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January 29, 2023

Auditor Phones in Auditing Revenue, Gets Totally Busted

The PCAOB posted 26 new inspection reports today, none of which were all that remarkable. But we did take a peek at MaloneBailey's, where we found this little nugget from Issuer C:

In this audit, the Firm failed to perform sufficient procedures to determine whether the issuer properly recognized revenue. The issuer manufactured custom products for end-users. The issuer recognized revenue upon the customer's acceptance of the delivered product even though certain of the issuer's sales contracts included payment terms that were extended beyond customer acceptance of the delivered product or were based on milestones, which had not occurred at the time of revenue recognition. There was no evidence in the audit documentation, and no persuasive other evidence, that the Firm had performed procedures to evaluate whether the extended or milestone-based payment terms indicated that the issuer's sales price for its product was fixed or determinable and whether collection of that sales price was reasonably assured. (AS No. 14, paragraph 30)

Remember in elementary school math class when the teacher would insist you show your work? Think of the PCAOB as your teacher who thought you were being a smart ass when you said you didn't need to show your work because you had the multiplication tables memorized.

In case you haven't gotten to that particular chapter in your Becker book yet, Auditing Standard No. 14 is like the Cliff Notes version of the Auditor Bible. The standard is pretty clear here, as in "the entire point of an audit, basically":

30.     The auditor must evaluate whether the financial statements are presented fairly, in all material respects, in conformity with the applicable financial reporting framework.

Note:  AU sec. 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles, establishes requirements for evaluating the presentation of the financial statements. Auditing Standard No. 6, Evaluating Consistency of Financial Statements, establishes requirements regarding evaluating the consistency of the accounting principles used in financial statements.

A 14-year-old Journal of Accountancy article explains the distinct difference between off-standard accounting treatments and straight up fraud — such as a company recognizing sales when they're really just unloading inventory to their own warehouse. That's fraud. Anyone who ever took an audit class knows that.

As for Issuer C, the question is not whether they intended to commit fraud, nor was that question up to the auditors to answer. It was, however, on them to show their work and as far as the PCAOB is concerned, they completely phoned this one in. Better luck next time, guys.

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