Audit regulators published the third and fourth Big Four accounting firm inspection reports last week—for Ernst & Young and PricewaterhouseCoopers—continuing the themes of earlier reports that cited significant audit deficiencies.
But it's not the audit problems that's disturbing the preparer community: it's the restatements that seem to inevitably accompany the inspections.
Cunningham
“Accounting is so complex these days that looking at almost any audit with hindsight could create a restatement as a result of judgments made,” said Colleen Cunningham, president of the Financial Executives International. She’s concerned about the “behavioral issues” that these types of reports and restatements might create, because auditors are “in a mode to limit liability.”
In his waning days as chairman of the Public Company Accounting Oversight Board, William McDonough told a capacity crowd at the Financial Executives International conference on current financial reporting issues that the inspection process wasn’t meant to create a wave of restatements. He delivered a keynote address to the conference the day after PCAOB published its reports. Cunningham asked McDonough following his address about the restatement effect.
McDonough
“When we see accounting that’s not right, we call it the attention of the [audit] firm,” McDonough said. “They may agree, they may disagree, and it’s up to them if they decide to take it to the company.” He acknowledged that in the current environment, “if you’re questioned, you restate.”
Cunningham said preparers feel like they’re being second-guessed, even third-guessed in part because of the inspection process. “We feel like we’re being unfairly criminalized,” she said. “You could almost go into any company with hindsight and find a need for restatement,” she said.
McDonough emphasized the disclaimers found in the inspection reports—and Cunningham conceded it is a factor in the seeming severity of inspectors’ finding—that the inspection process is risk-based, focusing on audits or areas of auditing where problems are most likely to be found.
In his address, McDonough said the inspection process has changed auditors’ attitudes about their accountability to head off potential misstatements in financial reports. “Under the old system … the risk that an auditor’s failure to identify and address a financial reporting error would come to the attention of regulators was relatively low,” he said. “Under the new system, auditors understand that their work is much more likely to be reviewed within months or even weeks.”
Delicate Balancing Act
For 2005, the PCAOB inspected the nine largest firms auditing U.S. companies who are subject to annual inspection, plus about 280 smaller firms who are subject to inspection only every three years. With more than 1,500 audit firms registered with the PCAOB, the inspection rate still falls well behind the activity level the Board is supposed to meet to comply with Sarbanes-Oxley. In 2004, the Board inspected only about 100 firms in all.
McDonough acknowledged the Board is not meeting its inspection targets, saying it will be a subject of discussion during the budgeting process for the coming year. He said the Board will look at how many inspectors it needs to meet its statutory obligation.
Inspectors also are simplifying the process for smaller firms, where initially the process was more time-consuming, said McDonough. “We started doing inspections for the small firms as if they were big firms, but they’re not,” he said.
The soon-to-depart chairman, who announced that his resignation will be effective at the end of the month unless a successor is named sooner, also acknowledged criticism that the PCAOB has been slow to post inspection results. He said it has been “a very delicate balancing act” to establish the format for the report. He was committed, he said, “to doing it right, not quick.”
That drew fire from conference attendees after McDonough’s talk, who said they are under tight—and tightening—deadlines to meet filing requirements, followed by multiple levels of review of their work. “I find myself biting my tongue a lot,” said one corporate finance professional who asked for anonymity. “He wants to be right, not quick, but we have to be quick—and perfect.”
No comments yet