Issues for the Academic Community to Consider

Date: April 16, 2015

Speaker: Steven B. Harris, Board Member

Event: PCAOB/AAA Annual Meeting

Location: Washington, DC

Welcome to the 2015 PCAOB Academic Conference. The Board always benefits greatly from your participation at this forum. I think it is fair to say that by effectively educating future accountants and auditors, you play an essential role in protecting the integrity of financial statements upon which our capital markets are dependent.

Before I continue, let me say that the views I express are my own and do not necessarily reflect the views of the Board or the PCAOB.

Today I will touch on three topics: the evolving audit firm business model; recruitment at the firms and the various new skills sought by the firms; and the importance of diversity in the profession.

I hope that you will consider examining each of these topics in your future research.

Business Model of the Firms

Both the PCAOB Investor Advisory Group and the International Forum of Independent Audit Regulators' (IFIAR) Investor and Other Stakeholders Working Group, each of which I chair, have raised concerns about the rise of advisory and consulting services at the largest accounting firms. Investor representatives are concerned that auditor independence and audit quality could be threatened by this growth.

As you know, the rise in advisory and consulting services in the 1980s and 1990s is generally considered to have fundamentally changed the culture and tone at the top at the firms.

Today we are told that, in some cases, firm leaders may be focusing more on offering broader services to audit clients and less on their core audit services, audit quality, and investor protection.

Following the passage of the Sarbanes-Oxley Act, which prohibited the provision of a number of non-audit services by auditors to audit clients, three of the four major firms divested their advisory and consulting practices.

Since then, however, each of these firms has rebuilt its advisory and consulting practice. And, today, these practices at the Big Four are growing much faster than other service lines.

In 2014, at both the global level and domestically, revenues from non-audit services represented a larger percentage of total revenues than audit services.

Here in the United States, revenues from advisory alone represent a larger percentage of total revenues than audit for the Big Four audit firms, on an aggregate level.[1] Several indicators point to firms wanting to make advisory services an even more pronounced source of revenue in the future.

These developments raise some fundamental concerns for investors, including:

Audit regulators around the world believe that this trend in the profession should be evaluated with considerable care to ensure that the rise in advisory and consulting at the firms do not adversely impact independence and audit quality and hence investor protection.

This topic was discussed by the PCAOB's Investor Advisory Group at its October 2014 meeting and will be a major focus at the meeting of the International Forum of Independent Audit Regulators next week in Taipei.

Concerns about the rise in advisory and consulting were also raised at the last IFIAR meeting held in Washington, D.C. in April 2014 by Ralph Whitworth, then Chairman of the Hewlett-Packard Board of Directors and Founder of Relational Investors LLC.

At that meeting, Mr. Whitworth cautioned that, "audit regulators and audit firms must be constantly reminded of the Enron experience, and related scandals, so that we do not repeat the past." He went on to state: "I'm concerned that audit firms, by increasingly diversifying into non-audit corporate services, are beginning to fall victim to the incentives and dynamics that prevailed in the early 2000s. This will inevitably lead to a decline in audit quality, and likely already has…. To enhance audit quality, audit regulators should ensure that audit firms remain primarily focused on conducting effective independent audits."

So, I encourage you to look at this issue.

Attracting and retaining top talent

A related topic that we continually hear about is the ongoing need for audit firms to attract and retain the best and brightest students to their audit practices. Some firms have justified the expansion of advisory and consulting services as a method to attract top talent for the audit service line.[2] While I do not believe this is the only or best way to attract talent, I agree with the underlying premise that actions need to be taken to ensure top students are attracted to the profession.

In the current market environment, the top students clearly have many options within an audit firm, including choosing to work for practices other than audit. The Board has heard, for example, that some students are questioning their decision to study accounting because of the higher salaries offered by the advisory and consulting practices of the firms.

