External auditors face new regulatory and enforcement pressure

Hold onto your butts: Financial and accounting regulators are ramping up efforts to rein in auditor misbehavior and are pushing ahead on revamping outdated auditing standards in 2023. The proposed reforms could have a major impact on the auditing profession, especially as regulators see the risk of fraud rising amidst economic uncertainty, and CFOs will need to pay close attention to the changes.

It’s not hard to see why regulators want to push for changes in the auditing profession. Auditors had some…um, undesirable headlines last year. In June, EY was fined $100 million when a “significant number” of EY audit professionals were caught cheating on ethics exams, of all things. In September, Deloitte paid a $20 million fine when auditors in its Chinese affiliate were found to have let companies conduct their own audits. And the auditors involved in signing off on FTX’s financial statements are already being sued for being “willfully blind” to what the suit calls a pattern of “racketeering” by the crypto exchange.

Along with these headline-grabbing scandals, research shows that audit quality is falling, too. A December report by the Public Company Accounting Oversight Board (PCAOB), a nonprofit corporation under SEC jurisdiction that oversees public company audits and regulates auditors, found that one-third of 2021 audits they examined had deficiencies.

Regulators are looking to change that. PCAOB Chair Erica Y. Williams delivered a warning in a December speech at an audit conference.

“I have said before, and I will say again, the PCAOB means business when it comes to enforcement,” said Williams. “We intend to use every tool in our enforcement toolbox and impose significant sanctions, where appropriate, to ensure there are consequences for putting investors at risk and that bad actors are removed.”

Regulators aren’t just going after bad actors either. There is now a significant push to change the rules of auditing to improve audit quality, catch fraud, and boost investor confidence. SEC Chair Gary Gensler laid out an aggressive agenda to update auditing standards in July of last year.

Sleepytown. Auditing standards and the proposed rulemaking agendas of acronym-heavy government regulators may not be as titillating a read as, say, Prince Harry’s new book. But the emphasis on regulatory changes and increased enforcement of violations, coupled with looming economic uncertainty, are important because it may change how finance departments work with their external auditors, according to one auditing expert.

“Auditor approaches could be different this year,” said Dennis McGowan, VP of professional practice at the Center for Audit Quality. “Maybe the auditors are going to audit something they haven’t audited in the past.”

In an email to CFO Brew, Williams also encouraged CFOs to help improve declining audit quality by becoming more active participants in the audit process.

“Unfortunately, right now, the trendline in audit quality is moving in the wrong direction,” she wrote. “CFOs have an important role to play through their auditor interactions—answer auditor questions and requests timely and thoroughly and do your part to boost audit quality.”

These changes are a long time coming. The PCAOB was created in 2003, as part of the Sarbanes-Oxley legislation, to address accounting and auditing failures in the wake of scandals like Enron, Worldcom, and Tyco. At the time, it migrated contemporary, industry-set auditing standards with the promise to update those standards.

However, most of the auditing standards have not been updated yet and, according to Gensler, are now decades out of date. The PCAOB has prioritized modernizing the standards over the last year and those efforts will pick up in 2023.

Risky business. Two of the PCAOB’s proposed standards updates for 2023 could impact how auditors gather and verify financial information like accounts receivable, bank holdings, and supplier costs from finance departments, a process called confirmation, and boost audit quality controls by implementing more rigorous risk assessments throughout the process. The proposed standard on confirmation is particularly important for fighting fraud, according to the PCAOB.

“During times of economic uncertainty, the risk of fraud is heightened, and auditors have to be more vigilant than ever,” said Williams in a press release. “When done right, confirmation can be a critical tool to help auditors combat fraud and keep investors protected.”

And if auditors will be held to higher standards for confirmation, finance departments will need to be prepared for greater demands from auditors. That also means that the public-company finance departments preparing financial reports for audit will need to pay attention to the changes to help improve audit quality, according to McGowan.

“If you’re not paying attention to the PCAOB standards setting agenda or priorities it might be helpful…to take a look at those things,” he said.—DA