The Impact Of the PCAOB Triennal Inspection Process on Inspection Year and Off-Year Audit Quality and Auditor Behavior

• In Event: Impact of Regulators

Abstract

The Sarbanes-Oxley Act of 2002 (SOX) ushered in a new era of government-sponsored auditor regulation. The Public Company Accounting Oversight Board (PCAOB) was created to replace the prior peer review system of self-regulation. As part of its goal of overseeing the audit processes of publicly-held registrants, the PCAOB is allowed to inspect the workpapers of auditors. The PCAOB performs the inspection process on an annual basis for auditors with more than 100 publicly-held clients on an annual basis. For auditors with less than 100 publicly-held clients, auditors are inspected once every three years (i.e. triennially-inspected auditors) with one year being the inspection year and two years being ‘off-years’. We argue the triennial inspection process creates an incentive (disincentive) for auditors to increase (decrease) audit quality during the inspection (off-inspection) years. Using several measures of audit quality and auditor behavior (including accruals, restatements, audit fees, audit report lag and resignations), we show that triennially-inspected auditors tailor their audit approaches and behavior in an opportunistic fashion so as to avoid severe PCAOB inspection reports. More specifically, we document that inspection year accruals are lower and restatement frequency is lower for financial statements audited during the inspection year. Whereas audit fees and audit report lag are higher for financial statements audited during the inspection year. We also find that triennially-inspected auditors are more likely to resign from a risky engagement in anticipation of the PCAOB inspection.

Authors

• William L Buslepp, Texas Tech University

• Lawrence J Abbott, University of Wisconsin-Milwaukee