The audit practices of firms are facing these recruitment challenges at a time when they are also incorporating into their audit methodologies sophisticated data analytical tools through the use of emerging technologies that enable them to examine large amounts of data. As a result, the Board has been told that the hiring by audit firms of students in other fields of study, such as information technology, computer science, organizational change, finance, and statistics has increased in recent years.

We are told that today incoming auditors must possess an ever-expanding portfolio of skills in order to be successful. For example, in a report released earlier this year, PricewaterhouseCoopers identified a number of new skills that incoming auditors must have in addition to an understanding of accounting and auditing.[3] These new skills include:

1. An ability to research and identify anomalies and risk factors in underlying data.

2. An ability to mine new sources of data, and use insights to bring new value to the business.

3. A deep understanding of various types of databases.

4. An ability to use various statistical methodologies, visualization tools and predictive analysis tools. And,

5. An ability to use new data analysis techniques and algorithms to isolate and investigate specific processes that might have led to changes to the data and/or accounting ledgers.

This raises the question of whether accounting programs should be altered in any way to better prepare students who are entering such a rapidly changing audit environment. For example, PwC suggests that data analytics, information systems, and statistics should become an even more integral part of the accounting curriculum.

At the same time, however, there needs to be ongoing focused education regarding the nature of the underlying data and financial analytical training so that there can be insight into the meaning of data with the realization that auditing will always require judgment and insight and, in the future, likely greater analysis.

I leave the feasibility of such changes to you and your respective universities.

In any event, it is clear that the audit firms are moving ahead and using technology in new and innovative ways to potentially enhance the audit by providing 100 percent sampling, and it follows that audit firms now are in need of students graduating with the skill sets to match these enhanced auditing techniques.

All of this raises a somewhat unrelated question, but one that I think also warrants your attention, and that is whether the firms' current pyramid staffing model with relatively few partners and managers overseeing many junior staff presents the best model for auditing large complex organizations, particularly given the growing complexity of audits and the judgment areas involved.

Diversity

Finally, I would like to offer a word about diversity and inclusion in the accounting profession. Last year at this time I noted that although all the major accounting firms, and for that matter many Fortune 500 companies, are increasingly focused on the concept of diversity and inclusion, we continue to hear that minority students are not particularly attracted to the accounting field.

I also noted that, according to the 2012 U.S. Census Bureau Report, by 2043 there will be no single ethnic or racial majority group in the United States as the share of non-Hispanic whites falls below 50 percent.

Since last year, more demographic information has come to my attention related to accounting firms. According to the AICPA's 2013 Trends in the Supply of Accounting Graduates and the Demand for Public Accounting Recruits, the career projection of minorities in accounting firms still lags significantly compared to their white counterparts even though the number of minorities in firms is increasing.[4] I believe that the profession should continue to commit not only to attracting talented minorities to the profession, but also continue to put a high-level focus on creating the sort of inclusive environments where those individuals want to stay, contribute, and feel that they are an invaluable part of the team.

We simply cannot afford old ways of thinking when America is going to look very different in the future.

In addition, a growing body of research continues to show that having diverse work groups leads to greater organizational innovation and also may improve the bottom line of companies. It is quite simply a virtuous cycle of rewards when the accounting profession commits to these core values.[5]

So, I hope you will continue the work of increasing the recruitment, participation, and promotion of underrepresented groups in the profession. Such efforts, I believe, will position the profession well in our rapidly changing demographic universe.

Conclusion

Thank you again for coming today. I look forward to hearing more of your views on actions that the PCAOB should undertake as we continue to work toward protecting investors by improving audit quality.

[1] Sources: EY 2013 Global Review, Deloitte 2013 Transparency Report, KPMG 2013 Transparency Report, and PricewaterhouseCoopers 2013 Transparency Report.

[2] See "Auditing in the ERA of Big Data", Compliance Week, April 2014.

[4] The AICPA's 2013 Trends in the Supply of Accounting Graduates and the Demand for Public Accounting Recruits report is located at: http://www.aicpa.org/interestareas/accountingeducation/resources/pages/default.aspx.