PCAOB Inspections of Smaller CPA Firms: Initial Evidence from Inspection Reports

We examine 316 Public Company Accounting Oversight Board (PCAOB) inspection reports issued to smaller CPA firms (100 or fewer issuer clients) through July 2006. We find that 60 percent of the inspected firms have audit deficiencies. Firms with audit deficiencies are smaller, have a larger number of issuer clients, and are growing more rapidly than firms without deficiencies, suggesting an over-extension into the issuer client market by some firms. Deficiencies are more likely for inspections conducted in 2004 than 2005, and the PCAOB appears to have targeted smaller, riskier, rapidly growing audit firms for its 2004 inspections. In addition, we find some evidence that clients of deficiency firms are smaller, less profitable, and more highly leveraged. We also summarize the most common audit deficiencies and offer implications and directions for future research.