Audit Overseer Faults BDO, Grant Thornton

The PCAOB says BDO had trouble testing revenue-recognition controls, while Grant Thornton did not adequately identify GAAP errors. Both firms complain that the board criticized judgment calls.

Annual inspection reports for BDO Seidman and Grant Thornton, released last Thursday by the Public Company Accounting Oversight Board, criticized some of the audit testing procedures and practices at the two large accounting firms.

The review of BDO focused mainly on issues related to testing controls around revenue recognition, while Grant Thornton was chastised for not identifying or sufficiently addressing errors in clients’ application of generally accepted accounting principles with respect to pension plans, acquisitions, and auction-rate securities.

With regard to BDO, the inspection staff reviewed seven of the company’s audits performed from August 2008 through January 2009 as a representation of the firm’s work.

The report highlighted several deficiencies tied to what it said were failures by BDO to perform audit procedures, or perform them sufficiently. According to the reports, the shortcomings were usually based on a lack of documentation and persuasive evidence to back up audit opinions. For example, the board said, BDO did not test the operating effectiveness of technology systems that a client used to aggregate revenue totals for its financial statements. The systems were used by the client company for billing and transaction-processing purposes.

The inspection team also reported that BDO’s audit of a new client failed to “appropriately test” the company’s recognition of revenue practices. Specifically, the audit firm noted that sales increased in the last month of the year but it failed to get an adequate explanation frommanagement. Also, the report concluded that BDO reduced its “substantive” revenue testing of two other clients, although more thorough testing was needed.

And while BDO identified so-called “channel stuffing” as a risk of material misstatement due to fraud, at another client, its testing related to whether the client engaged in the act was not adequate, said the inspectors. (Channel stuffing is the practice of accelerating revenue recognition by coaxing distributors to hold excess inventory.)

Other alleged problem spots for BDO included a failure to design and perform sufficient audit procedures to test: journal entries and other adjustments for evidence of possible material misstatement due to fraud; valuation of accrued liabilities related to contra-revenue accounts; a liability for estimated sales returns in connection with an acquisition; and assumptions related to a client’s goodwill impairment of a significant business unit.

In response to the inspection report, BDO performed additional procedures or supplemented its work papers as necessary. It also noted in a letter that was attached to the report that none of the clients cited had to restate their financial results.

In the letter, BDO acknowledged the importance of the inspection exercise, commenting that “an inherent part of our audit practice involves continuous improvement.” However, the firm also said the report does not “lend itself to a portrayal of the overall high quality of our audit practice,” since it reviews only a tiny sampling of audits. What’s more, BDO pointed out that many of the issues reviewed “typically involved many decisions that may be subject to different reasonable interpretations.”

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