PCAOB Form AP: Leveraging Information about Audit Personnel Free

The Public Company Accounting Oversight Board (PCAOB 2015) issued “Improving the Transparency of Audits: Rules to Require Disclosure of Certain Audit Participants on a New PCAOB Form and Related Amendments to Auditing Standards,” and public company audit firms must now file Form AP to comply with this rule. Lending his support, (former) PCAOB Chairman James Doty noted that “the disclosure will require no new work by the auditor … and it holds the promise of improving audit quality by sharpening the mind and reminding auditors of their responsibility to the public” (PCAOB 2013). Further, (former) PCAOB Chief Auditor, Martin Baumann, stated that “Form AP will provide transparency to investors about the engagement partner and other accounting firms that took part in the audit” (PCAOB 2016). This regulation is part of a global trend toward audit partner identification, which has been required in Australia since the 1970s and was adopted in the U.K. in 2009.¹ The U.S. is now the 17th of the 20 countries with the largest market capitalization in the world to require audit partner identification, and is one of the first to require disclosure of other audit participants.

The PCAOB board members were not unanimous in their support of some aspects of the initial rule due to concerns around cost–benefit and possible unintended consequences. For example, (former) PCAOB board member Jay Hanson expressed concern about litigation risks that might accrue to engagement partners if their signatures are included on the audit report, a concern that ultimately yielded the current approach whereby the engagement partner's name is revealed only via the Form AP filing and not on the face of the audit report itself (PCAOB 2013). In addition to concerns about identifying whether and how to provide information about the partner, the PCAOB shifted its stance on the level of materiality necessary before an audit firm must disclose other firms participating in the audit; the original threshold was three percent of total audit hours, whereas the final threshold is five percent of total audit hours. Additionally, the PCAOB eliminated disclosure of participation by non-accounting firms or entities under common control by the signing firm (e.g., offshore service centers or consultants; PCAOB 2015). The debate surrounding Form AP raises awareness of the availability, relevance, and implications of associated data, but its nuances and applications are not yet commonly understood. Form AP disclosures are available for download on the PCAOB website: https://pcaobus.org/Pages/Form-AP-Filing.aspx.² The PCAOB Form AP data are empirically and pedagogically powerful, and the objectives of our narrative are as follows:

Form AP requires that the audit firm disclose the name and identification number of the partner with primary responsibility for the audit, thereby providing transparency about leadership. What information might this yield? As one example, the PCAOB database (https://pcaobus.org/engagement-partners/0004200999) shows that Mr. David William Gay has been the audit partner for Harley Davidson, Inc. and Badger Meter, Inc. Once a user knows the partner's name, they can look for his or her online profile, thereby enabling inferences about education, experience, industry qualifications, and community engagement (see https://www.linkedin.com/in/david-gay-0bb597b7/). Doing so for Mr. Gay's LinkedIn profile reveals that he leads the Milwaukee, Wisconsin office of Ernst & Young and he specializes in SEC filings, financial reporting, audit committees, public and privately-held organizations, and consumer and industrial products. The profile reveals his community involvement in various non-profit organizations, along with his work experiences and academic degree. In the audit report for Harley Davidson (https://www.sec.gov/Archives/edgar/data/793952/000079395218000012/hog12-31x201710xk.htm; p. 49), note that Mr. Gay's name does not appear; it is only present in the Form AP database. In contrast, in Europe the audit partner's name conveniently appears directly on the audit report, so the PCAOB's process for identifying the audit partner differs in that regard. Researchers and practitioners can aggregate and compare individual audit partner profiles to glean information about market conditions and potential upcoming partner transitions or competitive bidding opportunities.

In addition to providing information such as this example illustrates, what questions can users answer with the audit partner identification data? Consider the following possibilities: (1) How busy is a partner in terms of the number of public clients for which s/he signs? (2) What is the fiscal year-end of each of the clients, i.e., are they distributed over the course of the year or are they condensed into a shorter period of time? (3) Does the partner seem to audit clients in the same industry, i.e., what is their industry specialization profile? and (4) Can we trace audit partner identification to subsequent, negative events such as restatements or to indicators of financial reporting quality and/or audit quality (see DeFond and Zhang 2014; Gaynor, Kelton, Mercer, and Yohn 2016)?

