Written by Steven Randall, Partner, Vonya Global
An article published in the Journal of Accountancy on December 17, 2013 highlighted that the PCAOB is focusing a lot of attention on auditing of internal control over financial reporting. The Center for Audit Quality lists internal control over financial reporting as one of its primary key risk areas of external auditor’s work heading into the 2013 audit cycle.
The PCAOB conducts annual audits of the Public Accounting Firm’s financial statement audit process. The results of the PCAOB audits were discussed in a speech given by Jeanette M. Franzel, PCAOB Board Member, on Oct. 13, 2013 at the NACD Board Leadership Conference 2013. During her speech, Ms. Franzel stated that relative to internal control over financial reporting “the external auditor failed to gather sufficient audit evidence to support the audit opinion” in 36% of audits during the 2011 audit cycle and 37% of audits during the 2012 audit.
Ms. Franzel is not stating that the public accounting firm financial statement opinion was wrong, rather that there was insufficient work completed to formulate the opinion. If there is insufficient work to formulate an opinion, the opinion becomes unreliable. An unreliable opinion should send a warning signal to investors.
The response by the public accounting firms this year has been to significantly increase internal control testing. The burden falls onto the external audit client (the publicly registered company) to provide evidence of risk assessments, internal control design, and internal control effectiveness. This results in increased time commitment from both the auditors and the audit client. Audit fees for the accounting firms are increasing as is operating costs for the audit client. The combination of these two unintended consequences is placing an onerous burden on public registrants.
As investors, we want to rely upon the accuracy of financial reports, which inherently means we want to rely on the effectiveness of internal control over financial reporting. Audit Committees are charged with the responsibility to maintain oversight on the accuracy of financial reports, which also inherently means assuring the effectiveness of internal control over financial reporting. The Audit Committee can’t do this alone; they must heavily rely on the public accounting firm opinion and there is a significant problem if the audit approach is unreliable.
There is an obvious answer to this. There is a group, typically in-house, charged with the responsibility to evaluate the effectiveness of internal control over key risk areas of the corporation, including financial reporting risks. This group has a time tested methodology for assuring the reliability of their work. This group has a set of professional standards they must adhere to while completing their work. Best of all, the public accounting firms can place reliance on the work of these qualified and accredited individuals reducing the amount of time public accounting firms spend on the audit. This group is the Internal Audit Department.
So Audit Committees, who can you rely on? Your Internal Auditors.
This blog post was authored by Steven Randall. Steve is a Managing Partner with Vonya Global, a premier provider of internal audit co-sourcing, outsourcing, and consulting services; a member of the Institute of Internal Auditors (IIA) Chicago Chapter Board of Governors; a Director of the Adler-Caris Foundation, a not-for-profit dedicated to raising funds for Alzheimer’s Disease research; the President of the Oz Park Baseball Association, a not-for-profit organization dedicated to providing fundamental based baseball in a safe environment in the city of Chicago; and an Advisory Board Member of the Chicago Youth Baseball Initiative, a University of Illinois at Chicago community group dedicated to providing Chicago youth with the opportunity to play baseball in a fun and safe environment, while offering educational experiences on a world-class college campus. If you would like more information about Vonya Global or if you have a question for Steve, you may contact him through this blog, the company website, twitter, or his LinkedIn Profile.