PwC Disputes Oversight Board’s Report

For its review of 2005 audits by PricewaterhouseCoopers, the PCAOB found deficiencies at six of the firm's clients.

The Public Company Accounting Oversight Board’s evaluation of PricewaterhouseCoopers faults the firm for not taking the proper steps to support its audit opinion for six of its clients. However, the Big Four audit firm claims the PCAOB is mistaken in its findings.

“We have concluded that, in each instance, our original procedures were sufficient to support our audit conclusions and the opinion rendered at the time,” PwC wrote in a letter to the PCAOB dated September 26. The letter is included in the auditor overseer’s 2006 inspection report of PricewaterhouseCoopers’ 2005 audits, which was released last week.

Even though it took issue with the PCAOB’s findings, PwC responded to PCAOB’s criticism by adding documentation to its working papers for one of the audits that the regulator that had a significant enough deficiency to include it in the report.

But providing more evidence of the work it conducted for one client was the only concession PwC made. In another instance, it said one of the PCAOB’s findings was “factually incorrect.” And for yet another client, PwC used “professional judgment” as a defense for its auditors’ work on an audit the PCAOB said lacked proper testing.

Indeed, PwC disputed much more of PCAOB’s findings in its response letter to this inspection report than they did in their response to precious reports by the oversight board. On the other hand, there were fewer deficiencies noted this time than during previous inspections of the firm. Its evaluation of PwC 2004 turned up audit deficiencies at nine of the accounting firm’s clients, and the prior year’s report listed 30 of PwC’s clients that received deficient audits.

The PCAOB discourages readers of its inspection reports from drawing any conclusions based on the number of audit deficiencies that are listed. The board’s audits are not randomly chosen but are rather risk based — meaning the PCAOB chooses audits it perceives as having difficult issues, and therefore a higher risk of deficiencies. “The total number of audits reviewed is a small portion of the total audits performed by these firms, and the frequency of deficiencies identified does not necessarily represent the frequency of deficiencies throughout the firm’s practice,” the PCAOB says in its report.

Critics of the PCAOB reports have said it’s hard to draw a conclusion about a firm’s quality based solely on the findings because of what the PCAOB does not include. It doesn’t say, for example, how many audits its inspectors examined and it doesn’t identify the firms’ clients. For PwC’s latest report, the PCAOB merely noted that its inspections occurred between May 2006 and January 2007 at the firm’s national office and 22 of its approximately 63 practice offices.

What follows are excerpts from the inspection report, which listed the significant definciencies in PwC’s audits that made the PCAOB inspectors doubt the firm’s basis for some of its audit opinions.

Issuer A: The firm failed to adequately test mortgage servicing rights and their amortization.

The firm should have done a better job of testing whether its client’s impairment analysis complied with FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. The PCAOB took issue with the firm’s reasoning for accepting its client’s application of the standard. The firm also didn’t have proof of whether it had tested the data the issuer used to support a change in the estimated period for the amortization of mortgage service rights.

In its defense, PwC said the issuer’s accounting treatment in this area is acceptable under current accounting literature and said it believes its work was sufficient enough to support its final opinion.

Issuer B: The firm failed to support its audit opinion with sufficient, competent evidence.

For a company that has different industry segments and reporting units with separate internal control systems, the firm didn’t perform necessary procedures in several areas. For example, PwC didn’t consider how deficiencies in some of the issuer’s key controls should have affected its control-risk assessment and the nature, timing, and extent of some of its procedures. Among the other problems listed were a failure to properly test consolidated revenues, and whether revenue was recognized in the proper period.

For its part, PwC said its work was sufficient and tried to put the PCAOB’s finding in context. The issues listed under Issuer B applied to only one audit area (revenue) and concerned only one business unit, the firm noted. Still, “we acknowledge that aspects of the work performed in auditing this area for this business unit could have been enhanced and more fully documented,” PwC wrote in its response letter.

Issuer D: PwC failed to sufficiently test assumptions that management used in its goodwill impairment test.

The firm should have evaluated the appropriateness of the issuer’s projections, rather than simply making inquiries of management.

PwC contended here again that its audit procedures were adequate. “The level of testing of a forecasting process in the context of a goodwill impairment test is a matter of audit judgment,” the firm wrote.

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