Prior research explores previously explored these types of questions by accessing audit partner identification data primarily from jurisdictions outside the U.S. (see Lennox and Wu 2018 for a review). For example, Ittonen, Johnstone, and Myllymaki (2015) use data from Finland to show that partners who have greater public-client specialization (three to six public clients) provide higher quality auditing, likely because they have a deep domain knowledge required to audit public clients, a keen sense of associated litigation risks, and a heightened willingness to resist client pressure because of their relatively larger portfolio of available clients. Carcello and Li (2013) use data from the United Kingdom and reveal that upon the release of the audit partner identification, client abnormal accruals decline, there is less of a propensity to meet earnings thresholds, and an increase in the incidence of qualified audit reports; in short, identifying the audit partner seems to be associated with improvements in audit quality. Knechel, Vanstraelen, and Zerni (2015) use audit partner data from Sweden and show that audit partner reporting decision preferences are systematic, i.e., that individual partners have unique and recurring patterns, e.g., regarding the going-concern decision. In a similar vein, Gul, Wu, and Yang (2013) use data from China to show how audit partners affect audit outcomes, revealing significant variations in audit quality that can be explained by auditor characteristics such as education, Big N firm experience, rank, and political affiliation. Using audit partner data from Finland and Sweden, Ittonen, E. Vahamaa, and S. Vahamaa (2013) report that female audit partners are associated with smaller abnormal accruals at their client companies, suggesting that they have a constraining effect on earnings management as compared to their male counterparts. However, whether such findings extend to the U.S. environment remains an empirical question.

Form AP requires that the audit firm disclose whether the audit report is dual-dated. Auditors dual-date the audit report when they become aware of material subsequent events occurring after the original audit report date (audit work completion date) but before they release the audit report to the public. Dual-dating informs financial statement users that the auditor has considered subsequent events up to the original report date, with the exception of the specified, subsequent event for which the audit work is separately dated. Dual-dating is advantageous to the auditor because it allows them to avoid updating the entirety of their audit work, including the assessment of the client's business environment, going concern risk, and repetition of certain substantive analytical procedures for a single subsequent event. Form AP requires auditors to indicate whether the report is dual-dated, and the PCAOB auditor search database aggregates this information into a dual-dating indicator variable.

What questions can users answer using the dual-dating disclosure in Form AP? Consider the following possibilities: (1) Given a market-wide significant event, what types of auditors respond by dual-dating their audit reports? (2) Is there an information transfer effect within an industry or local market such that other firms do the same? (3) What types of subsequent events result in dual-dating?

Form AP requires accounting firms to disclose whether any other firms participated in the audit, and, if so, the number of those firms, the amount of audit work performed, and whether or not the primary accounting firm is assuming responsibility for the work of participating firms. In this sub-section we describe the types of audit participants, explain the difference between dividing responsibility with and assuming responsibility for participants' audit work, and explore the information available in Form AP for each kind of lead auditor/participating auditor relationship.

Participating accounting firms include both affiliated (in-network) and unaffiliated (out-of-network) participant auditor. Participant auditors conduct audit procedures over distinct components of an issuer's business, often due to their proximity to the issuer's operations within a geographic region or operating segment. Participating auditors are often necessary in the audits of large, multinational corporations since nearly all jurisdictions require that auditors be locally licensed to practice in the region (see Downey and Bedard 2018b as well as the World Trade Organization's General Agreement on Trade Services [WTO 1994]). Using participant auditors also significantly decreases travel costs associated with sending primary audit team members abroad. However, geographically distributing the audit team in this manner can introduce communication and coordination challenges between the primary and participants auditors (Downey and Bedard 2018a). Participating auditors may be affiliates of the primary auditor; for example, KPMG Australia is an affiliate of KPMG U.S. and may audit the Australian operations of a U.S.-based multi-national corporation to reduce costs, such as monitoring, given KPMG's global methodology and technological tools. Participant auditors may also be unaffiliated audit firms with which the primary audit firm independently contracts on an as-needed basis. Notably, form AP does not require firms to disclose whether participant auditors are affiliates of the primary audit firm. This is likely due to the prevalence of the largest U.S. accounting firms to almost exclusively rely on their network affiliates (Doty 2011). While it is sometimes possible to tell if firms are affiliated based on similarities in the firm name or tracing the firm to the PCAOB's registration database, there is not currently an accurate way to comprehensively identify affiliate relationships using Form AP data. Importantly, participating auditors represent legally separate accounting firms (e.g., KPMG France), and do not include non-accounting firms or entities under control of the U.S. (or primary accounting) firm. As such, use of offshoring service centers is excluded from these disclosures (PCAOB 2015).

