The PCAOB's Concept Release on the Audit Reporting Model

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    Paul Polinski
    PCAOB's Summary Fact Sheet on Auditor Reporting Changes
    trigger document posted July 8, 2011 by Paul Polinski, last edited February 10, 2012 
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    PCAOB's Summary Fact Sheet on Auditor Reporting Changes
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    The PCAOB's executive summary document for its concepts release on changes to the auditor reporting model.

    publication date:
    July 8, 2011 1:00am - 5:19pm

    Comment

     

    • 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

       

    • 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

      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

      "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

      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

      "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

      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

      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

      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