PCAOB Rips E&Y on Revenue Recognition

Two of Ernst & Young's clients had to restate financial results after the accounting-firm overseer found departures from GAAP.

Ernst & Young failed to note when two clients strayed from revenue-recognition rules, according to the latest inspection report on the Big Four firm by the Public Company Accounting Oversight Board. Consequently, the regulator’s sixth annual inspection of E&Y resulted in those clients having to restate their previously issued financial statements to make up for the departure from U.S. generally accepted accounting principles.

These companies — whose identity the PCAOB keeps confidential — had “failed” to fully follow FAS 48, Revenue Recognition When Right of Return Exists. The rule calls on companies to, at the time of sale, make reasonable estimates of how many products that customers will return as a factor in deciding when revenue can be recorded.

Further criticizing the audit firm for its work on a third client, the PCAOB claims E&Y didn’t test the issuer’s VSOE, or vendor-specific objective evidence, which is used to figure out whether the amount of revenue recognized for individual parts of a technology contract was reasonable.

The PCAOB noted the revenue recognition audit deficiencies mentioned here, as well as several others at eight of E&Y’s clients after reviewing the firm’s work between April and December of last year. The deficiencies were linked to the firm’s national office in New York and 22 of its 85 U.S. offices. These errors were significant enough for the oversight board to conclude the firm “had not obtained sufficient competent evidential matter to support its opinion on the issuer’s financial statements or internal control over financial reporting.”

The PCAOB also criticized E&Y for not fully exploring a client’s revenue contracts to see how their terms could affect the issuer’s revenue recognition, for not doing enough work to assess the valuation of another issuer’s securities, and for relying on information an issuer had deemed unreliable for estimating an income-tax valuation allowance.

To be sure, eight clients may not be many in terms of the number of audits looked at by the oversight board, or when taking into account that E&Y audits more than 2,300 publicly traded companies. The PCAOB, however, doesn’t specify how many audits it reviewed and discourages readers of its inspection reports from drawing conclusion on a firm’s performance based solely on the number of the reported deficiencies mentioned. “Board inspection reports are not intended to serve as balanced report cards or overall rating tools,” the PCAOB notes.

For its part, E&Y, in all but two of the deficiencies cited, revisited its work and made changes. “Although we do not always agree with the characterization in the report … in some instances we did agree to perform certain additional procedures or improve aspects of our audit documentation,” E&Y wrote in a letter dated May 4, that was included in the PCAOB report.

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