Dive Brief:

• The Public Company Accounting Oversight Board (PCAOB) revealed its inspection goals for 2022, warning of rising audit risks from disruptions including supply chain bottlenecks, harm to businesses from COVID-19 and market volatility fueled by high inflation and rising interest rates. 
• “We developed our 2022 inspection procedures to focus on anticipated financial reporting and audit risks that are primarily driven by the recent economic environment,” according to a statement by PCAOB, the federal watchdog of firms that audit publicly traded companies.
• Staff shortages at audit firms and trends in initial public offerings and mergers and acquisitions —  including by special purpose acquisition companies (SPACs) —  also increased audit risk and influenced PCAOB goal-setting, the agency said. “The current economic environment changes the risk landscape,” potentially increasing the incidence of fraud and other wrongdoing.

Dive Insight:

PCAOB said it will focus inspection audits on banking, energy, information technology and other industries that pose higher risks because of “the complexity and judgmental nature of the financial statement accounts and related internal controls.”

PCAOB inspectors will determine whether auditors sufficiently vetted financial statements for unreasonable assumptions used in the timing and amount of revenue recognition, and in projections to account for M&A or impairment of goodwill and intangible assets because of changes in the economy, the agency said.

Inspectors will look for earnings manipulation stemming from inflation-induced harm to profit margins and from other business headwinds, and for signs that supply chain constraints have prompted distortions in valuation of in-transit inventory.

PCAOB will also try to unearth evidence that auditors lack independence from their clients. “In our inspections, we continue to identify a high rate of deficiencies that suggest some audit firms may not have appropriate quality control systems in place to provide reasonable assurance to prevent violations of SEC and PCAOB independence rules,” PCAOB said.

Some PCAOB inspections will review the auditor’s technology management, including governance, hardware, software, communications, training and the experience level of personnel. The oversight will especially focus on digital assets, response to cybersecurity threats and use of data in the audit.

Auditors should consider how Russia’s invasion of Ukraine may increase the complexity of financial statements, PCAOB said. The war and subsequent sanctions against Russia have incurred direct and indirect losses at many companies that may be difficult to accurately measure.

Also, auditors should track a potential increase in fraud risk from the move by companies to remote or hybrid work, PCAOB said.

Audit firms have faced sharp scrutiny in recent years from both their clients and regulators.

The Securities and Exchange Commission (SEC) fined Ernst & Young $100 million for cheating by its auditors on ethics exams and for withholding evidence of wrongdoing from the agency’s enforcement division. The penalty is the largest ever imposed on an audit firm, the SEC said on June 28.

The SEC finding is the second instance of wrongdoing identified by the agency in recent years among the Big Four accounting firms that audit the books of public companies.

In June 2019 the agency announced that it fined KPMG $50 million for widespread cheating on internal training exams, including the sharing of answers and manipulating results. The agency also said former KPMG partners had obtained a stolen, confidential list of audits that would be the target of reviews by PCAOB.

More recently, PCAOB released a report describing concerns among audit committee chairs toward their external auditors over such issues as cost management, sub-optimal use of technology and “last-minute pileups” of workflows.

Several audit committee chairs said they want their auditors to better manage costs, reduce turnover of the audit engagement team, provide prompt notification of cost overruns, broaden use of technology and improve communication with internal audit staff, PCAOB said in March.