On engagements involving other accounting firms (participating auditors), PCAOB standards provide the primary auditor a choice of whether to assume responsibility for the participant auditor's work or divide responsibility with the participating auditor. If the primary auditor chooses to divide responsibility, the audit opinion will disclose that the primary audit firm did not audit the entirety of the financial statements and it will indicate the portion of assets or revenues the participating firm audited (PCAOB AS 1205: 3, 6–7). Dividing responsibility may reduce liability associated with misstatements in the portions of the financial statements for which the participant auditor performed work. PCAOB AS 1205, Paragraph 6 states that it is appropriate for the principal auditor to divide responsibility when they cannot review the participant auditors' work, are unable to otherwise obtain comfort over the work performed by the participant auditor, and/or the component auditor performed a material portion of the audit.

Principal auditors rarely exercise the option to divide responsibility with participant auditors, and are therefore responsible for directing and supervising of the other accounting firms for the majority of engagements.³ There are at least two reasons why primary auditors are unlikely to divide responsibility with participant auditors, including: (1) the comfort auditors obtain when participant auditors are affiliated with the primary auditor (i.e., belong to the same network—KPMG); and (2) divided responsibility requires each firm's permission to reproduce the audit opinion during debt and equity offerings, which is a potential headache for issuers who engage regularly in such activities. While dividing responsibility is not particularly common at present, emerging research using Form AP data is beginning to investigate issues around dividing responsibility and subsequent auditor accountability for audit failures (Brumley, Czerney, Schmidt, and Thompson 2019). They examine restated group financial statements with divided responsibility audit reports and find that the restatements typically originate in a component for which the principal auditor accepts responsibility. Further, principal auditors that divide responsibility are not held any less accountable for restatements than principal auditors that do not divide responsibility.

When the primary audit firm does not divide responsibility with participants (the typical case), the only information disclosed on the audit opinion is the name of the lead accounting firm and city where the audit opinion is signed (e.g., KPMG, New York). In such instances, Form AP provides investors and other stakeholders with detail into the engagement structure. This information includes the number of participants and the total percent of audit hours performed by participants. Additionally, the primary audit firm must disclose the name, location, and magnitude of audit hours for each participating firm that individually performs at least five percent of the total audit hours in Form AP. Figure 1 illustrates the disclosure options and relevant data available from participant auditor information in Form AP.

Research is beginning to emerge relating to using participating auditors. For example, both Dee, Lulseged, and Zhang (2015) and Mao, Ettredge, and Stone (2018) use PCAOB Form 2 to identify auditors who participate in a U.S. issuer audit, but do not themselves audit a U.S. issuer (i.e., small, foreign audit firms). Dee et al. (2015) find evidence of higher discretionary accruals for such engagements (relative to engagements without such disclosures) and Mao et al. (2018) find that audit quality does not improve (and may actually decline) when the primary auditor takes responsibility for participating auditors. Carson, Simnett, Trompeter, and Vanstraelen (2018) report that audit fees in Australia increase with the use of participating auditors, and that audit quality improves after the implementation of International Standard on Auditing (ISA) 600 for engagements where non-Big 4 firms serve as the primary auditor. Other related research shows that primary auditors can develop expertise in engagements involving participating auditors (Gunn and Michas 2018) and that issuer size and global structure contribute to challenges on engagements involving participating auditors (Downey and Bedard 2018a).

What other questions can researchers answer using audit participant data? These might include, for example: (1) What are the determinants of using a participating auditor? (2) How does disclosure of such information change auditor, investor, and director (e.g., audit committee) behavior? and (3) How do the effects of participation by other domestic auditors differ (if at all) from participation by other foreign auditors?

In Table 1, we summarize the various sources of Form AP information that we explain previously, note whether and where that data was previously available, along with articulating various research opportunities and identifying the state of any available existing research.

