The PCAOB's Concept Release on the Audit Reporting Model

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    Paul Polinski
    PCAOB's full Concept Release Document on Auditor...
    trigger document posted July 8, 2011 by Paul Polinski 
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    PCAOB's full Concept Release Document on Auditor Reporting Changes

    The PCAOB's formal release for comment on potential changes under consideration to auditor reports on public company financial statements.

    publication date:
    July 8, 2011 1:00am - 5:16pm



    • Robert E Jensen

      "Regulator Says Broker Audits Fail to Include Required Work," by Floyd Norris, The New York Times,  August 20, 2012 ---

      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 ---


    • 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

      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.

      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

      Inspection Finds Defects in 19 PricewaterhouseCoopers Audits
      by Michael Rapoport
      Jun 30, 2014
      Online Exclusive

      Regulator Finds Deficiencies in 15 Deloitte & Touche Audits
      by Michael Rapoport
      Jun 02, 2014
      Online Exclusive

      Ernst & Young 2013 Audit Deficiency Rate 49%, Regulators Say
      by Michael Rapoport
      Aug 28, 2014
      Online Exclusive

      "KPMG Audits Had 46% Deficiency Rate in PCAOB Inspection," Michael Rapoport, The Wall Street Journal, October 24, 2014 ---

      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

      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.


      January 23, 2015 reply from Bob Jensen



      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. ---

      "Koss suit against former auditor (Grant Thornton) to proceed," by Doris Hajewski, Journal Sentinel, June 22, 2011 ---

      "Defending Koss And Their Auditors: Just Loopy Distorted Feedback," by Francine McKenna, re: TheAuditors, January 16, 2010 ---