PCAOB Inspection Report of Broker-Dealer Audits

Report Provides Insights for Broker-Dealer Financial Reporting

Per the most recent FINRA Industry Snapshot Report, there were 3,394 broker-dealers registered with the U.S. Securities and Exchange Commission (“SEC”) in 2021. Generally, these broker-dealers are required to file annually, and the auditors of these broker-dealers are overseen by the Public Company Accounting Oversight Board (“PCAOB”). Beginning in 2015 when audits of broker-dealers first became subject to PCAOB standards, the PCAOB has conducted inspections of a sample of all broker-dealer audits and summarizes the results of their inspections in an annual report.

The findings from these inspections can provide insight into the areas in which the PCAOB is most focused. While the findings are primarily geared to assist audit firms, they can also be useful for the management and audit committees of broker-dealers as they engage with audit firms regarding audit quality and broker-dealer financial reporting.

2020 PCAOB Inspection Report

The PCAOB’s most recent Inspection Report was released August 19, 2021, and included the inspection of financial statement audits with fiscal years ending April 1, 2019 through March 31, 2020. Of the 360 total PCAOB-registered audit firms, the PCAOB selected a total of 65 firms for inspection, which is relatively consistent with the prior year. When selecting firms for inspection, the PCAOB uses a combination of a risk-based selection methodology (such as the number of broker-dealer audits performed, results from previous inspections, etc.) and a random selection methodology that provides an element of unpredictability. Based on the information provided in the report, it is interesting to note that approximately 89% of firms that audit broker-dealers perform between 1 and 20 audits per firm per year.

From the firms selected, the PCAOB then selected 105 total audits for review, which is also relatively consistent with the prior year. The PCAOB noted that the number of firms with one or more audit and/or attestation engagement deficiencies decreased 14% from 2019, but this number still remained high as a percentage of firms inspected at 78%.

Insights from the Report Findings

In reviewing the report, Keiter noted the following observations related to auditing financial statements engagements that had the largest percentages of deficiencies and thus reasonably represent focus areas of the PCAOB.

Revenue Recognition

While the number of audit engagements with deficiencies related to revenue recognition declined from 53% in 2019 to 47% in 2020, this by far represents the largest deficiencies area. The significant deficiencies in this area included instances where firms did not perform any procedures for one or more significant revenue accounts, or did not perform procedures to address the assessed risks of material misstatement for one or more relevant assertions for revenue. Additional deficiencies noted included:

• Failing to identify a fraud risk related to revenue or failing to overcome the assumption of revenue recognition as a significant fraud risk
• Failing to plan and design an appropriate sample that was deemed to be representative of the population
• Failing to test the accuracy and completeness of information provided by the broker-dealer as audit evidence either through tests of controls, information, or both
• Failing to develop expectations for substantive analytical procedures that were sufficiently precise to identify misstatements
• Failing to sufficiently test controls to support the reduction of control risk assessments below maximum
• Failing to sufficiently test necessary user organization controls outlined in the service auditor’s report as they related to modification of the nature, timing, and extent of substantive procedures

Leases

Given the recent implementation of Accounting Standards Codification (“ASC”) 842, it is unsurprising that deficiencies with lease accounting represented the second largest area of audit deficiencies at 40% in 2020. Specifically, the deficiencies stemmed from firms not adequately testing the right-of-use assets and related lease liabilities, which include testing the present value calculations of each. For more details on ASC 842 implementation, see Keiter’s article on lease implementation.

Going Concern Considerations

The third largest area of deficiencies resulted from considerations of a broker-dealer’s ability to continue as a going concern. While the number of audits with deficiencies in this area decreased substantially from 67% in 2019 to 30% in 2020, it still represents a large area of focus.

• In order to avoid deficiencies in this area, the auditor must evaluate any conditions that, considered in the aggregate, could provide substantial doubt about the broker-dealer’s ability to continue as a going concern for a reasonable period of time. These conditions could include recurring operating losses, negative cash flows from operating activities, accumulated deficits, declining net capital levels, etc.
• For any instances in which the auditor identifies one of more of these factors, the auditor must evaluate management’s plans to overcome the adverse condition. This would include obtaining evidence and reviewing management’s plans to remediate these conditions, such as the intent and ability of other parties to provide financial support to the broker-dealer.

For more detailed information from the PCAOB’s inspection results, please review the full report on the PCAOB’s website:

• 2020 Broker Dealer Annual Report
• 2020 Broker Dealer Supplementary Information

The Keiter Financial Services Industry team closely monitors these and other industry publications to keep you updated and informed. If you have any questions, please reach out to your Keiter Opportunity Advisor or Email | Call: 804.747.0000.