PCAOB: Deloitte Fails on Fair-value Testing

In its 2006 inspection report, the regulator raps the Big Four firm for trusting management's assertions.

In its latest evaluation of Deloitte & Touche, the Public Company Accounting Oversight Board takes the firm to task for not properly testing its clients’ fair-value calculations.

In four instances during its 2005 audits, Deloitte should have done more to confirm management’s assertions by doing more testing, the PCAOB investigators said. In three of those instances, the PCAOB said, the firm may have conducted the appropriate evaluations but showed no evidence of doing so.

The Deloitte report comes on the heels of comments by PCAOB chairman Mark Olson expressing growing concern about whether audit firms have the ability properly audit fair-value accounting at companies. The PCAOB has a meeting scheduled Thursday with its advisory council this Thursday to consider changes to its guidance for auditing fair-value accounting.

Released on Monday, the PCAOB’s report on Deloitte marks its third official inspection of the firm’s work. In the publicly released portion of the report, the PCAOB noted several significant audit deficiencies at eight of Deloitte’s clients, including “some cases” where errors could be material to those companies’ financial statements.

In its response letter to the PCAOB’s claims, Deloitte acknowledges that its auditors conducted additional auditing procedures at six of the eight companies following the inspectors’ findings. But the firm has not changed any of its original audit opinions.

However, one of Deloitte’s clients has issued a restatement following the PCAOB’s inspections. In that case, Deloitte had not noticed the company had departed from generally accepted accounting principles by applying a block sale discount when determining the fair value of warrants issued to purchase common stock.

For its review of Deloitte’s 2005 audits, the PCAOB inspectors spent time from May to November of last year in the firm’s national office and 20 practice offices. Other than those numbers, the PCAOB does not reveal publicly the total numbers of audits its inspectors conducted for Deloitte, or any other firm. The regulator discourages the public from drawing any conclusions based on the number of audit deficiencies listed in the report and notes that the number of audits the inspectors review is a small portion of the total number conducted by each firm.

Still, this year’s review of Deloitte is remarkably different than last year’s. In its 2005 inspection report, the PCAOB noted audit deficiencies at 17 of Deloitte’s clients, including instances the firm did not appropriately address errors in those companies’ use of GAAP. In the firm’s response letter last year, Deloitte disputed many of the PCAOB’s claims, many of which had to do with proper documentation. Deloitte said at the time that, based on the PCAOB’s standards, the nature and extent of documentation should be based on an auditor’s judgment.

Also on Monday, the PCAOB released its inspection reports for 21 other audit firms, including its review of mid-tier firm McGladrey & Pullen’s 2005 audits. (The PCAOB conducts inspections of firms with more than 100 issuers annually and every three years for smaller firms.) In McGladrey’s report, the PCAOB noted four instances where the firm did not show its auditors had performed procedures to support its audit opinion for one company. The firm did not dispute the PCAOB’s findings in its response letter.

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