U.S. Big 4 Audit Deficiency Rates Remain Steady; Gap Widens Compared to Non-Big 4 Firms

PCAOB Also Provides Enhanced Reporting With the 2023 Inspection Reports

Introduction

Last week, the Public Company Accounting Oversight Board (“PCAOB”) published its 2023 U.S. inspection findings (“Inspection Reports”) including reports for the “Big 4” public accounting firms: Deloitte, PwC, EY, and KPMG. In a press release, the PCAOB noted the August release was earlier than prior releases, which was a welcome improvement as the 2022 reports were not made public until February 2024. The 2023 release was also accompanied by a detailed PCAOB staff “Spotlight” publication that provides an overview of staff observations from the 2023 inspections as well as links to enhanced year-over-year reporting for certain U.S. audit firms.

In this article, we summarize the Big 4’s U.S. Inspection Report results over the last five years, provide a comparison to non-Big 4 U.S. inspection results over the same period, and also provide data on Big 4 Non-U.S. inspection outcomes. We also discuss some of the enhanced reporting by the PCAOB that accompanied the 2023 results that we believe is useful for evaluating audit firm overall performance.

Big 4 Audit Deficiency Trends

The deficiency rates discussed herein are based only on audits selected by the PCAOB for inspection. The PCAOB selects audits based on its evaluation of the registrant, accounting firm considerations (for example, the audit firm’s inspection history), and audit areas for each registrant that the PCAOB believes have heightened risk of material misstatement. Of note, in addition to risk-based audit selections for inspection, the PCAOB also makes random selections.

Big 4 U.S. Audit Deficiencies: 2019 – 2023

The overall U.S. Big 4 deficiency rate of 25.7% in 2023 was almost identical to the 2022 deficiency rate (25.6%), which are both an increase from 2021 (16%) and 2020 (12%).

When focusing on individual firms, Deloitte and PwC performed the best in the 2023 inspection year at 21% and 18%, respectively, however both firms experienced deficiency rate increases compared to the prior year. EY and KPMG experienced year-over-year decreases of their deficiency rates in the 2023 year as compared to 2022, with KPMG coming in at the Big 4 average for the 2023 inspection year at 26% and EY above the average at 37%.

The following graph illustrates the deficiency rates for the Big 4 over the last five inspection years compared with the Big 4 average deficiency rate:

We noted the following trends for the Big 4’s U.S. inspections:

• PwC’s deficiency rate increased year-over-year for a third straight year, nearly doubling each year from a 2% deficiency rate in 2020, to 4% in 2021, to 9% in 2022 and 18% in 2023. Despite this upward trend in deficiency rates, PwC had the lowest deficiency rate of the Big 4 for the fourth straight year (2020 to 2023) after having the highest deficiency rate among the Big 4 in 2019 (30%).
• Deloitte’s deficiency rate also rose year-over-year for the third straight year, from 4% in 2020, to 13% in 2021, to 17% in 2022 and 21% in 2023. Over the last five years, Deloitte had the second lowest average deficiency rate of 13%, trailing only PwC at 12%.
• KPMG had a deficiency rate of 26% in 2023, continuing a consistent track record of deficiency rates between 25% and 30% over the last five years. This follows the prior five-year period from 2014 to 2018, when its average deficiency rate was 44%.
• After EY’s deficiency rate more than doubled in 2022 to 46% from 21% in 2021, it decreased to 37% in 2023. These deficiency rates of 46% and 37% in 2022 and 2023, respectively, are EY’s highest since 2013, when it had a deficiency rate of 49%.

The Big 4 deficiency rate over the last five years was approximately 20%, vastly better than the non-Big 4 firms that are inspected annually. The graph below summarizes the Big 4 deficiency rate average compared to non-Big 4 U.S. firms that have annual inspections, which includes the following firms: BDO, Grant Thornton LLP, Marcum LLP, RSM US LLP, Crowe LLP, WithumSmith + Brown, PC, Moss Adams LLP, Baker Tilly LLP, B F Borgers CPA PC, and Cohen & Company, Ltd.

As depicted in the graph, audit deficiency rates for non-Big 4 annually inspected firms have steadily increased over the last several years. The deficiency rate held steady at 34% in 2019 and 35% in 2020 before jumping to 43% in 2021. This upward trend persisted, with rates climbing to 50% in 2022 and 53% in 2023, widening the gap compared to U.S. Big 4 firms whose average deficiency rate in 2023 of 26% is roughly half that of non-Big 4 firms (57%).

Non-U.S. Big 4 Audit Deficiencies: 2019 – 2023

For the 2023 inspection year, the PCAOB inspected between 12 and 35 non-U.S. audits for each of the Big 4, totaling 89 audit inspections, or just under 28% of the 319 Big 4 inspections during the period. The overall non-U.S. 2023 deficiency rate was 26%, which was equal to the Big 4’s overall U.S. deficiency rate.

