Are CPAs ready for PCAOB Inspections? Prior to 2004, the AlCPA conducted a mandatory peer review on selected firm on a three-year cycle. Contradictory views existed about whether the peer reviews benefited or not the accounting firms and the users of the audited financial statements. Some academic researchers believe that the AlCPA's peer review processes have benefited the accounting firms. Others thought that the process was ineffective due to peer reviewers were not independent and the system was nonpunitive. Despite criticism, the AICPA continues its peer review program to monitor the members (CPA firms auditing private companies) audit quality. With the occurrenee of the fraud incidents of Enron and WorldCom and their auditors (Arthur Anderson), the SEC announced plans to overhaul the regulation of public accounting firms, and the U.S Congress passed the Sarbanes-Oxley Act of 2002 (SOX), which established the Public Company Accounting Oversight Board ( PCAOB ) and mandated that the organization to inspect the auditing firms performing the examination and review of the financial statements for listed companics. PCAOB auditors inspect the accounting firms" audit papers and assess their audit quality. The process intends to put a stronger grip and review on the internal controls of accounting firms and their quality of audits. PCAOB targets riskiest engagements, more specifically evaluates an accounting firm's quality control and reviews high-risk areas of high-risk audits. Upon completion of an annual inspection, PCAOB issues a report to the accounting firm. Without identifying the issuers (clients of the accounting firm), PCAOB will publish on its web link (www.pcaob.org) the date of the report, major deficiencies, the firm's responses, and date of respenses. Thus, the inspections reports prepared by PCAOB reveal the nature of audit deficiencies in the engagements and assignments undertaken by auditing firms registered with PCAOB. The audit deficiencies included in such inspection reports would have negative effects on the audit quality. The inspection process represents a fundamental change in regulating the public accounting firms from a self-regulated regime by the American Institute of Certified Public Accountants (AlCPA) to a statutory regulation. The creation of the PCAOB's investigation processes address key ineffectiveness of the AICPA's reviewing processes. First, the PCAOB's inspection staff is independent that means, inspectors are prohibited from being active auditing practitioners. Second, the PCAOB has investigative and disciplinary authorities over registered accounting firms that fail to comply with SOX, the rules of the PCAOB and the SEC, and other rules, laws, and professional standards. For unintentional violations for example negligent acts, the PCAOB has the authority to levy fines up to $100000 per person and up to $2000000 per firm. For intentional violations, the amounts increase to $750000 and $15000000, respectively. The PCAOB also has the authority to prohibit or to suspend an accounting firm from conducting audits of public companies by mean of suspension or revocation of accounting firms" registration. The change from being a self-regulated industry to a statutory regulated means a trade-off of independence. Being independent, the PCAOB has more authority than AICPA for the oversight organization is authorized to impose penalties on failing auditors and to prohibit a firm from conducting an audit for a listed firm. Failing to comply will bring shameful effects on the firm in terms of reputations and images. On the other hand, inspectors may be under pressure to be critical of the others' audit 1 work. The critics, pressure and unwarranted exposures may discourage some firms, in particular medium sized firms from accepting audit and assurance services for listed firms. Some academics believe that the inspection process promotes leaming and mentorships. Inspectors discuss issues with accounting firm representatives and provide formal feedbacks on audit deficiencies and on the firms' quality controls, while the inspectors could mentor the others on audit quality and audit approaches. Detailed examinations of the inspection reports (see http:ilpcaob.org/inspections/public_reports/index.aspx) help reveal audit deficiencies that may undermine audit quality, and areas that firms and the audit profession could learn and progress in the techniques and approaches. PCAOB was intended to improve the firms' audit quality and to project the audit quality and confidence, and the firms' accountability and trust to the stakeholders in particular the stockholders. Many of the inspection reports published by PCAOB on its website report the types of audit deficiencies, accounting restatements and departures from Generally Accepted Accounting Principles (GAAP) to inadequate documentation and insufficient testing. Many inspection reports indicate lack of sufficient and competent evidential matter to support the audit opinion on the issuer's financial statements. In some instances, audit firms failed to follow up on post balance reviews and disclosures, and lack of sufficient and reliable evidence to support audit opinions. Students are required to pinpoint the common, recurring audit deficiencies, while providing a general understanding of the overall inspection reports and allowing readers to avoid similar erroneous and failing on audit quality. Students should focus their understanding and analysis of the selected inspection reports of the big four public accounting firms showing any significant differences on audit quality for these firms based on the content of the PCAOB inspection reports. Students should follow the PCAOB's definition of audit deficiencies which are "those with lack of sufficient and competent evidential matter to support the audit opinion on the issuer's financial statements. " Examples of the type of deficiencies reported by PCAOB during its years of reporting include: - Audit firms failed to follow up on post balance sheet reviews and disclosures. - lack of sufficient and reliable audit evidence to support audit opinions. - Audit firm failed to perform a procedure required during an interim or annual audit such as test impairment for fixed assets or intangibles and test general computer controls. - Absence or poor documentation to support specific transactions related to an issuer's activities or decision to make a restatement of the issuer's financial statements. - Ineffective role by the principal audit when performing a group audit with related component auditors. - Failure to project misstatement results of a sample related to the firm's testing of revenue, to the items from which the sample was selected. - The failure to perform sufficient audit procedures related to revenue, including the inadequate performance of substantive analytical procedures. - The failure to perform sufficient procedures related to the existence of accounts receivable. - The failure to perform sufficient audit procedures with respect to income tax contingencies. - The failure to perform sufficient audit procedures to test the existence of the issuer's investment securities. - The failure to perform sufficient audit procedures to test the issuer's information technology (IT) change management controls and processes. - The failure to perform audit procedures to test legal liability accruals and related disclosures relating to litigation, claims, and assessments. - The failure to perform sufficient audit procedures to test the existence of cash and investment securities. - The failure to perform sufficient audit procedures with respect to cash and cash equivalents. - A chairperson of an issuer misled the board of directors in the disclosure of and reporting of financial information including "inflated cash and bank balances, non-existent accrued interest, an understated liability, an overstated debtors " position, and overstated revenues covering certain reporting periods." Such deficiency would have negative effects on the firm's quality control system. Students should examine and assess the audit firm's response in each inspection report, regarding any disagreements to the PCAOB's findings included in the draft report (if any). The question would be whether audit firms acknowledge the PCAOB's findings or objected to such findings providing proper justifications considering the requirements of PCAOB's auditing standards and other related requirements. Other question would be whether audit firms provide action plans or penalties that they face. Students are required to assess whether the two inspections reports selected for investigation and the inspection process in general have enhanced audit quality as well as may have negative impact on the client or the issuer's stock prices and reputation