An Updated Analysis of Enforcement Actions against Engagement Quality Reviewers

Abstract

Engagement quality review (EQR) is designed to be a quality control mechanism for improving the quality of audit engagements. This paper updates the findings of Messier, Kozloski, and Kochetova-Kozloski (2010) on enforcement actions against engagement quality (EQ) reviewers, especially in light of the December 2009 implementation of the new standard on engagement quality review, Auditing Standard No. 7 (AS7). We identified 16 enforcement actions since 2009 that involve some type of sanction against an EQ reviewer. Only two cases involved a Big 4 firm. Thus, the vast majority of cases involved EQRs from smaller public accounting firms. Six cases occurred prior to the implementation of AS7, nine cases occurred after AS7 took effect, and one case involved violations both prior to and after AS7 implementation. All of the pre-AS7 cases involved sanctions resulting from an inadequate EQR. In contrast, all of the post-AS7 cases involved sanctions resulting from a failure to perform an EQR. Our review of these post-AS7 cases suggests that some small firms were either unable or unwilling to bring in qualified outside reviewers. Our findings provide important implications for practitioners, regulators, and researchers interested in engagement quality review and in improving the overall quality of audit engagements.

Opening Up the “Black Box” of Audit Firms: The Effects of Audit Partner Ownership on Audit Adjustments

“…Messier, Kozloski, and Kochetova-Kozloski [2010] identify enforcement actions in which EQ reviewers were sanctioned for a lack of professional care (23 cases), lack of professional skepticism (22 cases), overreliance on management representations (20 cases), and failing to consider materiality (5 cases). In an updated analysis, Kraussman and Messier [2015] find an additional 16 sanctions against EQ reviewers in the period since 2009. Regulators in China have also sanctioned auditors for ineffective EQ reviews.…”

A Review of the PCAOB's Enforcement Program: 2005–2017

“…Gilbertson and Herron (2009, A26) report an average lag of 2.83 years (34 months) as the time between the last day of an inspection review and the issuance date of the disciplinary order. Because our dataset does not include inspection dates, we follow the approach used in Kraussman and Messier (2015) and substitute the last financial statement year in question for the last day of an inspection review. Following this approach, the average lag during Gilbertson and Herron's (2009) 2005-2008 sample period is 3.05 years (approximately 37 months).…”

“…Another set of studies has failed to find an improvement in audit quality related to disciplinary orders issued (Lennox and Pittman 2010;Boone et al 2015). A final set of studies has analyzed inadequate engagement quality reviews reflected in both PCAOB disciplinary orders and SEC Accounting and Auditing Enforcement Releases (Messier, Kozloski, and Kotchetova-Kozloski 2010; Kraussman and Messier 2015). Of the 258 disciplinary orders in our sample, these prior studies have examined 26 of them.…”

Examining PCAOB disciplinary orders on small audit firms: Evidence from 2005 to 2018

“…First, a particular criticism of some small firms is that they are either unwilling or unable to bring in qualified outside reviewers (Kraussman & Messier, 2015). We find, however, that small audit firms may not have the financial or organizational resources to comply with all the applicable rules and standards 26 .…”

“…Regarding the Engagement Quality Review, prior research has focused on describing EQR policies in the major accounting firms or the general EQR process that uses surveys or experiments (e.g., Emby & Favere‐Marchesi, 2010; Epps & Messier, 2007). Given that a particular criticism of some small firms is that they are either unwilling or unable to bring in qualified outside reviewers (Kraussman & Messier, 2015), one implication is that small audit firms must independently enhance their engagement review process in order to improve their audit practice.…”