Robert Kugel's Analyst Perspectives

Over the past three years, the Public Company Accounting Oversight Board (or PCAOB, sometimes pronounced “peekaboo”) has found an increasing prevalence of auditing deficiencies in its inspections of accounting firms. PCAOB was established as part of the Sarbanes-Oxley Act of 2002 in the wake of several major accounting scandals. The agency acts as the auditor of auditors with the objective of being a neutral arbiter of the quality of these inspections. It recently indicated that approximately 40% of audits reviewed in 2022 had at least one deficiency, meaning the audit firm failed to obtain sufficient evidence to back up its opinion. This is up from 34% in 2021 and 29% in 2020.

One common explanation for the increase in deficiencies is the impact of staff turnover, as many experienced accountants and auditors decided to retire early during the pandemic years and have been replaced at audit firms with less experienced workers. Another contributing factor has been the decline in the number of college students pursuing an accounting degree and the percentage of these obtaining a U.S. certified public accountant license.

I suggest that one solution to the audit quality issue is for audit firms to actively support a virtual audit methodology and encourage clients to adopt the same. Remote audits became common during office lockdowns. A virtual audit differs by providing the audit firm’s team with remote access to all necessary systems, such as general ledgers, the consolidation application and close-management software. Read-only permission prevents access to nonessential and confidential information.

Many software vendors offer applications to support a virtual audit. An organization’s risk-management software can fully document audit analysis reviews and sign offs to mitigate fraud, ensure separation of duties and prevent access violations. Such an approach can fully demonstrate to external auditors that systems are in place to monitor security and manage access workflows. Today, technology that reduces the need for on-site examinations is common, including remote teleconferencing, shared data repositories and collaborative document-sharing across and between organizations.

The virtual approach benefits audit firms by substantially increasing efficiency and improving the ability to hire and retain staff by offering better working conditions (spending less time on the road, for example). Organizations that require financial audits achieve similar benefits, minimizing staff time devoted to the audit. And because, in many cases, a virtual audit can enable full testing rather than sampling, it results in higher quality audits and financial statements at potentially lower costs. Ventana Research asserts that this approach will become the norm by the end of the decade and that by 2026, one-fifth of boards of directors will insist on a virtual audit to reduce the annual cost of compliance.

Technology can cut audit staff’s workload to boost productivity. Auditors are likely to find a significant share of their clients will embrace this approach because it can reduce the time they spend completing the process, increase the productivity of accounting staff and help reduce fees to best-in-class levels. The virtual audit structure also enables a continuous audit, where tests and tasks are spread out over a fiscal year to better balance the need for resources to avoid period-end spikes. As a result of the change in work patterns accelerated by the pandemic, audit firms are already doing this to some extent. However, a virtual audit that enables remote access to client systems broadens the scope of how testing and reviewing calendars are structured to better level workloads over a fiscal year.

The virtual audit is consistent with our continuous accounting methodology, an approach to managing the finance function that enables executives to transform how their organization operates to improve productivity while ensuring financial statement quality with less effort. Information technology has been at work keeping the books of organizations since the 1950s, but until recently, it was incapable of making fundamental changes to basic accounting and auditing methods because systems were really nothing more than a digital iteration of centuries-old analog methods.

The financial close process is a case in point. With paper-based journals and ledgers, the most efficient way of managing the books while ensuring financial control was to have a monthly routine of “balancing the books” and a more extensive and detailed quarterly or semiannual process. In those days, taking staff accountants offline daily or weekly to do all the adding, allocating, reconciling, ticking and tying would be monumentally inefficient, with limited benefit to the quality of financial statements or management’s understanding of organizational performance. For decades, digital systems were incapable of transformation because technology limitations forced accounting software to operate in batch mode, and most of what improved were transaction speed, scalability and system downtime.

Auditing is at a crossroads. Artificial intelligence will not put robots in charge of accounting departments, but it will eliminate a substantial amount of the robotic work that accountants do. In turn, this will have a profound impact on an audit firm’s business model, forcing it to abandon billing structures based on maximizing low-value hourly compensation. Technology can transform how auditors work to address the current shortage of experienced workers. Software can make the auditing profession more attractive by significantly reducing the need for junior auditors to do soul-deadening repetitive rote work. A continuous audit methodology can also improve the quality of the work staff performs by reducing the cause of errors and oversight at their source. I recommend that auditors embrace technology to its fullest and adopt a continuous audit methodology.

Regards,

Robert Kugel