The PCAOB's Concept Release on the Audit Reporting Model

all of the materials surrounding their decision processes

This is a public regulatory initiative  public

Comments

  • 1-12 of 12
  • Robert E Jensen

    Are PCAOB Inspection Reports Revealing Audit Firm Deficiencies Misleading?

    January 23, 2015 message from a practitioner friend

    Hi Bob, I hope all is well with you.

    As part of your classroom application you might ask the following

    How are engagements selected by the PCAOB for inspection

    Do the engagements selected represent a random sample of the Firm’s audit practice

    Are entire engagements reviewed or only selected areas

    How are deficiencies determined (i.e. against objective requirements for audit testing and performance or is the evaluation subjective)

    I think if this is a teaching application, the students should understand the subjectivity in how engagements are selected and evaluated.

    Practitioner XXXXX

    January 23, 2015 reply from Bob Jensen

    May I quote you in a message to the AECM?

    Alternately may I quote you as being "Anonymous?"

    In fairness, I think the PCAOB does not pretend to use random sampling or inspections of the complete audits.

    Also in fairness, auditing is rather unique in that we are and probably should be critical of deficiencies of any type that are not disclosed in the audit reports. Auditing in this regard is a bit like a surgeon's report on 1,000 surgeries. Even though that surgeon may have done a great job on 990 of those surgeries, a misleading report on 10 of the surgeries is inexcusable if the deficiencies are not disclosed in the report.

    If I were on a medical board investigating a surgeon I would want the board to selectively chose what surgeries to investigate for deficiencies. The real test of a surgeon is how whether he or she occasionally cuts corners rather than how often corners are cut.

    Of course in the case of surgeries there may sometimes be acceptable reasons for cutting corners such as when the patient is doomed no matter what. Then we might ask why the surgery is even being performed.?

    For example, a former colleague of mine only had a few months to live with bone cancer. Surgeons in the Eastern Maine Medical Center in Bangor installed two new artificial hips. He was never going to walk again with or without those new hips. They probably cut a few corners in his case. I don't blame them for cutting corners. I blame them for doing the surgeries in the first place.

    Thanks,
    Bob

    January 23, 2015 reply from Bob Jensen

    Bob

     

    I probably should stay anonymous until retirement and then I can “come out”. I would not debate your comments at all.

     

    The point of my additional questions is that for those that don’t understand the process, the headline numbers are that the Firms that are inspected don’t know how to audit because of the high “failure” rate, language that my former partner, Jay Hanson, wants to change by the way. I thought it important if we are teaching students for them to understand that the audits the PCAOB inspects are the high risk audits (which they clearly say in their report but the public does not seem to understand) and that many (I won’t say most because no one has the statistics) of the deficiencies are subjective because the PCAOB does not want to write rule based standards which the auditors have asked them to write.

     

    The information shows PCAOB inspections don’t cause restatements or withdrawn opinions rather deal with if you had sufficient evidence when the report was released. If the auditing was so bad, you would see more restatements and more withdrawn opinions. Lastly, consider that an exit conference is like dealing with the prosecutor who tells you if you don’t accept the plea bargain for distracted driving, he will indict you and make you stand trial for first degree murder (maybe a bit of an exaggeration).

     

    Your analogy regarding surgeons, although a good one, is not exactly on point since their reviews tend to have a dead patient or the like as a starting point.

    Practitioner XXXXX

    January 23, 2015 reply from Bob Jensen

    I don't think its fair to judge inspection reports in terms of restatements. Restatements more often than not do not reflect audit deficiencies. Restatements are ever so often caused by deceptions of top management and outright frauds that financial statement auditors are not intended to detect in the first place (except maybe by accident). Throughout the history of CPA auditing standard setters have repeated that financial statements are not fraud detection audits except to the extent that standard auditing procedures should detect material departures from GAAP in financial statements and some other related issues such as going concern issues and examination of internal controls via new responsibilities imposed by SOX.

    Time and time again CPA audit firms are not held responsible for not detecting frauds from the bottom to the top of organizations. Fraud audits for such purposes would be much more extensive and costly beyond what the SEC and public sector agencies are willing to pay for in financial statement audits.

    There are some gray zone settlements that really frighten CPA audit firms, but these are few and far between. A gray zone settlement now commonly used in audit courses is the Grant Thornton audit of Koss Corp. ---
    http://en.wikipedia.org/wiki/Koss_Corporation

    "Koss suit against former auditor (Grant Thornton) to proceed," by Doris Hajewski, Journal Sentinel, June 22, 2011 ---
    http://www.jsonline.com/business/124389194.html

    "Defending Koss And Their Auditors: Just Loopy Distorted Feedback," by Francine McKenna, re: TheAuditors, January 16, 2010 ---
    http://retheauditors.com/2010/01/16/defending-koss-and-their-auditors-just-loopy-distorted-feedback/

     

  • Robert E Jensen

    From the CFO Journal's Morning Ledger on December 15, 2014

    SEC: PCAOB Accounting board is dragging its feet
    http://www.wsj.com/articles/sec-accounting-board-is-dragging-feet-1418605107
    The SEC is clashing with federal auditing regulators over their priorities, suggesting they haven’t moved quickly enough to enact rules on how auditors do their jobs. Thee senior SEC officials publicly took issue with the Public Company Accounting Oversight Board last week, suggesting that it has been slow to deliver new rules that would govern the nuts and bolts of how accounting firms conduct audits.

    Changing PCAOB Audit Inspection Report Priorities
    From the CFO Journal's Morning Ledger on December 16, 2014

    Corporate accountants would be wise to make sure that their books are crystal clear about environmental risks, international tax and the estimated value of corporate investment portfolios. A director of the Public Company Accounting Oversight Board (PCAOB) pointed to those areas as topics of special focus when the audit watchdog begins its next inspection of annual audits of U.S. traded corporations, CFO Journal’s Noelle Knox reports. Big data and cybersecurity will also be potential red flags.

    The director, Helen Munter, sounded her warning at the American Institute of CPAs conference in Washington after inspectors found more deficiencies in audited annual reports this year. The PCAOB uncovered weaknesses in 39% of audits inspected in the latest evaluations of the Big Four firms, up from 37% the year before.

    The deficiencies don’t necessarily mean that companies’ filings were incorrect, but rather that auditors didn’t do the proper work to justify their opinions. And the PCAOB is itself finding itself subject to criticism for alleged foot-dragging in its processes for revising its standards for auditors. Several audit performance issues have been on the PCAOB’s agenda for years, including an update to the rules on auditing companies’ use of fair-value measurements and other accounting estimates.

    Jensen Comment
    One of the major reasons large audit firms are cited for audit deficiencies (sometimes in nearly half the sampled audits to inspect) is for cost cutting such as not doing sufficient detail testing of transactions and account balances.

