million annually for their services, Deloitte failed to identify or report these significant issues. Their audit letters for 2022 and 2023 were nearly identical, focusing only on inventory valuation as a critical audit matter.

Adding to the concern, an AI system developed by Hudson Rock had identified potential accounting risks at Supermicro two years before these issues came to light. As my co-host, David Leary, points out, “If AI can surface these audit problems before companies can, people aren’t going to want to pay $4.5 million for an audit.”

The emergence of AI challenges the traditional audit model and demands a reevaluation of how we approach financial oversight.

A Call for Reform

The audit profession stands at a crossroads. The alarming PCAOB deficiency rates, misaligned incentives driving audit firm business models, and high-profile failures like the Supermicro scandal all point to a systemic crisis in audit quality.

This isn’t just an issue for accountants and auditors—it’s a threat to the integrity of our entire financial system. Investors rely on audited financial statements to make informed decisions, and when those audits fail, the consequences can be catastrophic.

The emergence of AI as a potentially more effective tool for detecting accounting irregularities further challenges the traditional audit model. Significant changes are needed—from realigning incentives to embracing new technologies—to restore trust in the audit process and secure the future relevance of the profession.

But change won’t happen without a concerted effort from all of us in the accounting world. We must confront these challenges head-on, push for meaningful reforms, and reimagine what high-quality auditing looks like in the 21st century.

To hear our full analysis, including potential solutions and ways you can make a difference, listen to this episode of The Accounting Podcast.

The Eroding Trust in Audits: Confronting a Crisis of Confidence

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In a stunning courtroom moment, auditing giant BDO argued that its own audit opinions were too generic to be relied upon by investors. This shocking admission underscores a disturbing trend: the rapid erosion of trust in the value of audits.

In this eye-opening episode of The Accounting Podcast, we sit down with accounting professor Ed Ketz to confront the harsh realities facing the auditing profession amidst a crisis of confidence. How have the limitations of audit opinions, the pass/fail nature of audits, and high-profile failures contributed to this erosion of trust? What does the alarmingly high rate of audit deficiencies reveal about the state of the profession? Can the value of audits be restored, or are we facing a fundamental reckoning?

The Limitations of Audit Opinions

At the heart of the trust crisis lies a troubling question: How much value do audit opinions provide investors? In the AmTrust case, BDO made a jaw-dropping argument that strikes at the core of the audit’s purpose. As Prof. Ketz explains:

“Essentially, they said that the audit opinion is just too general. It cannot be refined or dug down into very far, and therefore, it really couldn’t have value. Therefore, they wanted the case dismissed. They said it was not actionable because it didn’t say anything, which is an incredible statement for an accounting firm. They’re basically trying to talk themselves out of a business.”

This stunning admission from an audit firm raises doubts about the usefulness of opinions in their current form. If the auditors themselves disclaim the value of their work, how can investors be expected to rely on it?

The Pass/Fail Problem

The binary pass/fail system of audits has also come under scrutiny as a contributing factor to the erosion of trust. As I pointed out: “When we have this pass/fail system where the bar is seemingly very, very low, and very few companies ever actually fail an audit, we have this system that just doesn’t create much value anymore for investors. If we want the audit to have value and the CPA to be valuable, maybe we should consider changing how we do business to create value for investors.”

The low bar for receiving an unqualified or “pass” opinion fails to provide meaningful information to investors. A more nuanced and informative reporting model is needed for audits to regain trust.

However, Prof. Ketz argues that despite the limitations of the pass/fail model, research suggests audits still provide valuable signals to the market. Studies have found that going concern opinions offer predictive power above and beyond financial ratios alone. UK firms that continued to be audited even when no longer required enjoyed higher credit ratings. So, while the current system is flawed, Ketz cautions against dismissing the value of audits entirely.

Rampant Deficiencies

Compounding the crisis of confidence is the staggering rate of audit deficiencies revealed by regulatory inspections. The PCAOB’s findings of deficiencies in over 40% of audits inspected in 2022 paint a disturbing picture of a profession struggling to uphold basic standards, further eroding public trust.

Can investors trust any audit opinions if 40% of audits are so deficient that they shouldn’t have been relied upon? These findings underscore the need for the profession to get its house in order if it hopes to restore confidence.

High-Profile Failures

Nothing has done more damage to the credibility of audits than the litany of high-profile failures in recent years. From Wirecard to Tingo to Colonial Bank, each scandal has chipped away at public confidence, raising doubts about auditors’ ability to fulfill their essential role.

The Colonial Bank case, in particular, stands out as a damning indictment. As Prof. Ketz notes:

“In that case, PwC was sued by the FDIC, and the FDIC refused to settle the case. Reading Barbara Rothstein, the judge’s opinion, you can see her chastisement. But more to the point, you can understand the over $600 million judgment she levied against PwC.”

Prof. Ketz notes that in addition to regulatory penalties, the tort system plays a vital role in holding auditors accountable. He points to the Colonial Bank case, where PwC faced a $600 million judgment, as evidence that the threat of costly lawsuits can be a powerful deterrent against shoddy audits.

However, such massive failures and the lack of detailed information in audit reports that could help investors understand what went wrong have still affected the profession’s standing.

A Case for Value?

Amid the crisis, it’s crucial to examine the evidence that audits, despite their flaws, still provide value to investors. Research shows that audit opinions improve the prediction of business failures, and data on higher credit ratings for audited UK firms suggest audits aren’t entirely without merit.

