PCAOB Fines Deloitte $1 Million

The auditor watchdog raps the Big Four firm for continuing to employ an accountant who misjudged the reasonableness of a client's method for revenue recognition.

The Public Company Accounting Oversight Board has censured and penalized Deloitte & Touche $1 million for not following the PCAOB’s auditing standards during a 2003 audit. Deloitte had knowingly allowed one of its partners who was apparently in over his head to lead an audit of a drug maker’s financials for almost four years, according to the PCAOB.

“Deloitte failed to exercise due professional care in the performance of the audit and failed to obtain sufficient competent evidential matter to support the opinion expressed in the audit report,” the PCAOB wrote in its order announcing its settlement with the audit firm, released on Monday.

Deloitte has agreed to pay the penalty and implement procedural changes without admitting or denying the audit-firm overseer’s findings. The firm didn’t respond to CFO.com’s request for comment.

The PCAOB has also settled charges against James Fazio, a former Deloitte partner in its San Diego office accused of not having enough competence to have led the firm’s audit team for Ligand Pharmaceuticals. Also not admitting or denying the board’s findings, Fazio has been barred from being associated with a public accounting firm for the next two years. He could not be reached for comment.

Toward the end of Fazio’s work as the engagement partner of Ligand’s audits, the audit firm started to question his competence and proficiency, according to the PCAOB. In fact, some people at Deloitte decided that Fazio should no longer work for the firm even while he was working on Ligand’s 2003 audit. But he stayed with the firm and served as the lead Ligand auditor after Deloitte issued its unqualified opinion on the drug company’s 2003 financials and until May 2004.

At issue is how Ligand recognized revenue for its oncology drugs. To follow generally accepted accounting principles, Ligand needed to incorporate estimated product returns into its revenue estimates. Because some of Ligand’s products were fairly new, the company did not have historical data available nor did it have a full view of its distribution channels on which to base its future return estimates.

Under FAS 48, Revenue Recognition When Right of Return Exists, Ligand should have delayed recording revenue from some of its product sales until it either could have indeed made a reasonable estimate on how many products would be sent back to its offices or until the product’s right of return had expired.

Deloitte had continually noticed instances where management’s estimates for returns were off, leading the Big Four firm to consider its Ligand engagement as a “greater than normal” risk. Despite that risk’s trigger to pay special attention, Fazio and his team did not conduct the required audit procedures to analyze Ligand’s ability to make reasonable estimates of future product returns, according to the PCAOB.

The PCAOB also found fault with the way Fazio followed up his work during the following year’s audit when Deloitte conducted retrospective reviews to assess whether the 2003 returns reserve had been adequately estimated. If he had done proper analysis, he would have found that the reserve had been understated by $3.1 million and not by the $520,190 he had assumed.

The PCAOB concluded that Fazio failed to comply with the auditing standards requiring him to “exercise due professional care, exercise professional skepticism, obtain sufficient competent evidential matter … and supervise assistants.”

Deloitte resigned after nearly four years as Ligand’s independent auditor in August 2004. At the time, Ligand noted that the auditor’s reports on the previous two fiscal years “had contained no adverse opinion or disclaimer of opinion, and were not qualified or modified as to uncertainty, audit scope, or accounting principles.”

Indeed, under Fazio’s leadership, Deloitte had issued unqualified opinions on the drug company’s 2003 and 2002 consolidated balance sheets, as well as other financials. The firm also said the company’s accounting had conformed to GAAP.

But in mid-2005, Ligand announced it would restate nearly three years’ worth of financials, all of which had been audited by Deloitte. For 2003, Ligand had to make a 52 percent adjustment for its product sales revenues, or $59 million less than it had previously reported.

That restatement led to an investigation by the Securities and Exchange Commission, which is still ongoing, according to the company’s most recent 10-Q. Ligand did not return CFO.com’s request for comment.

Deloitte’s procedural fixes for making the PCAOB happy suggest much of the lag in keeping Fazio employed had to do with a communication problem at the firm. Deloitte has since created an oversight committee to review supervision concerns at the national level and to put employees under special oversight or training if needed. The firm has also adjusted its system for rating its partners’ quality.

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