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The PCAOB Finishes The Big Four

Location: Blogs AAO Weblog (Public)
Posted by: Jack Ciesielski	11/22/2005 7:38 AM
[Note: the PCAOB and KPMG subscribe to The Analyst's Accounting Observer. Not that it has any bearing on the comments below, but someone might care.] Around the beginning of last month, the Public Company Accounting Oversight Board released its annual inspection reports on half of the Big Four: KPMG and Deloitte & Touche. As you'd expect, the reports weren't flattering. The PCAOB does not exist to hand out "attaboys" to the audit profession, it exists to keep spurs under auditors' saddles. Last week, it was time for the other half of the Big Four to take a turn in the woodshed. Ernst & Young was criticized for not gathering sufficient competent evidence to support its audit opinion for a number of 2003 audits in the PCAOB sample. Some of the issues involved in the audits: improper operating treatment for a lease that should have been capitalized; allowing presentation of only two segments in a client's financials, obscuring operating losses at one segment that should have been displayed; a failure to confirm terms of an agreement amounting to 15% of annual revenue; and the proposal of judgmental audit adjustments for obsolete inventory without support. In auditing the allowance for loan losses for a group of four financial institutions, in three cases the E&Y audit teams had failed to gather documentable evidence that the "unallocated component of the allowance represented a supportable estimate of probable losses inherent in the issuer's loan portfolio." In short, E&Y couldn't prove that it had really examined the squishiest part of the institutions' allowance for loan losses. In another case, E&Y workpapers didn't support that there had been enough analysis done to support the client's treatment of a divestiture as discontinued operation. PricewaterhouseCoopers didn't fare any better. Deficiencies were found in auditing of accounts receivable (insufficient evidence obtained, improper sample sizes, lack of follow-through on differences found); failure to evaluate whether certain commodity contracts of one client were, in fact, derivatives; and deficiencies in internal control testing (improper reliance on controls that hadn't been tested for several years, reliance on controls tested only in first half of year, tests of controls based on a too-small sample size). Other problems found in audit client financial statements that escaped PwC detection: incorrect tax accounting for foreign subsidiary; improper inclusion of securities as cash equivalents; and recalculation of allowance for doubtful accounts using the client's methodology -without testing the methodology's soundness. There are many more similar findings. It's not encouraging stuff to read; you'd like to think that the Big Four would do a higher-quality job in what should now be their mainstay business - auditing. But you also have to recognize that the tension between regulator and regulated is what makes the process work for investors. If the day ever comes when the PCAOB doesn't find some flaw in the way public accounting firms operate, investors should be concerned that the regulator isn't doing its job.

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