The biggest barrier to improving audit quality may not be new regulations, but the complexity of implementing quality-control improvements within accounting firms. A new study from Gies College of Business finds that internal resistance to change, competing priorities, and implementation challenges create more tension around these improvements than external regulatory pressure does. These tensions can make meaningful enhancements hard to achieve.
The study’s authors – Christie Hayne (right), Mark Peecher, and Dan Zhou from Gies College of Business and Jeffrey Pickerd from BYU’s Marriott School of Business – report their findings in “Managing Quality Control System Changes: How Audit Firm Leaders Experience and Navigate Conflicting Institutional Demands,” in the American Accounting Association’s flagship journal, The Accounting Review.
Why Audit Firms Struggle to Implement Quality Control Changes
Federal law requires regulators to evaluate and report on firms' quality control systems as part of their inspection processes. However, regulators privately communicate quality-control defects to audit firms, initially giving them a chance to remediate them. The investing public learns about these specific defects from regulators only if firms fail to satisfactorily remediate them within 12 months, which occurs relatively infrequently.
Therefore, for this study, the researchers relied on interviews with QC leaders and users who voluntarily participated to get the bigger picture of how they work with others to prevent these defects and try to implement QC enhancements proactively.
“We’re really fortunate at the University of Illinois to have great alumni networks and Big Four firm support,” Hayne said. “Because it’s a topic that hasn’t really been examined previously, they were just as interested as we were in the study.”
“Going into the project, we thought tensions would be more between the accounting firms and regulators since oftentimes firms and regulators have different perspectives on QC systems,” Zhou (right) said. “However, almost all of the responses identified tensions within the accounting firms.”
In the United States, the Public Company Accounting Oversight Board (PCAOB) and even some international regulators recently updated the QC standards after years of the status quo. While the Sarbanes-Oxley Act of 2002, which established the PCAOB, ignited numerous changes in performing specific audit engagements, it did not ignite changes in QC standards over firms’ portfolios of audit engagements.
“The quality control standards were updated for the first time in 20 years,” Hayne added. “What I think is special about the study is that while this new standard came out with very prescriptive, detailed guidance, very little is publicly observable about how firms actually manage quality control systems and changes to quality control systems internally.”
“With the recent change in the nature of audit, including the increasing use of technology and the outsourcing of services, QC systems are even more important in the changing environment,” said Zhou on the motivation for the study.
What the New PCAOB Quality Control Standards Mean for Firms
After interviewing 27 QC leaders and eight QC users, the research found tensions in the following areas:
- Balancing stability with constant improvement and resistance to change
- Evaluating the costs and benefits of new initiatives given the challenges of measuring audit quality
- Shifting from a reactive to a proactive approach
- Managing differences between global firms’ requirements and local offices responsible for implementing those requirements
“Obtaining buy-in was the most significant challenge. We found that quality control leaders are spending a lot of time building buy-in,” Hayne noted. “In terms of the negotiation or balancing exercise when thinking about the different offices (local firms vs. international firms), a quality control system is not a one-size-fits-all.”
“Measuring and monitoring quality control systems is very difficult,” she added. “What are the metrics to pay attention to? Maybe in the coming years, firms will identify better ways to evaluate their quality control systems internally.”
“It came through clearly in the interviews that firms and these quality control leaders want to anticipate future risks and be proactive, but in practice, they are often pulled toward reacting to, for example, inspection findings (regulatory pressure) and other emerging problems,” Hayne said. “As a result, the QC leaders describe being caught between putting out fires today versus investing in changes that might be helpful to prevent the fire tomorrow.”
Practical Strategies for Building Better Audit Quality Systems
In addition to identifying the challenges, the paper offered a few strategies to shift to a more proactive approach.
- Using data and evidence-based reasoning to justify the changes
- Creating committees to manage change
- Piloting programs on select engagements before making broad, permanent changes
- Carefully managing the timing and frequency of changes (Issuing fewer changes now and letting users be more involved in how they should implement the changes.)
“Because the change has to happen, the conversation is not whether we adopt this change, but rather how we explain it,” Hayne said. “They can use data, analytics, and root cause analyses to legitimize the change.
“If you are going to do a pilot within a firm, the firm needs to see if this change is appropriate,” she added. “At the same time, the pilot can demonstrate to users, who may not have wanted the change, that it can be effective.”
“One interesting feature about the accounting firm is that it is a partnership-based structure,” Zhou said. “Because of that, the QC leaders need to be more sophisticated and subtle in implementing or persuading the QC users. That is why they need more sophisticated strategies, such as scientizing, to show that this is the right thing to do.”
A powerful aspect of our approach is that the researchers interviewed both QC leaders and auditors who lead specific audit engagements, or QC users, to look for systematic agreements and divergent views.
“The QC users reinforced the tensions mentioned by most QC leaders, but more poignantly emphasized that the timing of communicating QC changes is critical,” noted Peecher (right). “The message was to headquarters to get news of upcoming changes to audit partners in the field early in the audit cycles, as late-breaking changes create more angst and even pushback. That message is striking as it reinforces one of the problematic aspects of external regulators’ approach, which comes in well after the pertinent audit cycles have concluded. That’s far too late for firms who are interested in upping the quality of the audits in any across-the-board sense to improve investor confidence in our capital markets.”