    Bob Jensen's threads on professionalism and independence in auditing firms ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

  • Robert E Jensen

    Teaching Case from The Wall Street Journal Weekly Accounting Review on October 31, 2014

    KPMG Audits Had 46% Deficiency Rate in PCAOB Inspection

    by: Michael Rapoport
    Oct 24, 2014
    Click here to view the full article on WSJ.com
     

    TOPICS: Accounting Firms, Auditing, Deficiencies, PCAOB

    SUMMARY: The 23 deficient audits the Public Company Accounting Oversight Board found in its 2013 inspection of the firm, were out of 50 audits or partial audits conducted by KPMG that the PCAOB evaluated - a deficiency rate of 46%. In the previous year's inspection, the PCAOB found deficiencies in 17 of 50 KPMG audits inspected, or 34%. The report spotlights the PCAOB's continuing concerns about audit quality. Overall, 39% of audits inspected in the latest evaluations of the Big Four firms - KPMG, PricewaterhouseCoopers LLP, Deloitte & Touche LLP and Ernst & Young LLP - were found to have deficiencies, compared with 37% the previous year.

    CLASSROOM APPLICATION: This is useful for an auditing class to present recent results of PCAOB inspections.

    QUESTIONS: 
    1. (Introductory) What is the PCAOB? What is its function?

    2. (Advanced) What are the "Big Four" accounting firms? What are the results of the annual inspections of the Big Four accounting firms? Did one firm perform better than others?

    3. (Advanced) What is the purpose of these inspections? What do the inspectors do? What is a deficiency? What do the firms do with the inspection results?

    4. (Advanced) What happens once these results are determined? Are the financial statements changed as a result of these inspections? Are the firms sanctioned?

    5. (Advanced) The article notes that the PCAOB has made public what was previously secret criticism of the firms. Why were those previous results secret? Should this information be secret? Why or why not?

    6. (Advanced) Should these results impact the reputations of the Big Four firms? Why or why not? How should the firms handle these public revelations?
     

    Reviewed By: Linda Christiansen, Indiana University Southeast
     

    RELATED ARTICLES: 
    Inspection Finds Defects in 19 PricewaterhouseCoopers Audits
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    by Michael Rapoport
    Jun 02, 2014
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    Ernst & Young 2013 Audit Deficiency Rate 49%, Regulators Say
    by Michael Rapoport
    Aug 28, 2014
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    "KPMG Audits Had 46% Deficiency Rate in PCAOB Inspection," Michael Rapoport, The Wall Street Journal, October 24, 2014 ---
    http://online.wsj.com/articles/kpmg-audits-had-46-deficiency-rate-in-pcaob-inspection-1414093002?mod=djem_jiewr_AC_domainid

    Audit regulators found deficiencies in 23 of the KPMG LLP audits they evaluated in their latest annual inspection of the Big Four accounting firm’s work.

    The 23 deficient audits the Public Company Accounting Oversight Board found in its 2013 inspection of the firm, released Thursday, were out of 50 audits or partial audits conducted by KPMG that the PCAOB evaluated—a deficiency rate of 46%. In the previous year’s inspection, the PCAOB found deficiencies in 17 of 50 KPMG audits inspected, or 34%.

    In a statement responding to the PCAOB inspection, KPMG said, “We are always mindful of our responsibility to the capital markets, and we are committed to continually improving our firm and to working constructively with the PCAOB to improve audit quality.”

    The 23 deficiencies were significant enough that it appeared KPMG hadn’t obtained sufficient evidence to support its audit opinions that a company’s financial statements were accurate or that it had effective internal controls, the PCAOB said. A deficiency in the audit doesn’t mean a company’s financial statements were wrong, however, or that the problems found haven’t since been addressed.

    Still, the report spotlights the PCAOB’s continuing concerns about audit quality. Overall, 39% of audits inspected in the latest evaluations of the Big Four firms—KPMG, PricewaterhouseCoopers LLP, Deloitte & Touche LLP and Ernst & Young LLP—were found to have deficiencies, compared with 37% the previous year.

    In addition, all of the Big Four have now seen the PCAOB make public some of its previously secret criticisms of the firms. Separately from the latest report, the PCAOB on Thursday unsealed previously confidential criticisms of KPMG’s quality controls it had made in 2011 and 2012, mirroring previous moves the board had made with regard to PwC, E&Y and Deloitte. The unsealing amounts to a public rebuke to KPMG for not acting quickly enough to fix quality-control problems, in the regulator’s view.

    In the unsealed passages, the board said some of the firm’s personnel had failed to sufficiently evaluate “contrary evidence” that seemed to contradict its audit conclusions.

    In the latest inspection report, among the areas in which the PCAOB found audit deficiencies at KPMG were failure to sufficiently test companies’ loan-loss reserves, testing of companies’ valuations of hard-to-value securities, and audits of certain kinds of derivatives transactions.

    The PCAOB didn’t identify the clients involved in the deficient audits, in accordance with its usual practice.

    PCAOB inspectors evaluate a sample of audits every year at each of the major accounting firms—focused on those the board believes are at highest risk for problems. Because of that focus, the PCAOB says the inspection results may not reflect how frequently a firm’s overall audit work is deficient. The inspections are intended only to evaluate the firms’ performance and highlight areas for potential improvement, so the firms aren’t subject to any penalties.

    Only part of the inspection reports typically becomes public. A separate portion, with the PCAOB’s criticisms of the firm’s quality controls, is kept confidential to give the firm an opportunity to address any concerns. If the firm does so, that portion of the report stays sealed permanently.

    If the firm doesn’t do enough to satisfy the PCAOB within a year, however, the board makes the concerns public. Again, though, the unsealing doesn’t carry any formal penalties for the firms.

     

  • Robert E Jensen

    From the CFO Journal's Morning Ledger on January 14, 2014

    Audits are getting tougher
    Financial executives say their external auditors are requesting far more documents and details than usual on everything from pension assets to management reviews,
    CFOJ’s Emily Chasan writes in today’s Marketplace section. It’s all because of the PCAOB’s warning in October that it had found “high levels of deficiencies” in audits of internal controls. Loretta Cangialosi, Pfizer‘s controller, notes that the alert came just as companies were planning their year-end audits for 2013 and budgets for 2014. “They’re really focusing on the audits of internal controls,” she said.

    The PCAOB’s warning has pushed audit firms to make big changes. To test management’s oversight controls, for example, auditors in the past might have checked that managers signed off on a particular transaction. Now, Chasan writes, auditors are asking for more documentation, going line-by-line through budgets, sitting in on meetings to observe internal controls in action, and meeting with company accountants to understand their thinking when they signed a specific document. The intensity forces companies to produce more minutes from meetings in which executives approved transactions and produce more evidence for valuation assumptions, says Ms. Cangialosi. “The view is, if it’s not documented it didn’t happen.”

    Regulators say the tougher audits will curb fraud. “Audit firms are getting the message,” said James Doty, chairman of the PCAOB. But some companies complain that because auditors are making changes in response to PCAOB inspections of past audits, their new requests and procedures can vary. Companies “have been operating in somewhat of a black hole, with only the ability to react to the changes, as opposed to being able to proactively work with our auditors,” says Gilead Sciences CFO Robin Washington.