However, while this research shouldn’t be ignored, it can’t erase the deep scars on credibility left by failures and deficiencies. While not baseless, the case for audit value faces an uphill battle in the current climate.

Confronting Hard Truths

The erosion of audit trust is not a hypothetical concern – it’s a full-blown crisis threatening the profession’s foundation. Limitations of opinions, binary results, rampant deficiencies, and high-profile failures have all taken a staggering toll.

Rebuilding this lost trust will require a fundamental rethinking of audits conducted and communicated. Band-aid solutions won’t suffice in the face of such deep-rooted problems. The profession must confront hard truths, embrace bold reforms, or risk irrelevance.

This is a conversation the accounting world can’t afford to ignore. Tune in to the full episode to hear more of Prof. Ketz’s insights and join us in grappling with these critical challenges. The future of auditing hangs in the balance.

Why Withum Got Slapped with a $2 Million PCAOB Fine

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The PCAOB’s recent $2 million fine against WithumSmith+Brown, PC has sent shockwaves through the audit profession, and for good reason. A prominent audit firm is in hot water due to severe audit quality issues.

In a recent episode of The Accounting Podcast, I discussed this alarming development with Chris Vanover, a former Big 4 firm chief auditor who now leads CPAClub. Our conversation highlighted the root causes behind Withum’s missteps and the broader implications for the audit profession.

As Chris Vanover pointed out, “I think this is the PCAOB’s shot across the bow, where they’re starting to hammer firms with respect to whether they actually have the resources to execute the audits… The crux of the issue is they didn’t have enough people to get through the significant number of audits they decided to take on.”

SPAC Audits: A Lucrative but Risky Opportunity

Chris highlighted a startling fact from the PCAOB disciplinary order: Withum’s issuer audits skyrocketed from a mere 76 in 2020 to a staggering 445 in 2021 – a nearly 500% increase in just one year! This explosive growth can be attributed to the rise of SPACs, which have become a lucrative opportunity for audit firms as the market for these investment vehicles has soared.

However, the allure of SPAC audits has come with a heavy price for Withum, which failed to properly assess the resources needed to handle such a massive uptick in engagements.

Overworked and Overwhelmed Partners & Staff

Chris pointed out that the firm’s partner headcount only increased from 15 to 23 despite the nearly 500% increase in issuer audits. A mere eight additional partners were expected to handle an extra 369 engagements – an equation that doesn’t balance.

Partners found themselves drowning in an overwhelming number of audits. Chris revealed that according to the PCAOB, just five partners were responsible for a staggering 62% of the firm’s issuer audits, with one partner reported working an astonishing 200 hours in a mere two-week period.

The Consequences: Audit Deficiencies Galore

But the pain didn’t stop at the partner level. Chris said, “Imagine what the ripple effect is for the senior managers, the managers, the seniors, and the associates on the engagement.”

The strain on Withum’s people greatly affected the firm’s audit quality. The PCAOB’s investigation revealed a litany of deficiencies, including inadequate consultation with external resources when faced with complex accounting issues and improper auditing of estimates. These are just a few examples of how Withum’s audit quality suffered due to the firm’s overstretched resources.

Partner Incentives: The Elephant in the Room

As we dig deeper into the root causes of Withum’s audit quality issues, it’s impossible to ignore the role that partner incentives may have played. In many audit firms, partner compensation is heavily tied to revenue growth and client acquisition. This incentivizes partners to prioritize short-term profits over long-term quality and sustainability.

In Withum’s case, the explosion of SPAC audits presented an irresistible opportunity for partners to boost their bottom lines at the risk of creating a toxic work environment. This contributes to staff burnout and turnover and increases the risk of errors and oversights.

As Chris told me, “This is the fundamental issue with audit quality. People are overworked, and they’re missing things that are critically important to executing a qualified audit.”

Was the PCAOB Fine Enough to Deter Future Misconduct?

The PCAOB’s decision to slap Withum with a $2 million fine signals that the regulatory body is taking a harder line on audit firms that fail to prioritize quality, especially considering that the PCAOB also levied a $3 million fine on Marcum in June 2023 for similar problems.

But are these penalties enough to change behavior and deter future misconduct?

On one hand, a multi-million dollar fine like this represents a serious reputational blow. No one wants to be the next firm in the headlines for all the wrong reasons, and the threat of public embarrassment may be enough to spur some much-needed introspection and reform.

However, there are also reasons to be skeptical about the deterrent effect of this fine. Chris argues, “At the end of the day, you need a higher penalty for what they did wrong.”

While it sounds like a lot, a one-time $2 million fine may not be enough to change the calculus for large audit firms, which generate hundreds of millions or even billions of dollars in revenue. Withum brings in $550 million per year. For firms that prioritize profits via their partner compensation model, a fine of this size may be seen as simply a cost of doing business.

How to Build A Stronger, More Resilient Audit Profession

The Withum case is a stark cautionary tale for the entire audit profession, highlighting the dangers of taking on too many engagements without adequate resources.

Only time will tell whether Withum learns from its mistake. We cannot rely on fines to drive meaningful, lasting change. To address these issues, the profession must examine the incentive structures and cultural norms prioritizing short-term revenue growth over long-term quality and sustainability. This may require a significant overhaul of partner compensation models and a renewed focus on talent development, work-life balance, and technological innovation.

For insights from industry experts like Chris Vanover, subscribe to The Accounting Podcast. We aim to spark meaningful conversations and drive positive change in the accounting profession. By coming together as a profession and facing these challenges head-on, we can build a stronger, more trusted, and more valuable audit function for the future. Will you join me?