Does the PCAOB’s Quality Control Remediation Process Promote Audit Report and Financial Statement Reliability?

Abstract

Part II of the Public Company Accounting Oversight Board (PCAOB) inspection report is released one year after the initial inspection report (Part I) only for firms that fail to remediate quality control criticisms (QCC firms). We provide evidence that the release of Part II discloses new relevant information about a firm’s disregard for maintaining an effective quality control system. More specifically, we find that QCC firms have lower audit quality in terms of restatements after the PCAOB provides their inspection findings than those firms that address their criticisms (Remediate firms). This suggests that the release of Part II indicates a disregard or an inability to address the identified weaknesses, which results in continued audit quality issues. We also find that the release of Part II foreshadows a change in auditors, either due to dismissal or resignation. Finally, we find that a majority of restatements for clients of QCC firms are discovered by a successor auditor of higher quality (non-QCC firm) after the client has changed auditors. We conclude that for triennial firms, Part II signals audit quality and the two-part reporting process leads to improved financial statement reliability.

Keywords: PCAOB; quality control criticisms; audit quality; restatements; auditor switching

JEL Classification: M42