    Until this article I thought the PCAOB thought the worst audit firms were in the Big Four
    Turns out Grant Thornton has the worst record with 65% audit "failures" as defined by the PCAOB for 2012

    "PCAOB Gives Grant Thornton Record Failure Rate," by Tammy Whitehouse, Compliance Week, January 9, 2014 ---
    http://www.complianceweek.com/pcaob-gives-grant-thornton-record-failure-rate/article/328793/

    The Public Company Accounting Oversight Board gave a failing grade to Grant Thornton on 65 percent of audits inspected in 2012, the highest failure rate ever registered in a single inspection report by a major firm.

    The PCAOB found fault with 22 of the 34 Grant Thornton audits scrutinized, a notable jump from the 15 of  35 audits, or 43 percent, with problems in 2011. In the four years that the PCAOB has provided data in its reports on how many audits it inspects, only Crowe Horwath has registered a failure rate above 60 percent, hitting 62 percent in 2011 and 2010.

    s the PCAOB has hammered firms to get tougher on internal control over financial reporting, inspectors found internal control problems in 19 of Grant Thornton's 22 problem audits in 2012, or 86 percent. In a letter attached to the inspection report, Grant Thornton acknowledged the disturbing figures. “The volume of findings in this report is concerning and of great importance to our dedicated professionals,” wrote CEO Stephen Chipman along with Trent Gazzaway, national managing partner of audit services.

    Chipman and Gazzaway also note, however, that the report addresses 2011 financial statements that were audited in 2012 and inspected in 2013. The firm revised its audit methodology and training around internal control in the summer of 2012 based on concerns raised by the PCAOB about the quality of internal control auditing across the profession. “Those changes were in effect during our audits of 2012 financial statements (conducted in 2013), and we believe have been effective at improving audit quality in this important area,” they wrote.

    Beyond internal control, the PCAOB also called out 10 audits where the firm failed to comply with standards on assessing the risks of material misstatements, and nine cases where the firm had difficulty with auditing fair value measurements. Seven audits also contained problems with auditing accounting estimates.

    Over the latter part of 2013, the PCOAB published reports for all four Big 4 firms, with their failure rates ranging from a low of 25 percent for Deloitte to a high of 48 percent for EY. Among major firms, 2012 reports are still outstanding for McGladrey, BDO USA, and Crowe Horwath.

    Jensen Comment
    When are large auditing firms going to take the PCAOB criticisms seriously?

    Bob Jensen's threads on audit firm professionalism and independence ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

    Bob Jensen's threads on Grant Thornton ---
    http://www.trinity.edu/rjensen/Fraud001.htm

  • Robert E Jensen

    Until this article I thought the PCAOB thought the worst audit firms were in the Big Four
    Turns out Grant Thornton has the worst record with 65% audit "failures" as defined by the PCAOB for 2012

    "PCAOB Gives Grant Thornton Record Failure Rate," by Tammy Whitehouse, Compliance Week, January 9, 2014 ---
    http://www.complianceweek.com/pcaob-gives-grant-thornton-record-failure-rate/article/328793/

    The Public Company Accounting Oversight Board gave a failing grade to Grant Thornton on 65 percent of audits inspected in 2012, the highest failure rate ever registered in a single inspection report by a major firm.

    The PCAOB found fault with 22 of the 34 Grant Thornton audits scrutinized, a notable jump from the 15 of  35 audits, or 43 percent, with problems in 2011. In the four years that the PCAOB has provided data in its reports on how many audits it inspects, only Crowe Horwath has registered a failure rate above 60 percent, hitting 62 percent in 2011 and 2010.

    s the PCAOB has hammered firms to get tougher on internal control over financial reporting, inspectors found internal control problems in 19 of Grant Thornton's 22 problem audits in 2012, or 86 percent. In a letter attached to the inspection report, Grant Thornton acknowledged the disturbing figures. “The volume of findings in this report is concerning and of great importance to our dedicated professionals,” wrote CEO Stephen Chipman along with Trent Gazzaway, national managing partner of audit services.

    Chipman and Gazzaway also note, however, that the report addresses 2011 financial statements that were audited in 2012 and inspected in 2013. The firm revised its audit methodology and training around internal control in the summer of 2012 based on concerns raised by the PCAOB about the quality of internal control auditing across the profession. “Those changes were in effect during our audits of 2012 financial statements (conducted in 2013), and we believe have been effective at improving audit quality in this important area,” they wrote.

    Beyond internal control, the PCAOB also called out 10 audits where the firm failed to comply with standards on assessing the risks of material misstatements, and nine cases where the firm had difficulty with auditing fair value measurements. Seven audits also contained problems with auditing accounting estimates.

    Over the latter part of 2013, the PCOAB published reports for all four Big 4 firms, with their failure rates ranging from a low of 25 percent for Deloitte to a high of 48 percent for EY. Among major firms, 2012 reports are still outstanding for McGladrey, BDO USA, and Crowe Horwath.

    Jensen Comment
    When are large auditing firms going to take the PCAOB criticisms seriously?

    Bob Jensen's threads on audit firm professionalism and independence ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

    Bob Jensen's threads on Grant Thornton ---
    http://www.trinity.edu/rjensen/Fraud001.htm

  • Robert E Jensen

    "PCAOB to consider proposing new auditor’s reporting model," by Ken Tysiac, Journal of Accountancy, August 8, 2013 ---
    http://journalofaccountancy.com/News/20138496.htm

    "E&Y fined and reprimanded over audit work (in England)". by Kevin Reed, Accountancy Age, March 13, 2012 ---
    http://www.accountancyage.com/aa/news/2159027/-fined-reprimanded-audit

    August 14, 2013 message from Denny Beresford

    If you are interested in the new PCAOB proposal on the auditor’s report, and most accounting educators should be, you can get a good summary of what’s in the proposal and what are some of the contentious issues by reading the statements of the Board members at the public meeting when the release was unanimously approved. You can see from those statements that most of the Board members were less than thrilled with at least certain aspects of the proposal so it is far from a done deal. See:
    http://pcaobus.org/Rules/Rulemaking/Pages/Docket034.aspx

    Teaching Case from The Wall Street Journal Accounting Weekly Review on August 16, 2013

    Audit Reports Add Beef
    by: Michael Rapoport
    Aug 14, 2013
    Click here to view the full article on WSJ.com
     

    TOPICS: Audit Report, Auditing

    SUMMARY: The article reports on proposed changes to the standard form of audit report to discuss "Critical Audit Matters" [CAMS] and other disclosures. "The moves are aimed at making the audit report more useful for investors, as opposed to the current boilerplate letter that critics say tells investors little of substance about a company's true condition." The Public Company Accounting Oversight Board (PCAOB) issued the proposal and is accepting public comments until December 11, may hold a public roundtable early in 2014, and plans for required implementation by early 2017.

