Doty Seeks Answers to Auditor/Client Conflict and Lack of Skepticism

PCAOB Chair James Doty spoke at a recent audit quality symposium hosted by the Canadian Public Accountability Board about some of the common themes that arise in the regulation of audits, including structural challenges that threaten the relevance of auditing. Doty said the financial audit is the linchpin to investor confidence in the markets, but the PCAOB’s inspections have found that there is room for improvement.

The PCAOB’s inspectors have found instances where firms have failed to understand the assumptions and valuation methods used by their clients to determine the fair value of financial instruments, he explained. The inspectors also have found instances were auditors have not considered the effects of significant differences between their own fair value measurements and those recorded by their clients.

Doty said that internal control audits are not the leading indicators of the risk of misstatements in financial reporting that they are meant to be. Instead, auditors too often rely on imprecise business processes or fail to identify within the flow of transactions where a material misstatement may occur.

Doty said there are two significant issues that audit regulators should address. The first is the payment model in which the auditor is hired and fired by its client company. Some have questioned whether the payment model can be changed, such as having stock exchanges hire and pay the auditors. Doty said that structural reform may be demanded if new scandals erupt and auditors’ ability to remain independent is questioned.

The second issue is skepticism. The absence of skepticism is hard to detect because it is a state of mind, according to Doty, while objectivity is a silent success. He said that too often, audit failures identified by the Board’s inspections do not appear to be based on a lack of knowledge about the necessary steps to take.

Doty pointed to common findings among audit regulators abroad which have cited insufficient professional skepticism where auditors either accept or attempt to validate management’s evidence and representations without sufficient challenge and independent corroboration. The underlying conflict has not been resolved, but Doty believes that auditors can be better insulated from client pressures. He said that regulators must try to find a way before the public demands more structural changes.