PCAOB Inspection Reports Still Not Up to Par

Regulatory inspection of auditing firms finally seems to be settling into a groove, but inspection reports still aren’t the scorecard of auditing expertise that corporations and investors had hoped for.

All auditing firms that work with publicly traded companies must submit to inspection by the Public Company Accounting Oversight Board. For the Big 4 and a few other large firms, the inspections come annually. And since inspections began five years ago, voices across the capital markets have welcomed them as tools to improve sloppy audit work and otherwise keep the audit profession on its toes.

But are the inspections all that useful to auditing firms’ clients? That’s not entirely clear. After a few initial years when audit firms meekly accepted PCAOB criticism, the firms now defend themselves more forcefully when chastised by Board inspectors. And while inspection reports give plenty of observations about work done on specific audits by specific firms, little empirical data exists to give corporate accounting executives glimpses into the overall performance of audit firms.

For example, sift through the PCAOB’s most recent reports on Big 4 firms. Inspectors did their usual dive into high-risk areas of high-risk audits, and took issue with predictable issues such as revenue recognition, valuations, goodwill impairments, allowances for loan losses, taxes, and pension plans.

Deloitte, however, simply rebuffed the criticism as differences of professional judgment. “In our view, such reasonable judgments should be respected and not second guessed,” the firm wrote to the PCAOB. “We believe that … the conclusions reached and related documentation were appropriate in the circumstances, and, accordingly, we believe such observations should not be included in the final report.” Such language is nothing unusual from the Big 4 these days.

That may be so, or the PCAOB may have a point. But either way, such stand-offs aren’t terribly illuminating to corporations wondering if their audit firm is the right fit.

Hansen

The PCAOB itself has cautioned repeatedly, and puts disclaimers in every inspection report, that the documents are not scorecards of audit quality. But that doesn’t stop firms from touting a clean inspection report as an indicator of the quality of its work, says Gaylen Hansen, a partner with the Ehrhardt Keefe Steiner & Hottman audit firm in Colorado and a member of the PCAOB’s Standing Advisory Group.

“There are tremendous opportunities for improvement, but only if the PCAOB is willing to swallow hard and do a better job of acknowledging what the profession can bring to the table.”

—Doug Prawitt,

Professor,

Brigham Young

“It’s not a legal discovery where you’re found guilty or innocent,” she says. “It shouldn’t be looked at as a scorecard. The more clients you have, the more likely you’re going have a comment of some sort.”

The inspection process also has been criticized as being too slow to affect audit work meaningfully. For the latest round of Big 4 reports, for example, PCAOB inspectors spent 2008 canvassing audit work on 2007 financial statements and published the reports in the first half of 2009.

Howard

Richard Howard, a practice leader at auditing firm Mayer Hoffman McCann, says the delays make it difficult for corporate finance departments or investors to find value in the inspection reports. “If you’re a user wanting to compare current information on firms, you’re not going to be able to use information from the inspection reports,” he says.

The PCAOB acknowledged there are questions about how to improve inspections. A Board spokeswoman says the inspection process “is regularly updated and improved, based on factors, such as inspection findings, the financial environment, and changes in law. Improvement in audit quality is always our primary goal in making any changes.”

Inspection Improvements

All that still leaves the question of how to demonstrate audit quality to investors, corporations, and other users of PCAOB inspection reports. Last year a Treasury Department committee reviewing the audit profession asked the PCAOB to find indicators of audit quality and effectiveness. The PCAOB, in turn, asked its Standing Advisory Group to offer ideas.

So far, however, the PCAOB has taken no action; nor has any other professional body, such as the Center for Audit Quality or the American Institute of Certified Public Accountants. Howard says the very fact that people are still trying to define “audit quality” means the inspection reports aren’t living up to expectations. “If the inspection reports are indicators of quality, it would seem we wouldn’t need” to define indicators of quality, he says.

Waldron

Matthew Waldron, director of financial reporting policy at the Certified Financial Analyst Institute, says investors probably don’t get much insight about audit quality from reading inspection reports. Instead, investors and other users of financial statements want more transparency into the audit itself. He cites a recent survey that found most users of audit reports want less of the standard boilerplate language, and more talk about the risks and materiality issues auditors explored at a client company.