    CLASSROOM APPLICATION: The article may be used in an auditing class when discussing forms of the audit report and the scope of responsibility for reviewing items related to audited financial statements.

    QUESTIONS: 
    1. (Advanced) What are the components of the standard, unqualified form of an audit report on an entity's financial statements?

    2. (Advanced) Under current audit practice, what departures from the standard, unqualified report may be required? Under what circumstances are these report changes required?

    3. (Introductory) What are the proposed changes to the standard form auditor's report as described in the article?

    4. (Introductory) What entity is proposing these report changes? Why are the changes being proposed?

    5. (Advanced) According to the article, what expanded responsibilities are being proposed for auditors? Compare the proposed expansion to an auditor's responsibility under current standards to review items related to audited financial statements.
     

    Reviewed By: Judy Beckman, University of Rhode Island

     

    "Audit Reports Add Beef," by Michael Rapoport, The Wall Street Journal, August 14, 2013 ---
    http://online.wsj.com/article/SB10001424127887324769704579010561839513086.html?mod=djem_jiewr_AC_domainid

    Auditors would have to tell investors more about the tough decisions they had to make in evaluating a company's finances under a new proposal from the government's audit-industry regulator.

    The proposal, issued Tuesday by the Public Company Accounting Oversight Board, also would require auditors to evaluate whether the assertions a company makes in its annual report are accurate—a move which would take the auditors beyond their traditional rule of verifying a company's numbers.

    Both changes are part of a plan by the PCAOB to overhaul and expand the audit report— the letter in every annual report in which an auditor avers that the company's financial statements are "fairly presented." The moves are aimed at making the audit report more useful for investors, as opposed to the current boilerplate letter that critics say tells investors little of substance about a company's true condition.

    The PCAOB's proposal also would add some disclosures to the audit report, notably information about how long the auditor has worked for the company. Many companies have used the same audit firms for decades, and some critics think that can lead to coziness that can jeopardize an auditor's professional skepticism and ability to conduct a tough audit.

    "I think we've got a better mousetrap," said PCAOB Chairman James Doty. He called the proposal "a watershed moment for auditing."

    Change won't come soon, though.

    If the PCAOB's proposal is enacted in its current form, the first audit reports with the new information wouldn't be required until early 2017. The board is accepting public comments through Dec. 11 and may hold a public roundtable early next year to discuss the proposal.

    nvestor advocates and accounting-industry leaders were both guardedly positive about the proposal. The Council of Institutional Investors, which represents pension funds and other large investors, called it "a positive step forward to considering improvements to the usefulness of the standard form auditor's report."

    PricewaterhouseCoopers LLP, one of the Big Four accounting firms, "strongly supports any enhancements to the auditor's report that will address the needs of today's users," said Vin Colman, PwC's U.S. assurance leader.

    Cindy Fornelli, executive director of the industry's Center for Audit Quality, said her group is "committed to embracing calls for responsible change to the auditor's report."

    The proposed new report would retain the current pass-fail judgment by the auditor on a company's numbers.

    In addition, however, auditors would have to discuss any "critical audit matters," or "CAMs," as PCAOB members and staff are already calling them—parts of the audit in which the auditor had to make its toughest or most complex decisions, or which gave it the most difficulty in forming its audit opinion.

    For instance, the PCAOB said, an auditor might have a "critical audit matter" when it tries to determine whether a company has assigned a reasonable valuation to a large portfolio of thinly traded, hard-to-value securities.

    "It's telling investors what kept the auditors awake at night," said PCAOB member Jay Hanson.

    Auditors also would have to evaluate other information in a company's annual report beyond the financial statements—the company's assertions in its Management's Discussion and Analysis section, for example—to see if they have any errors or misstatements and to make sure they don't conflict with the numbers the company is reporting.

    Not everyone was on board with the PCAOB's proposal. PCAOB member Steven Harris said he voted to issue the proposal to start a discussion, but that he still thought it was "not strong enough to meet the concerns of investors."

    Continued in article

    Bob Jensen's threads on professionalism and independence in auditing and financial reporting ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

  • Robert E Jensen

    "Regulator Says Broker Audits Fail to Include Required Work," by Floyd Norris, The New York Times,  August 20, 2012 ---
    http://www.nytimes.com/2012/08/21/business/accounting-board-faults-audits-of-brokerage-firms.html?_r=1

    The many auditors who inspect the financial statements of brokerage firms appear to be cutting corners and not doing all the work they should do, a worrisome sign after the collapse of the Peregrine Financial Group, a leading commodities brokerage firm, where a fraud had gone undetected for many years.

    Having completed the first review of such brokerage firm audits, the Public Company Accounting Oversight Board said on Monday that it had found deficiencies in every audit its inspectors reviewed.

    “The auditors,” said Jeanette M. Franzel, a member of the board, “were not properly fulfilling their responsibilities to provide an independent check on brokers’ and dealers’ financial reporting and compliance with S.E.C. rules.”

    That does not mean that any of the statements misrepresented the financial conditions of the 23 brokerage firms whose audits were reviewed by inspectors from the board. In most cases, the accounting board concluded that the audit firm had failed to do the necessary work to ensure that the financial statements were accurate or that the firms had sufficient capital.

    “In 13 of the 23 audits,” the board reported, auditors “did not perform sufficient procedures to identify, assess and respond to the risks of material misstatement of the financial statements due to fraud.”

    Lynn Turner, a former chief accountant of the Securities and Exchange Commission, called the report “mind-boggling” and said it indicated that audit firms had failed to respond to the disclosure of Bernard Madoff’s Ponzi scheme. It was that fraud that led Congress to authorize the oversight board to review audits of brokerage firms.

    The Peregrine fraud was uncovered after the National Futures Association, a self-regulator, stopped relying on paper copies of bank records in its own inspections. Peregrine had forged such records for years. Its independent auditor, a one-person firm, did not discover the fraud even though bank accounts are supposed to be confirmed.

    A significant question for auditors of brokerage firms to evaluate is whether the brokers are subject to consumer protection rules specifying what can be done with customer money, and, if so, whether they are in compliance with the rules. Generally, brokers who do not handle customer cash are not covered by the rule, and auditors of those smaller firms have been pushing to be exempted from inspections by the accounting oversight board when final rules are established.

    Of the 23 firms, 14 claimed to be exempt from the rule, but the board said none of the auditors of those 14 smaller firms had gone to the trouble of establishing whether that was actually the case. It added that auditors for two of the nine bigger brokerage firms had failed to verify that the firms maintained special reserve bank accounts that “were designated for the exclusive benefit of customers and that the account agreements contained the required restrictive provisions.”

    The accounting oversight board, which was established by the Sarbanes-Oxley Act a decade ago, initially was authorized only to review audits of companies that issue securities in the public market. Audit firms that audited only broker dealers were not subject to inspection by the board.

