Earmark CPE

Earn CPE Anytime, Anywhere

The Accounting Podcast

The Eroding Trust in Audits: Confronting a Crisis of Confidence

· ·

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.

Navigating the Crossroads: How the Accounting Profession Can Thrive in a Rapidly Evolving Landscape

· ·

The accounting profession is at a critical juncture, facing unprecedented challenges and opportunities in a world that’s changing faster than ever. As co-host of The Accounting Podcast, I’ve been diving deep into the pressing issues confronting our profession, and it’s clear that we need to embrace innovation and adaptation to stay relevant and thrive in the face of change.

In episode 376, my co-host David Leary and I tackled two issues related to these challenges: The 150-hour rule and billable hours. Here’s a summary of our discussion. For more, I encourage you to listen to the full episode.

Challenging the Status Quo: The Debate Over CPA Licensure Requirements

One of the most heated debates in our profession right now is around the 150-hour CPA licensure requirement. In Minnesota, there’s a proposed legislation to create an alternative pathway to the CPA license, requiring 120 credit hours and two years of experience instead. This challenges the long-standing 150-hour rule and has sparked a lot of discussion in the accounting community.

Jen Leary, CEO of CliftonLarsonAllen LLP, testified in support of this change, saying, “There are multiple studies that show that the 150-hour requirement has created barriers for students, especially minority students, to becoming CPAs. There is no evidence that the 150-hour requirement has improved the quality of the profession. We have the power to change this.”

If this legislation passes, it could inspire other states to explore innovative solutions to the challenges facing the CPA pipeline. It highlights the importance of reevaluating traditional models of education and credentialing to ensure they remain relevant, accessible, and equitable in a changing world.

Beyond Billable Hours: Reimagining the Business of Accounting

Another hot topic in our profession is the billable hour business model. It’s been a staple of the accounting profession for decades, but it’s increasingly scrutinized for its impact on employee well-being and work-life balance. 

As I’ve argued passionately on the podcast, “It all comes down to the billable hour. Treating people like machines that churn out hours like widgets. The firm is built to overwork you, to get as much as possible out of you like you are a machine.” If we want to address the cultural issues in our profession, we need to explore alternative business models that prioritize employee well-being and work-life balance.

Embracing Change: The Way Forward for the Accounting Profession

From rethinking CPA licensure requirements to reimagining the business of accounting firms, the profession faces significant challenges and opportunities in the years ahead. As societal expectations around diversity, inclusion, and work-life balance continue to evolve, the profession must be willing to question long-standing assumptions, explore innovative solutions, and chart a new course forward.

To dive deeper into these critical issues and join the conversation about the future of the accounting profession, be sure to listen to the full episode of The Accounting Podcast.

Why Withum Got Slapped with a $2 Million PCAOB Fine

· ·

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?