PCAOB to Auditors: Turn Up the Skepticism

The auditor watchdog's latest report covers a litany of problems inspectors uncovered at the eight largest firms.

In its latest summary of its inspections of the eight largest audit firms — covering four years of reviews — the Public Company Accounting Oversight Board pings the auditors for failing to use enough professional skepticism in their audits of companies’ financial statements.

Audit deficiencies have continued to be a problem much in evidence during the series of PCAOB reviews that was mandated by the Sarbanes-Oxley Act of 2002, the board says in its report, released Friday. The firms have frequently strayed from following the PCAOB’s standards in issues related to revenue, management’s accounting estimates, fair-value measurements, and materiality thresholds.

Some of these problems have made the PCAOB question whether the auditors rely too heavily on what their clients tell them. “In some instances, firms did not sufficiently test or challenge management’s forecasts, views, or representations that constituted critical support for amounts recorded in the financial statements,” the report says. The 28-page document also blames the firms’ audit deficiencies on weaknesses in training, supervision, methodologies, monitoring, and enforcement.

“Even in recent years, we are seeing deficiencies in the most important and high-risk areas of the audits, where appropriate levels of care and professional skepticism are needed,” writes George Diacont, director of the PCAOB registration and inspections division.

The PCAOB’s summary of the four years’ worth of inspections touches upon trends that its auditors have noticed and revealed each year through its auditing of the largest firms: Deloitte & Touche, Ernst & Young, KPMG, PricewaterhouseCoopers, BDO Seidman, Grant Thornton, McGladrey & Pullen, and Crowe Chizek (now called Crowe Horwath). These firms are reviewed annually by the audit firm watchdog.

The report does not mention any of the firms by name, but highlights how dominant the larger firms are over public-company auditing. The group audits about 66 percent of all American public companies, and the Big Four’s public-company clients represent 98 percent of the total U.S. market capitalization.

For the first time, the PCAOB also shares some findings from the portion of its inspections that it has generally kept from public view. As long as the auditors make changes to these types of issues — having to do with quality control — within a year of the inspection, then the PCAOB’s specific findings will continue to remain private. (None of the largest firms have had their quality-control deficiencies released publicly. But smaller firms have. In fact, on Friday the PCAOB announced that it had made public the quality-control findings of 12 firms that did not address their deficiencies to the board’s satisfaction.)

Presumably, because the larger firms’ quality issues have not been made public, they have fixed the faults previously noted by the PCAOB. For instance, the board’s inspectors found that audit partners’ quality of work did not affect their pay or evaluation. According to the PCAOB, individual auditors were sometimes not held accountable for not finding significant deficiencies that were later found by the their firms’ internal inspectors or the PCAOB’s inspectors. Some of this discrepancy was due to conflicts of interest; technical employees were reporting to workers responsible for growing for expanding the firm’s business.

This issue has since been addressed by some firms that have changed their evaluation processes, reworked their management structures, and created new positions or committees to improve quality issues, the board says.

Also noted in the non-public portion of the board’s inspections was concern over the apparent lack of objectivity in the firm’s internal inspections of its work; lack of data-sharing between U.S. firms and their foreign subsidiaries that review companies listed on American exchanges; and holes in procedures designed to adhere to Sarbox’s independence requirements.

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