    That was changed in 2010 by the Dodd-Frank law, as lawmakers reacted to the Madoff scandal, which was carried out through his brokerage firm. The Madoff enterprise was audited by a tiny firm that was not subject to board inspection. The audit firm’s principal, David G. Friehling, has since pleaded guilty to nine criminal charges, admitting he did not perform adequate audits.

    The new report covers work conducted by 10 audit firms, seven of which were previously exempt from board review because they did not review the financial statements of any public companies.

    The board said that about 800 accounting firms perform audits of brokerage firms, and that about 500 of those were previously exempt from board inspection. Most of them could continue to escape board oversight if the board decides against reviewing audits of smaller brokerage firms, as many auditors have urged.

    One issue with such audits that emerged in the board report was compliance with independence rules. Auditors of nonpublic companies often essentially prepare the books that they then audit, and that is allowed under the rules of the American Institute of Certified Public Accountants. S.E.C. rules prohibit such practices at public companies or at brokerage firms.

    Continued in article

    Bob Jensen's threads on professionalism and independence in auditing ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

     

  • Robert E Jensen

    On Wednesday, Diamond said its audit committee found that a "continuity" payment made to growers in August 2010 of approximately $20 million and a momentum payment made to growers in September 2011 of approximately $60 million weren't accounted for in the correct periods. The audit committee also identified what it called material weaknesses in the company's internal controls. Diamond said it will restate its results for both years.

    From The Wall Street Journal Accounting Weekly Review on February 10, 2012

    Snack CEO Ousted in Accounting Inquiry
    by: Emily Glazer, Joann S. Lublin, and John Jannarone
    Feb 09, 2012
    Click here to view the full article on WSJ.com
     

    TOPICS: Accounting Fraud, Debt Covenants, FASB, Financial Statement Analysis, Financial Statement Fraud, Restatement

    SUMMARY: The Diamond Foods Inc. Board of Trustees launched an investigation into accounting for payments made to walnut growers in August 2010 and September 2011 after a WSJ investigative report questioned the transactions. That WSJ article was covered in this review and is listed as a related article. "Diamond originally maintained that the [2010] payments were an advance on the 2011 walnut crop. But three growers contacted by The Wall Street Journal said they were told by the company's representatives to go ahead and cash the checks even though they didn't intend to deliver walnuts [in 2011]." The investigation has found a material weakness in internal controls and that payments to walnut growers were not properly accounted for. "The company will restate its results for both years."

    CLASSROOM APPLICATION: Note to instructors: you likely will want to remove the above summary before distributing to students and use it as a solution to question #1. The article is useful in accounting systems or auditing classes to discuss internal control weaknesses; in financial reporting classes to discuss restatements, debt covenants, and/or business acquisitions; and in any class to discuss corporate management ethics.

    QUESTIONS: 
    1. (Introductory) Summarize the events at Diamond Foods reported in this article and the first related article.

    2. (Introductory) What has happened to the CEO and CFO as a result of their alleged actions? What do you think was their motive for these alleged actions?

    3. (Advanced) What financial statement results will be restated by Diamond Foods? Describe the specific changes you expect to see in the balance sheet, the income statement, and the statement of stockholders' equity.

    4. (Advanced) What are debt covenants? How might problems with debt covenants because of these recent events affect Diamond Foods Inc.'s operations?

    5. (Advanced) Refer to the second related article. Identify all financial statement ratios listed in that article, explaining their meaning and how they might be affected by the items you listed in answer to question 2 above.

    6. (Introductory) What is a material weakness in internal control? What must be done when such a weakness is found at any company? What further must be done when the company is public?

    7. (Advanced) Why is Procter & Gamble now concerned about selling its Pringles operations line to Diamond Foods?
     

    Reviewed By: Judy Beckman, University of Rhode Island
     

    RELATED ARTICLES: 
    Diamond Payments Questioned By Growers
    by Hannah Karp
    Dec 12, 2011
    Page: B1

    Walnuts Leave Diamond in the Rough
    by John Jannarone
    Feb 09, 2012
    Online Exclusive

     

    "Snack CEO Ousted in Accounting Inquiry," by Emily Glazer, Joann S. Lublin, and John Jannarone, The Wall Street Journal, February 9, 2012 ---
    http://online.wsj.com/article/SB10001424052970204369404577211490040427400.html?mod=djem_jiewr_AC_domainid

    Diamond Foods Inc. fired its chief executive and chief financial officer, and said it would restate financial results for two years, after an internal probe found it had wrongly accounted for payments to walnut growers.

    The findings mark a stunning comedown for the once-obscure walnut growers' cooperative, which under Chief Executive Michael J. Mendes tried to become a force in the snacks business through a series of acquisitions since 2005. Those efforts peaked last April, when Diamond agreed to pay $2.35 billion to buy the Pringles canned-chips business from Procter & Gamble Co.

    P&G is now highly unlikely to complete the sale, a person familiar with the matter said Wednesday. Diamond's shares, already down by about 60% since late September, fell more than 40% on Wednesday after the company's board audit committee released the findings of its investigation.

    Results of the internal probe—which was launched after The Wall Street Journal raised accounting questions in September—will now be turned over to the U.S. Securities and Exchange Commission and the San Francisco U.S. attorney's office, which have been investigating Diamond and how it handled the payments, a person familiar with the matter said. Federal investigators have progressed slowly in recent weeks, because they were waiting for the audit committee to produce its report, two people familiar with the matter said.

    The board notified Mr. Mendes and his chief financial officer, Steven M. Neil, late Tuesday that they had been removed from their jobs and placed on administrative leave. Mr. Mendes cleaned out his office early Wednesday morning, a person familiar with the matter said.

    Mr. Neil's attorney, Mike Shepard, said: "I think it's very disappointing news what we saw from the company in light of the fact that experts in the area say the company's accounting was strongly supported."

    Mr. Mendes couldn't immediately be reached for comment.

    The executives will remain on leave while the company negotiates their severance, their exit from their board seats and possibly clawbacks of previously awarded pay, a person familiar with the matter said Wednesday.

    Diamond board member Rick Wolford will serve as acting CEO. Michael Murphy, managing director at Alix Partners LLP, will serve as acting CFO. The board also appointed Robert J. Zollars as chairman. The company said it will begin searching for permanent replacements.

    The accounting controversy sprung out of California's walnut groves, which once sold the bulk of their output to Diamond. But the interests of growers and the company began to separate after the company began to answer to public shareholders. Growers have complained that Diamond, which sets walnut prices in secret and pays for crops in a series of payments months after they are delivered, began paying less than other buyers in recent years, according to growers and investors who have conducted their own surveys.

    At issue in the audit committee's investigation were payments made in August 2010 and September 2011, according to the company. The September payments, which the company called "momentum payments," confused growers who couldn't tell whether they were for the current or prior fiscal year.

    Diamond originally maintained that the payments were an advance on the 2011 walnut crop. But three growers contacted by The Wall Street Journal said they were told by the company's representatives to go ahead and cash the checks even though they didn't intend to deliver walnuts last year. At the time, Diamond said its agreements with growers are confidential.