As shown in the table below, PwC had by far the lowest non-U.S. deficiency rate of approximately 8% in 2023, while KPMG had the second lowest at 14%, followed by Deloitte at 21%. EY had the highest non-U.S. deficiency rate at 40%. When averaging the non-U.S. deficiency rates over the last five years, the Big 4 firms rank as follows (from lowest to highest average deficiency rate): Deloitte (22%), PwC (23%), EY (31%), and KPMG (35%).

When we analyze non-U.S. Big 4 inspections by country over the last five years, we observe that a total of 515 inspections were conducted and that a wide range of deficiency percentages existed by country over this timeframe. The following table lists the deficiency rates by country for the five-year period 2019 to 2023, ordered by highest deficiency rate, and only separately listing countries that had more than 10 inspections over the five-year period:

As shown in the table above, inspections of registrants domiciled in the People’s Republic of China (“PRC,” which includes mainland China and Hong Kong) had the highest audit deficiency rates of any country at 68%. Notably, this deficiency rate reflects only the last two years as China and Hong Kong have only recently started to undergo PCAOB audit inspections. Also, 2023 was a stark improvement for PRC with a 57% deficiency rate, compared to the PRC’s deficiency rate in the 2022 inspection year of 88%. ?

Overall, the average deficiency rate for non-U.S. Big 4 inspections was 29%, with PRC at 68% and Panama at 50% topping the list. Audit inspections conducted on entities domiciled in Greece and Bermuda had a 0% deficiency rate over the last five years spanning 26 audits. Other countries with low deficiency rates included Singapore (7% across 15 inspections), Taiwan (10% across 21 inspections), and South Korea (13% across 15 inspections).

PCAOB Debuts Enhanced Reporting and Analysis

In addition to more timely reporting in the 2023 inspection year, the PCAOB has enhanced the depth of its reporting and issued a spectator “Spotlight” report which breaks down the inspection data and provides readers with significantly more information than prior years. Specifically, the Spotlight report includes:

• Comparisons of performance between specific Global Network Firms and Non-Affiliated Firms over time,
• Analysis on emerging business risks and guidance on how auditors can address these risks in the future,
• Recent inspection enhancements such as new strategies, increasing the number of engagements reviewed as well as improvements to timeliness and scope,
• Detailed examples of deficiency scenarios describing the root cause of the deficiency.

The PCAOB also released inspection data for U.S. Global Network Firms and Non-Affiliated Firms which contains detailed graphic information on deficiency rate, audit selection method, audit areas affected, types of deficiencies, deficiencies by auditor /audit partner tenure, and other metrics that allow the reader to compare results among U.S. Global Network Firms (Big 4 plus BDO and Grant Thornton) and among the U.S. Non-Affiliated Firms (the remaining U.S. firms listed in this article which have annual inspections).

Notably, the Spotlight report and the inspection data links are a significant enhancement to prior inspection report years where data was available in the individual firm inspection reports, but it was incumbent upon readers to aggregate, analyze and draw insights from the data. This enhanced comparative reporting will be extremely helpful for audit committees to evaluate relative audit firm performance. In fact, the 2023 Spotlight report also lists several questions for audit committees to consider asking their independent auditor in light of their auditor’s performance, including the following:

• What are the pros and cons of audit tenure?
• How does the firm ensure non-U.S. affiliate personnel, staff from other areas of the firm, and/or other auditors used on the engagement maintain their independence?
• How does the firm ensure affiliates outside the U.S. follow PCAOB standards and rules, when required, on referred work related to the group audit?
• What were the results of your most recent remediation efforts with the PCAOB?
• Does the firm have any new initiatives related to improving audit quality?

Conclusion

Big 4 audit firm deficiency rates in the 2023 inspection year are consistent with 2022 in the U.S. and are decreasing overall outside of the U.S. However, overall, the rates are still higher than the lows achieved in the past, and the PCAOB and SEC continue to pay close attention. As such, similar to 2023, we expect the 2024 audit inspection process to be a challenging time for audit firms given the increased scrutiny.

On a positive note, the PCAOB provided the 2023 inspection results significantly faster than prior years, which, combined with the PCAOB’s enhanced reporting of audit deficiencies by firm, vastly improved the quality of information available to make audit firm decisions and evaluations.

We look forward to reporting on future PCAOB Inspection Reports as they are released.

Rob Lashway, CPA, ABV, CFF is a Partner and Matthew Schuster is an Associate at Floyd Advisory. Floyd Advisory is a consulting firm with offices in Boston and New York City providing financial and accounting expertise in areas of SEC reporting, transaction advisory, investigations and compliance, litigation services, data analytics, as well as business strategy and valuation.