With audit firm inspections well under way for the 2005 inspection season, the Public Company Accounting Oversight Board has made public only nine reports from the 2004 inspection season and is offering no timeline for when the remainder will be available.
The PCAOB faced questions from members of its Standing Advisory Group at their meeting last week. “There was a discussion of the lack of inspection reports," one SAG member told Compliance Week on the condition of confidentiality, "and people were critical of that.”
According to the SAG member, the group told the Board that, “The PCAOB is taking way too long to issue the reports to the public.” In particular, the accounting firms that have registered with the Board were in particular looking for a reaction from the PCAOB. “The firms wanted quicker feedback," notes the SAG member, "albeit some said they had gotten it.”
Board spokeswoman Christi Harlan said, “There is no timetable for posting more reports, but they are being processed.”
The SAG member said there was a sense that the PCAOB was holding something back. “From sidebar conversations, it was clear something was holding them up and yet the PCAOB had zipped their lips and were refusing to say what the hang-up was,” the member said.
Limited Inspections
The PCAOB is required to audit eight of the largest registered firms every year because of the number of clients they audit and the remainder every three years. Although the board had slightly more than 900 firms registered that were subject to inspection in 2004, the board completed only 99 inspections, including the eight larger firms and 91 smaller firms.
That’s about 10 percent of the eligible firms and only about one-third the number the board would need to complete in a year to inspect all firms over a three-year period. Harlan said earlier this year the number was low because it was the first full year of inspections, during which there’s been a learning curve for the regulators.
Section 104 of The Sarbanes-Oxley Act specifies that the PCAOB is required to send its reports to the Securities and Exchange Commission and state regulatory bodies, as well as make them available to the public. The rules include confidentiality provisions for proprietary information, and for any criticism of quality control systems that aren’t corrected to the Board’s satisfaction within 12 months of the inspection. If criticisms are unresolved after 12 months, the Board can publicize its concerns.
Board inspections of audit firms examine a selection of audit work from the prior year. As such, the 2005 inspection season will focus on audits of 2004 financial statements and internal control reports. The 2004 season focused on 2003 financial statements.
INSPECTIONS
The Audit Firm Inspection Process
In documents obtained by Compliance Week, the PCAOB provides guidance to audit firms on what to expect in the inspection process. For the 2004 inspection process, the PCAOB proceeds as follows:
Initial contact with the firm
Formal letter issued with document request; firms are required to provide:
Most recent firm financial statements
Current business model of the firm, including strategy, list of services, etc.
Code of conduct and ethics code for partners and staff
Firm’s quality control policies and procedures
List of individuals who manage the firm and their biographies, including board members
Agendas and minutes of any management committee
Policies and procedures related to consultations on technical matters
Description of “client service model"
Policies and procedures related to he evaluation of partner performance determination and method of partner compensation
Inspection commencement date determined
Engagements selected for review, one week prior to inspection start date
Quality control assessment and engagement reviews
Comment forms prepared, reviewed by firm, and responded to
Draft report prepared by inspection staff
Draft report is reviewed by Board of PCAOB
Board makes draft report available to firm
Firm has 30 days to respond to draft report
Board issues final report to firm and the SEC
The PCAOB also listed issues identified in all types of companies, including:
Audit of fair values
Related party issues
Prohibited loans
Revenue recognition
Auditing of expenses
Independence
Going concern/development stage designation
Control of issuer use of reports
Understanding of contractual arrangements/substance of transactions
Principal auditor
The Board conducted “limited inspections” of the Big Four in 2003, examining their 2002 audit work, and posted those inspection results in August 2004. The Board conducted official inspections in 2004, examining 2003 audit work, and has so far posted nine reports, none of them for Big Four or second-tier firms.
Langer
Dan Langer, director of solutions for internal audit and controls at Jefferson Wells, says the PCAOB deserves credit for what it has achieved to date. The regulatory body was created by Sarbanes-Oxley and opened its doors in 2003. To begin with, says Langer, the Board has hired and deployed a staff that is projected to number 450 by the end of 2005, and they've done so “in an environment where there’s a lot of competition" for accounting and audit experts. "It’s a very competitive resource market," says Langer. "You have to give them credit for being able to ramp up the way they have.”
At the same time, Langer acknowledges, “There’s a lot of interest in very quickly seeing the results of those inspections.” Issuers in particular “are very interested to see as much information as they can in inspection reports” because it gives them insight into their own relationship with their auditors, says Langer.
Marchetti
But not everyone in the business has high expectations about reviewing inspection reports, or even seeing them made public. “It was my understanding that they were doing inspections to keep the audit firms in check, but I was never expecting to see detailed information,” says Anne Marchetti, practice director for Parson Consulting.
Chris Allen at Financial Executives International says it interprets inspection rules as holding reports confidential. “We think that the inspection reports are confidential and that the PCAOB is under no obligation and has no intention of making these available publicly,” says Allen.
However, those views are not necessarily in sync with the PCAOB's own view of the reports. In a Board statement on the issuance of the inspection reports released last year, the Board specifically noted that it "has prepared the inspection reports to include both a section that is
being made public and a section that is being kept nonpublic," and insiders expect future reports to hold similar data. In addition, the PCAOB's inspection rule notes that the Board may, at any time, "publish such summaries, compilations, or other general reports concerning
the procedures, findings, and results of its various inspections as the Board deems appropriate."
An Unfortunate Position
Brod
In an April 1, 2005, letter to the SEC reacting to the first wave of internal control reporting, Frank Brod, chairman of the FEI’s Committee on Corporate Reporting, lobbied not only for an opportunity to review inspection reports, but also for publicizing audit firms’ financial statements to make transparent the “transfer of wealth” from shareholders to audit firms to pay for the audit work.
“We believe that the audit firms should be subject to similar reporting requirements that the companies they audit are subject to,” Brod wrote.
Some sources speculate that inspection reports may be slow to become public because of what they contain. Ernest Badway, an attorney with Saiber Schlesinger Satz & Goldstein in Newark, N.J., says the inspection process could have “turned up activity that is violative of some statute, rule or regulation. Thus, the reports are protected by a government investigative privilege.”
Harlan at the PCAOB is quick to point out that Sarbanes-Oxley makes a distinction between general inspection results, which are subject to public release, and criticisms, which are confidential pending audit firms’ actions to correct them.
Turner
Lynn Turner, former SEC chief accountant and director of research at Glass Lewis, says it could be the confidentiality provisions that are slowing the reporting process. “The PCAOB is put in the unfortunate position of having to go back and forth with the firms on what is private and what is public,” says Turner. “This takes a long time. Quite frankly, it is highly likely the firms are a significant hang up themselves.”
As a rule, accounting firms are quiet on PCAOB affairs. None of the Big Four firms or the second-tier firms answered a request for comment on the inspection process.
Langer at Jefferson Wells says that even if reports were currently available in larger number, they might not be terribly useful in providing guidance going forward because companies are still in the process of creating their internal control testing and reporting processes. “It’s going to take a few years to really integrate this into the fabric of the business,” says Langer. “We’re still in build-up mode.”
No comments yet