    That question mattered a lot for Diamond's financial reports. Shareholders suing the company allege the payments may have been used to shift costs from the last fiscal year into the current one, burnishing Diamond's earnings and improperly boosting its stock price.

    The company declined to comment on shareholders' claims that the payments had been used to inflate its earnings. Those suits have been consolidated.

    On Wednesday, Diamond said its audit committee found that a "continuity" payment made to growers in August 2010 of approximately $20 million and a momentum payment made to growers in September 2011 of approximately $60 million weren't accounted for in the correct periods.

    The audit committee also identified what it called material weaknesses in the company's internal controls. Diamond said it will restate its results for both years.

    Around the time of the September payments, Diamond reported that its earnings for the year ended July 31 had nearly doubled, to $50 million, sending its shares soaring above $90. The shares began a steep decline soon afterward, after The Wall Street Journal raised questions about the company's accounting for the payments.

    The probe has caused Diamond Foods to delay its planned acquisition of the Pringles snack brand from P&G.

    P&G in April agreed to sell the potato-crisp maker to Diamond Foods, a deal that would allow it to triple the size of its snack business.

    That deal is now in question, as Diamond is covering most of the purchase price by issuing stock to P&G's shareholders. The deal was initially valued at $2.35 billion. Since the deal was announced, Diamond's stock has lost nearly two-thirds of its value.

    P&G had said completing the deal depends on a favorable resolution of the accounting probe.

    "We're obviously disappointed by the information released by Diamond Foods," says Paul Fox, a P&G spokesman. "We need to evaluate our next steps…either retain the business or we sell it. It's already attracted considerable interest from outside parties."

    Diamond Foods had annual sales just shy of $1 billion in the latest fiscal year. Pringles has annual sales of nearly $1.4 billion.

    Diamond said in November it had opened an investigation into the payments. The audit committee, advised by law firm Gibson, Dunn & Crutcher LLP and accounting firm KPMG LLP, looked at hundreds of thousands of documents, a person familiar with the matter said.

    The committee reached its conclusion that the company's accounting was flawed on Tuesday, Diamond said in a securities filing. Once it had, the board moved quickly to make changes. It decided that day to remove Messrs. Mendes and Neil because of "a loss of confidence by the board more than anything else,'' a person familiar with the matter said.

    The restatements could put Diamond in violation of its lending agreements. That means it may have to negotiate with creditors, which in theory could impose increases in Diamond's debt costs.

    The company had just over $500 million in debt as of its last official filing.

    The new executives were appointed Tuesday with the exception of Mr. Murphy, the new CFO, who took his job Wednesday, according to the filing. Diamond informed P&G about the probe's results less than an hour before issuing a news release, people familiar with the matter said.

    The audit committee didn't uncover any evidence of intent to deceive shareholders, according to a person familiar with the matter. "There was a breakdown of controls,'' the person said.

    Continued in article

    REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

    To the Board of Directors and Stockholders of

    Diamond Foods, Inc.

    San Francisco, California

    We have audited the accompanying consolidated balance sheets of Diamond Foods, Inc. and subsidiaries (the “Company”) as of July 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended July 31, 2010. We also have audited the Company’s internal control over financial reporting as of July 31, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in “Management’s Report on Internal Control over Financial Reporting”, management excluded from its assessment the internal control over financial reporting at Kettle Foods, which was acquired on March 31, 2010 and whose financial statements constitute less than 10% of consolidated assets, and less than 15% of consolidated net sales of the consolidated financial statement amounts as of and for the year ended July 31, 2010. Accordingly, our audit did not include the internal control over financial reporting at Kettle Foods. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.

    We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

    A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

    Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

    In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Diamond Foods, Inc. and subsidiaries as of July 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 2010, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of July 31, 2010, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

    Deloitte & Touche LLP
    San Francisco, California
    October 5, 2010

    A December 21, 2011 WSJ Article on Those Startling Deloitte Audits That Are Beginning to Remind Us of Those Sorry Andersen Audits
    "Accounting Board Finds Faults in Deloitte Audits," by Michael Rapaport, The Wall Street Journal, December 21, 2011 ---
    http://online.wsj.com/article/SB10001424052970204879004577110922981822832.html

    Inspectors for the government's audit-oversight board found deficiencies in 26 audits conducted by Deloitte & Touche LLP in its annual inspection of the Big Four accounting firm.

    The report from the Public Company Accounting Oversight Board, released Tuesday, said some of the deficiencies it found in its 2010 inspection of Deloitte's audits were significant enough that it appeared the firm didn't obtain enough evidence to support its audit opinions.

    The 26 deficient audits found were out of 58 Deloitte audits and partial audits reviewed by PCAOB inspectors. The inspectors found that, in various audits, Deloitte didn't do enough testing on issues like inventory, revenue recognition, goodwill impairment and fair value, among other areas. In one case, follow-up between Deloitte and the audit client led to a change in the client's accounting, according to the report.

    The board didn't identify the companies involved, in accordance with its typical practice.

    The report is the first PCAOB assessment of Deloitte's performance issued since the board rebuked Deloitte in October by unsealing previously confidential criticisms of the firm's quality control.

    Deloitte said in a statement that it is "committed to the highest standards of audit quality" and has taken steps to address both the PCAOB's findings on the firm's individual audits and the board's broader observations on Deloitte's quality control and audit quality. The firm said it has been making a series of investments "focused on strengthening and improving our practice."

    Last month, the board released its annual reports on PricewaterhouseCoopers LLP, in which it found 28 deficient audits out of 75 reviewed, and KPMG LLP, in which it found 12 deficient audits out of 54 reviewed. The yearly report on the fourth Big Four firm, Ernst & Young LLP, hasn't yet been issued.

    The PCAOB conducts annual inspections of the biggest accounting firms in which it scrutinizes a sample of each firm's audits to evaluate their performance and compliance with auditing standards. The first part of the report is released publicly, but a second part, in which the board evaluates the firm's quality controls, remains confidential as long as the firm resolves any criticisms to the board's satisfaction within a year.

    Only if that doesn't happen does the PCAOB release that section of the report, as it did with Deloitte in October, the first time it had done so with one of the Big Four. In that case, the board made public a section of a 2008 inspection report in which it said Deloitte auditors were too willing to accept the word of clients' management and that "important issues may exist" regarding the firm's procedures to ensure thorough and skeptical audits.

     

    Bob Jensen's threads on Deloitte and the Other Large Auditing Firms ---
    http://www.trinity.edu/rjensen/Fraud001.htm

    Bob Jensen's threads on professionalism and independence in auditing ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

    Bob Jensen's Fraud Updates are at
    http://www.trinity.edu/rjensen/FraudUpdates.htm

     

  • Robert E Jensen

    "Audit Watchdog Fines Ernst & Young $2 Million," by Michael Rapoport, The Wall Street Journal, February 8, 2012 ---
    http://online.wsj.com/article/SB10001424052970204136404577211384224280516.html

    Ernst & Young LLP agreed to pay $2 million to settle allegations by the government's auditing regulator that the firm wasn't skeptical enough in assessing how a client, Medicis Pharmaceutical Corp., accounted for a reserve covering product returns.