To demonstrate using Form AP data in research, we undertake a simple investigation to answer the first question that we pose above, i.e., the determinants of audit firms' choice to use participating auditors. In conducting our analysis, we model this choice as a function of auditor size, along with issuer size, complexity, and performance in a logistic regression, as follows:

With respect to the dependent variable, PARTICIPANTS is an indicator variable set equal to 1 if the audit involves a participating auditor, and 0 otherwise. With respect to independent variables, LOG_ASSETS measures issuer size, FOREIGN_OPERATIONS is an indicator variable set equal to 1 if the issuer has foreign operations, and GEO_SEG measures the number of geographic segments. These variables measure client size, complexity, and geographic dispersion, so we expect that each will be positively associated with PARTICIPANTS (Hanes 2013). The remainder of our explanatory variables, BIG4_US (an indicator variable set equal to 1 if the auditor is a U.S.-based office of a Big 4 firm), DEBT_TO_ASSETS, return on assets (ROA), and market to book (MTB), control for auditor and issuer characteristics and we make no directional predictions for these variables in relation to PARTICIPANTS.⁴

In untabulated analyses, we find that 23 percent of our sample uses participating auditors. The mean number of participating audit firms is 2.73 and they perform about 5 percent of the work on these types of audits. U.S.-based Big 4 firms comprise 61 percent of the sample. Total assets is a mean of about $5.24 million. The mean numbers of foreign segments and geographic segments are about one and three, respectively. Mean DEBT_TO_ASSETS is 24 percent, ROA is −7 percent, and MTB is 3.35. Table 2 reveals that using participating auditors is positively associated with LOG_ASSETS (t = 8.26, p < 0.001), FOREIGN_OPERATIONS (t = 5.19, p < 0.001), and GEO_SEG ( t = 1.64, p = 0.101), each of which is consistent with our expectations. Using participating auditors is also positively associated with ROA and MTB (t = 7.06, p < 0.001 and t = 4.17, p < 0.001). While these results are not surprising, they do illustrate a starting point for imagining how Form AP filings may be useful in more complex empirical investigations.

We encourage instructors to expose students to the PCAOB's Auditor Search database and use it to reinforce core concepts in auditing courses. We believe it can be a powerful tool in encouraging students to learn with respect to: (1) using the PCAOB Auditor Search tool to find Form AP information, (2) studying the audit opinion and considering nuances therein, and (3) thinking critically about the practice of auditing. See Table 3 for potential teaching applications and activities to Form AP, along with illustrative solutions. First, instructors can have students access the Auditor Search database to find Form AP information, such as the identity of the audit partner for a public company in the area. From there, students can search by partner name to determine how many public companies that partner signs, and analyze how the partner's client portfolio compares to the frequency of public company audits for all other partners in the Auditor Search database. This activity allows instructors to discuss how partner busyness may affect audit quality, and facilitates a broader conversation on potential audit quality determinants. Second, students can study the audit opinion and consider the differences in information provided by Form AP. Identifying differences in audit opinion and Form AP information and discussing why the PCAOB chose this type of disclosure is likely to assist in familiarizing students with the current regulatory environment and the standard setting process. These class discussions can lead to a deeper understanding of the balance between minimizing auditor litigation exposure and investors' right to greater information about the audit. Finally, instructors can use the mission statements of the PCAOB, SEC, and a public accounting firm to engage in a conversation around key institutions in the system of investor protection. For example, instructors can encourage students to compare and contrast the mission statements to identify differences and similarities within each organization's objectives.

Two of the authors have introduced these types of activities in their undergraduate auditing classes and find that student engagement is positive, with students expressing surprise about the amount and nature of publicly-available information. Students benefit from the activities through practicing research, analysis, and communication skills. Instructors should ask that students come to class having already: (1) located and downloaded information about their selected company, along with relevant audit partner details, (2) accessed the relevant audit opinion and considered the differences between the contents of the audit opinion with the contents available from Form AP, and (3) accessed the mission statements of the PCAOB, the SEC, and their selected audit firm, respectively. Instructors can plan for approximately 30 minutes of class discussion to address the contents of Table 3.

With this paper, we aim to increase awareness about the powerful new information available in Form AP among academics and practitioners. We identify and define this new information, presenting potential research opportunities and discussing possible empirical applications, along with providing a brief empirical illustration. We encourage audit instructors to incorporate the concepts underlying Form AP, as well as the actual contents of Form AP, into their lectures and assignments, and provide suggestions for how to do so.