Auditors are under new pressure from regulators to get even more skeptical about whether companies are telling their investors the full story around any problems they may face as a result of mortgages.

The Public Company Accounting Oversight Board published a year-end staff audit practice alert to remind auditors of their duty to look closely at loss contingencies, disclosures and related items in light of ongoing investigations into shoddy mortgage securitization and foreclosure activities. Martin Baumann, chief auditor of the PCAOB said in a statement accompanying the alert that auditors need to be aware of the risks and costs associated with mortgage-related and foreclosure-related problems, not to mention the audit implications for companies caught in the web of allegations.

The alert says the PCAOB staff took note of allegations surfacing in the fall that public companies, mainly financial institutions, dressed up shaky mortgages to sell them to investors and may ultimately be required to buy them back. It creates a risk exposure for the banking sector of some $52 billion, the PCAOB noted, and the number could get bigger as authorities sort out allegations of hasty, half-baked foreclosure proceedings.

The PCAOB staff tells auditors that the ongoing mortgage- and foreclosure-related investigations could have implications for financial statements as well as internal control over financial reporting. The alert tells auditors, first of all, to take a close look at the accounting and disclosures related to legal contingencies, or unresolved legal issues. Under current auditing standards, auditors are required to gather evidence about the existence of a condition that would suggest a loss is possible, the period in which the underlying cause for legal action occurred, the degree of probability that the entity will lose the legal fight, and the amount or range of possible loss.

The staff also reminds auditors to take a close look at accounting estimates, such as accruals or reserves for contingencies. Auditors are expected to show some skepticism as they consider the subjective and objective factors that go into such estimates. When it comes to mortgage loan repurchase losses, that might include the estimated level of mortgage defects, defaults, investor repurchase demands, and appeal success rates.  Auditors will be expected to take a look at the information contained in quarterly reports and other filings with the Securities and Exchange Commission to consider whether it is consistent with what is reported in the financial statements.

Two years ago, the PCAOB published Alert No. 3 to point out a long list of issues that should get special attention from auditors in light of the economic conditions. “Audit risk that existed in December 2008 with respect to contingencies and guarantees as well as other issues continues to exist today,” the PCAOB said. The alert charged auditors to pay close attention to fraud risks, fair-value measurements, accounting estimates, management representations, disclosures, and a company's ability to continue as a going concern, among others.