    The Public Company Accounting Oversight Board also sanctioned four current or former partners of the Big Four accounting firm, including two whom it barred from the public-accounting field. Ernst & Young and the four partners settled the allegations without admitting or denying the board's findings.

    The $2 million fine is the largest monetary penalty imposed to date by the board, which inspects accounting firms and writes and enforces the rules governing the auditing of public companies.

    The board said Ernst & Young and its partners didn't properly evaluate Medicis's sales-returns reserve for the years 2005 through 2007. The firm accepted the company's practice of imposing the reserve for product returns based on the cost of replacing the product, instead of at gross sales price, when the auditors knew or should have known that wasn't supported by the audit evidence, the board said.

    Medicis later revised its accounting for the reserve and restated its financial statements as a result.

    Continued in article

    Bob Jensen's threads on Ernst & Young ---
    http://www.trinity.edu/rjensen/Fraud001.htm

     

  • Robert E Jensen

    Companies are starting to realize they don't get a bump in stock price because they paid extra for another audit firm's name.
    Trent Gazzaway

    "Fewer Companies Changing Auditors," by Tammy Whitehouse, The Wall Street Journal, January 31, 2012 ---
    http://professional.wsj.com/article/TPCOMPWK0020120130e81v00004.html?mod=wsj

    Fewer companies changed their auditor last year, according to a Compliance Week analysis, and while smaller firms made some inroads, the pecking order among major audit firms remained relatively stable in 2011.

    Among the Big 4 firms, KPMG won more new public company audit clients in 2011 and Deloitte & Touche lost the largest number, but the smaller firms outshone the Big 4 overall in winning new business.

    CLICK HERE TO SEARCH OUR AUDITOR CHANGES DATABASE!

    CLICK HERE TO DOWNLOAD A SPREADSHEET OF AUDITOR CHANGES FOR 2011.

    KPMG and its affiliates lost 27 audit engagements in 2011 but picked up 43 new ones, for a net gain of 16 audits, according to a Compliance Week review of Form 8-K filings announcing auditor changes in 2011. Deloitte, however, lost 30 clients and replaced them with only 8 new engagements for a net slide of 22. That was the largest swing among any of the first- and second-tier firms, but still a small move overall considering that 938 public companies changed auditors last year.

    The turnover was flatter at PwC, where 23 departures and 25 hirings produced a net gain of two clients for the year. Ernst & Young suffered a net loss of five clients, on 26 departures replaced by 21 engagements.

    Second-tier firms made small gains on the Big 4. Overall, the Big 4 firms lost more clients than they gained, but the opposite is true for the next tier of audit firms—that is, those audit shops large enough to be inspected annually by the Public Company Accounting Oversight Board, but who aren't among the Big 4. Those firms—BDO, Crowe Horwath, Grant Thornton, McGladrey & Pullen, MaloneBailey, and ParenteBeard—lost a total of 65 clients but scooped up 93 more, for a net gain of 28. In contrast, the Big 4 collectively suffered a net loss of eight clients.

    Still, second tier firms remain miles behind the Big 4 in terms of net client billings, according to data compiled by Bowman's Accounting Report based on 2010 fiscal year billings. The smallest Big 4 firm, KPMG, is nearly four times larger than the next firm, RSM McGladrey & Pullen, with $5.02 billion in net billings compared to $1.38 billion for McGladrey.

    Across the entire audit market, churn dropped 22 percent, from 1,205 in 2010 to only 938 last year.

    Reasons for auditor turnover vary widely, and “losing a client” is not always a bad thing. For example, a company may indeed decide to switch to another auditing firm because it was offered better service or a lower price—but an audit firm might also decide to resign an account because the client was too risky to keep. Of the total 938 auditor changes executed last year, 646 were cases where the company dismissed the auditor; in 244 cases the audit firm resigned (although it's not always clear whether the auditor walked away from the client or the client asked the firm to resign); in 35 cases, the auditor was terminated. In 14 cases the filings did not include a specific reason for the change.

    The data is not surprising to Erick Burchfield, senior director and financial consulting lead at the Kennedy Consulting Research & Advisory firm. He describes 2011's data as fairly typical for audit engagements, with changes concentrated among middle-market or smaller companies and audit firms. Larger companies tend to change auditors infrequently, he says, because of the complexity of the engagements and the cost and difficulty associated with a transition to a new firm.

    The differences among Big 4 firms are perhaps more noteworthy, although not easy to explain. None of the Big 4 firms were willing to discuss the data, except KPMG to provide some updates and corrections to Compliance Week's auditor-change database. Burchfield says Deloitte's drop in engagements could stem from any number of issues. As the Big 4 pursue growth strategies, they focus more on advisory and tax services than audit, he says. “Nowhere is that more true than at Deloitte,” he says.

    The Big 4 firms are taking careful note of the regulatory tone these days too— particularly in Europe, where the European Commission is considering measures to force the creation of audit-only firms and mandatory rotation, and in the United States where the PCAOB is flirting with mandatory rotation as well. Profit margins are already stronger in non-audit areas for the major accounting firms, so their growth strategies revolve around investing in those areas, Burchfield says. And Deloitte's recent unflattering reviews from the PCAOB probably haven't helped it win new business.

    “Companies are starting to realize they don't get a bump in stock price because they paid extra for another audit firm's name.” —Trent Gazzaway,

    National Managing Partner,

    Grant Thornton

    While all four firms have had their share of shareholder litigation and fraud entanglements, Deloitte is still the only Big 4 firm to suffer a public disciplinary action from the PCAOB, and the only firm to have its audit quality control methods openly criticized by the PCAOB. It also remains in a standoff with the Securities and Exchange Commission over audit documentation at a Chinese affiliate in connection with accounting fraud allegations at Longtop Financial.

    Still, the rest of the Big 4 are in the same uncomfortable spotlight as Deloitte. The PCAOB has issued blistering reports to the entire group lately based on audit inspections that found all the firms had a higher frequency of poor audits. While all Big 4 firms experienced nearly a doubling of failed audit inspections, Deloitte fared the worst, with failed inspections jumping from 22 percent in 2009 to 45 percent in 2010.

    Independent accounting analyst Art Bowman says litigation and regulatory enforcements are not likely to cause a Big 4 firm like Deloitte to lose business. “I'm not thinking Deloitte has a quality-control problem with its clients,” he says. “When they were the Big 8 or Big 6 and they would get beaten up occasionally and fined, it meant something. In these days, it's just a cost of doing business. A $1 million fine is not even an erasure mark on a spreadsheet.”

    According to Bowman, perhaps the biggest factor that might lead to auditor turnover, especially away from Big 4 firms and toward middle market or smaller firms, is cost. “The economy is a big factor,” he says. “Every company out there is looking for ways to save money.”

