For the second round of official inspection reports on the Big Four audit firms, the Public Company Accounting Oversight Board’s findings led to a handful of negative headlines: “Audit Watchdog Report Raps Ernst, KPMG,” “Deloitte Criticized by Board,” and “Failing Grades for E&Y, KPMG.” According to critics of the way the PCAOB has shared information about its inspections process, those descriptions don’t paint a clear picture about what the auditor overseer was probably trying to say in its reports. In addition, they say, the reports came out too late to truly tell how the audit firms are currently performing.
To be sure, the PCAOB’s critiques of the Big Four’s 2004 audits list several mistakes for each firm — specifically, the board found deficiencies in the audits of 9 PricewaterhouseCoopers clients, 10 Ernst & Young clients, 11 KPMG clients, and 17 Deloitte & Touche clients. Except for PwC, each firm had at least one error that appeared “likely to be material to the issuer’s financial statements.”
Using the terms “failed” and “failure” numerous times, the PCAOB cited the firms for basic accounting issues, some of which relate to lease and tax accounting, revenue recognition, and goodwill-impairment testing. All four of the reports, and the PCAOB’s previous evaluations of the Big Four’s work, noted that in some instances the firms did not “identify or appropriately address errors in the issuer’s application of GAAP.” The inspections led to restatements for one client of each auditor (two, in KPMG’s case). The bulk of the board’s criticisms were related to the auditors not properly documenting their work.
Despite an emphasis on “criticism of a firm’s policies, practices, and audit performance” and staying away from reporting on a firm’s strengths, the reports are intended to be solely a “dialogue” between the PCAOB and the firm, the 2003 inspection documents said. Much of this dialogue, however, is available on the PCAOB Website for anyone to review. And while releasing the information publicly is part of the mandate of keeping investors better informed under the Sarbanes-Oxley Act, the reports may, at first glance, skew public perception. The PCAOB rolled out the 2005 public reports starting in late November; the last two were released on January 11.
In fact, the reports’ negative tone is missing context, according to accounting experts who spoke to CFO.com about the PCAOB’s findings. Part of this ambiguous perspective arises out of the fact that the board won’t say how many inspections it conducts on each firm. “It’s unclear how to interpret the reports without knowing the number of audits they looked at,” says James Bierstaker, an associate professor in Villanova University’s accountancy department.
Keeping that figure private doesn’t protect the audit firms, says Susan Lister, national director of audit policy at BDO Seidman. But including it could encourage investors and potential audit clients to draw the wrong conclusions since the reports are missing so many other facts necessary for forming an opinion. For example, the PCAOB keeps the identities of the audited companies confidential because of Sarbox requirements and doesn’t even include basic descriptions of the issuers, such as revenue size. The PCAOB’s “comments are really generic, so it’s hard [for the public] to put them into perspective at all,” Lister told CFO.com.