PCAOB INSPECTIONS

Click on the link below to see PCAOB inspection reports for the top auditing firms from 2005 through 2009:

Deloitte & Touche LLP:

PCAOB Inspection Report 2009

PCAOB Inspection Report 05/19/2008

PCAOB Inspection Report 06/14/2007

PCAOB Inspection Report 11/30/2006

PCAOB Inspection Report 10/06/2005

Ernst & Young:

PCAOB Inspection Report 2009

PCAOB Inspection Report 04/29/2008

PCAOB Inspection Report 05/02/2007

PCAOB Inspection Report 01/11/2007

PCAOB Inspection Report 11/17/2005

KPMG:

PCAOB Inspection Report 2009

PCAOB Inspection Report 08/12/2008

PCAOB Inspection Report 07/26/2007

PCAOB Inspection Report 01/11/2007

PCAOB Inspection Report 09/29/2005

PricewaterhouseCoopers:

PCAOB Inspection Report 2009

PCAOB Inspection Report 06/27/2008

PCAOB Inspection Report 10/18/2007

PCAOB Inspection Report 12/14/2006

PCAOB Inspection Report 11/17/2005

BDO Seidman:

No 2009 Inspection Report Available

PCAOB Inspection Report 05/06/2008

PCAOB Inspection Report 05/16/2007

PCAOB Inspection Report 11/30/2006

PCAOB Inspection Report 11/17/2005

Crowe Chizek:

No 2009 Inspection Report Available

PCAOB Inspection Report 06/27/2008

PCAOB Inspection Report 09/24/2007

PCAOB Inspection Report 11/30/2006

PCAOB Inspection Report 01/19/2006

Grant Thornton:

No 2009 Inspection Report Available

PCAOB Inspection Report 04/04/2008

PCAOB Inspection Report 06/28/2007

PCAOB Inspection Report 11/30/2006

PCAOB Inspection Report 01/19/2006

McGladrey & Pullen:

PCAOB Inspection Report 2009

PCAOB Inspection Report 04/29/2008

PCAOB Inspection Report 06/14/2007

PCAOB Inspection Report 11/30/2006

PCAOB Inspection Report 11/30/2005

Source

Public Company Accounting Oversight Board.

None of the Big 4 audit firms agreed to discuss the PCAOB inspection process with Compliance Week, but KPMG did provide a written statement typical of what the firms usually say about their regulator and the inspections: “We’ve worked constructively with the PCAOB to help reach our shared objective of serving the capital markets by performing high-quality audits … We value the PCAOB’s input and information in connection with its inspection process and remain committed to continuously improving our firm and the profession.”

The PCAOB has revised the inspection process since it started in 2004, mainly to develop a risk-based approach to inspections (just as the Board advises audit firms to pursue a risk-based approach to auditing clients). Inspectors are instructed to focus on the audit work where they are most likely to find problems.

Taylor

One problem with that idea, says Mark Taylor, a professor at Case Western Reserve University, is that those people most expert in high-risk accounting areas already work for the Big 4 or other for-profit companies—not the budget-conscious PCAOB.

“It’s really difficult for the PCAOB to get industry experts in the highest risk areas,” Taylor says. “They’re highly sought after, and it’s a full-time job just to stay on top of the technical issues.”

University of Notre Dame law professor Matthew Barrett says the Securities and Exchange Commission could require audit firms to disclose more about what audit adjustments took place before audit reports were issued; that would provide more insight into the discoveries auditors make before issuing their boilerplate clean opinions. The PCAOB might also incorporate such information in its inspection reports, he says, which would help those reports to serve more like “scorecards,” Barrett suggested.

Glover

Another approach comes from Steve Glover, a professor at Brigham Young University. He argues that the PCAOB should adopt elements of the AICPA’s peer-review process, where member firms review one another’s work; that lets the reviews tap into the expertise of professionals in the field. Peer-reviews might raise independence concerns, Glover admits, but those could be mitigated by the PCAOB carefully selecting and scoping engagements for inspection, he says.

Doug Prawitt, another professor at Brigham Young, says the PCAOB sacrificed expertise for efficiency when it rejected the peer-review process and established an entirely separate inspection program. “There are tremendous opportunities for improvement,” he says, “but only if the PCAOB is willing to swallow hard and do a better job of acknowledging what the profession can bring to the table.”

A PCAOB spokeswoman says the Board leverages the expertise of the profession through its Standing Advisory Group, various PCAOB forums, other advisory groups, and auditors who comment on PCAOB proposals. She notes that the Sarbanes-Oxley Act established the PCAOB specifically to create an independent board and replace the peer review program.