    Small Proposition

    Not surprisingly, the smaller firms make the same argument. Trent Gazzaway, national managing partner for audit services at Grant Thornton, says smaller firms have had a great value proposition to compete against larger firms over the past few years. Following the swinging pendulum in the 2000s—when the Sarbanes-Oxley Act compelled the Big 4 to shed audit clients early on, then woo them back as internal control auditing matured—tough economic times have forced companies to scrutinize what they spend on audit services.

    Continued in article

    Companies are starting to realize they don't get a bump in stock price because they paid extra for another audit firm's name.
    Trent Gazzaway

    Jensen Comment
    I think that the PCAOB inspection reports over the years clearly demonstrate that switching to a more expensive audit firm does not necessarily buy you a better audit.

    On the other hand the Madoff fraud most certainly demonstrates that having an auditor with deep pockets may be in the best interest of investors and creditors.

  • Robert E Jensen

    A December 21, 2011 WSJ Article on Those Startling Deloitte Audits That Are Beginning to Remind Us of Those Sorry Andersen Audits
    "Accounting Board Finds Faults in Deloitte Audits," by Michael Rapaport, The Wall Street Journal, December 21, 2011 ---
    http://online.wsj.com/article/SB10001424052970204879004577110922981822832.html

    Inspectors for the government's audit-oversight board found deficiencies in 26 audits conducted by Deloitte & Touche LLP in its annual inspection of the Big Four accounting firm.

    The report from the Public Company Accounting Oversight Board, released Tuesday, said some of the deficiencies it found in its 2010 inspection of Deloitte's audits were significant enough that it appeared the firm didn't obtain enough evidence to support its audit opinions.

    The 26 deficient audits found were out of 58 Deloitte audits and partial audits reviewed by PCAOB inspectors. The inspectors found that, in various audits, Deloitte didn't do enough testing on issues like inventory, revenue recognition, goodwill impairment and fair value, among other areas. In one case, follow-up between Deloitte and the audit client led to a change in the client's accounting, according to the report.

    The board didn't identify the companies involved, in accordance with its typical practice.

    The report is the first PCAOB assessment of Deloitte's performance issued since the board rebuked Deloitte in October by unsealing previously confidential criticisms of the firm's quality control.

    Deloitte said in a statement that it is "committed to the highest standards of audit quality" and has taken steps to address both the PCAOB's findings on the firm's individual audits and the board's broader observations on Deloitte's quality control and audit quality. The firm said it has been making a series of investments "focused on strengthening and improving our practice."

    Last month, the board released its annual reports on PricewaterhouseCoopers LLP, in which it found 28 deficient audits out of 75 reviewed, and KPMG LLP, in which it found 12 deficient audits out of 54 reviewed. The yearly report on the fourth Big Four firm, Ernst & Young LLP, hasn't yet been issued.

    The PCAOB conducts annual inspections of the biggest accounting firms in which it scrutinizes a sample of each firm's audits to evaluate their performance and compliance with auditing standards. The first part of the report is released publicly, but a second part, in which the board evaluates the firm's quality controls, remains confidential as long as the firm resolves any criticisms to the board's satisfaction within a year.

    Only if that doesn't happen does the PCAOB release that section of the report, as it did with Deloitte in October, the first time it had done so with one of the Big Four. In that case, the board made public a section of a 2008 inspection report in which it said Deloitte auditors were too willing to accept the word of clients' management and that "important issues may exist" regarding the firm's procedures to ensure thorough and skeptical audits.

    "At Deloitte, More Pain Before Any Quality Gain," by Francine McKenna, re"TheAuditors, November 30, 2011 ---
    http://retheauditors.com/2011/11/30/at-deloitte-more-pain-before-any-quality-gain/

    Bob Jensen's threads on Deloitte and the Other Large Auditing Firms ---
    http://www.trinity.edu/rjensen/Fraud001.htm

    Bob Jensen's threads on professionalism and independence in auditing ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

  • Robert E Jensen

    "PCAOB Chair takes aim at auditors' controls testing and says mandatory rotation could be difficult," Reuters, November 11, 2011 ---
    http://www.reuters.com/article/2011/11/11/us-auditor-watchdog-doty-idUSTRE7A95XQ20111111

    Auditors are not properly testing U.S. companies' internal accounting controls, the head of the main auditor watchdog said, while also reiterating urgent concerns about audit firm inspections in China.

    Internal controls on books and records -- a requirement imposed on corporations by 2002's post-Enron Sarbanes-Oxley laws to combat accounting fraud -- are not being properly tested by outside auditors, Public Company Accounting Oversight Board (PCAOB) Chairman James Doty said on Thursday.

    "This is a very major issue for us," Doty told Reuters on the sidelines of a securities regulation conference.

    Internal control rules for ensuring the adequacy of accounting record-keeping and checks were among the costliest changes mandated by Sarbanes-Oxley, often requiring sophisticated electronic systems and detailed audits.

    Auditors are supposed to gain an understanding of the controls put in place by companies and test them, but "some auditors are just taking the business process that the company has put in place as a control," Doty said.

    Touching on another key issue for his group and auditors, Doty said the PCAOB needs to gain entrance soon to China to inspect firms that audit U.S.-listed companies.

    "We are not talking about something that should happen three years from now. It needs to happen now," he said.

    PRESSING CHINESE REGULATORS

    A meeting planned for October between U.S. and Chinese regulators to talk about inspections was canceled by the Chinese, possibly because of leadership changes at their regulatory body, Doty said.

    Late last month, China announced the appointment of Guo Shuqing as the new head of the China Securities Regulatory Commission, in a reshuffle of key financial regulators.

    The PCAOB and the U.S. Securities and Exchange Commission have been encouraging the new CSRC chairman to resume talks over inspections, Doty said.

    The PCAOB negotiated agreements this year to inspect audit firms in the United Kingdom, Switzerland and Norway, but Chinese regulators have resisted U.S. inspections on the grounds that it would infringe on their authority.

    The PCAOB is struggling over whether audit firms in China should lose their U.S. registration if that country does not allow inspections of its auditors, Doty said.

    "It is not something we want to have happen," he said.

    SEES PROBLEMS WITH TERM LIMITS

    In a speech at a Practicing Law Institute conference, Doty indicated a controversial proposal to require term limits for audit firms to increase their independence could be difficult to put into practice.

    "I recognize now that audit firm rotation presents considerable operational challenges," he said.

    The PCAOB in August issued a "concept release," or initial report, on rotation, the first step in drafting changes in auditor standards. It is seeking comments on the proposal through December 14.

    Considered as early as the 1970s, audit firm rotation has been strongly opposed by audit firms, which would lose some of their most lucrative clients if it went into effect.

    Sarbanes-Oxley mandated that lead auditors be switched every five years, but put no term limits on audit firms.

    Continued in article

    Bob Jensen's threads on professionalism and independence in auditing ---
    http://www.trinity.edu/rjensen/Fraud001c.htm