When accounting goes unaccounted for
Jonathan Weil over at Bloomberg has a new column up today and he is less enthusiastic about the Supreme Court decision in FEF v. PCAOB than say, everyone else.
JW is mostly wondering why we should keep having an “independent” PCAOB inside the SEC since the board members will now be at the mercy of the towing the political line inside the Commission, “While the court
This story is republished from CFOZone, where you’ll find news, analysis and professional networking tools for finance executives.
It looks like audit fees are stabilizing.
The 150 publicly-held companies responding to a recent survey paid an average of $4.8 million in audit fees in 2009, down 2.4 percent from the total shelled out by these respondents the prior fiscal year.
The 197 privately-held companies responding to the survey paid an average of $291,200, roughly even with the prior year.
Drilling further down, the survey found that total audit fees for 83 large accelerated filers-those with market capitalizations over $700 million–averaged $7.8 million, 3.6 percent less than what they paid the prior year. What’s more, this average of $7.8 million was possibly skewed to the high side this year due to the total audit fees reported by the 19 respondents from companies with more than $25 billion in annual revenues.
On the other hand, the average audit fees paid by the 22 non-accelerated filers were $579,900, 3.3 percent more than what they paid in the prior year.
These are some of the highlights of a newly-released annual report from Financial Executives Research Foundation (FERF), the research affiliate of Financial Executives International. It stresses that the averages reported in this year’s Audit Fee Survey are not comparable to those reported in the 2009 survey because this year’s respondents are not necessarily the same as last year’s respondents. In fact, FEI stresses that this year’s average was skewed slightly higher due to representation from more companies with revenues of $25 billion or more.
The survey also found that the total number of audit hours averaged 21,458 for all public companies, and-not surprisingly–was directly proportional to both the size of the company and to the number of legal entities comprising the company. Of the 19 respondents from companies with more than $25 billion in annual revenues, the total hours averaged 108,571.
The average hourly audit rate was $218 for all public companies–$186 for nonaccelerated filers and $220 for the large accelerated filers. Surprisingly, the survey found that the lowest hourly rate ($110) and the highest hourly rate ($400) were both reported by large accelerated filers. It said the $110 rate was reported by a large multi-national consumer goods distributor and the $400 rate was reported by a large multi-national financial services firm.
Other interesting findings:
• 88 percent of public company respondents used Big 4 audit firms compared to 36 percent of private companies.
• After the Big 4, Grant Thornton was mentioned by four respondents and BDO and McGladrey were both mentioned once.
• 21 of the 197 private companies plan to switch auditors, compared to only 7 of the 150 public company respondents. Service issues and fees were key reasons for both groups.
• Just 16 of the 150 public companies indicated that their auditors broke out the cost of the Section 404 attestation.
Auditors and audit firms have few options when it comes to defense strategy when they are sued for missing a fraud. If fraud occurs and an auditor partner claims to know everything that one should about his/her client, then the partner was probably in on it. That’s a little tricky.
However, if fraud occurs and the partner claims that he/she had no knowledge of any unscrupulous activity, then that means the audit sage is really just a two-bit glad-hander that couldn’t tell a debit from a credit.
And that appears to be the case of William Brizendine, a Crowe Horwath partner, who is claiming that he didn’t know about the relationship between executives of Peoples Bank of Northern Kentucky and Bill Erpenbeck who were engaged in scheme that artificially inflated the purchase price of model homes. Brizendine claims that he couldn’t possibly known that his client was involved with such a shifty character A) the bank’s execs didn’t tell him until after the shit hit the fan and B) this Erpenbeck character’s name only came up on the tax returns and why on Earth as an audit partner, would he look at those?
The bank’s lead attorney, Ron Parry, tried to establish that Brizendine was in a unique position to expose the fraud before it became large enough to take down the bank. Parry said auditors had to be aware of the business relationship because they also did the taxes of the company Finnan and Menne created with Erpenbeck.
[…]
Brizendine claimed he didn’t know of the relationship because he was just involved in the auditing of the bank and that JAMS tax returns were done by the tax department on another floor of the company’s offices.
Parry was able to show, however, that JAMS tax documents were sometimes sent directly to Brizendine. Brizendine claimed he never looked at those documents since his department didn’t prepare taxes.
Brizendine also admitted on the stand that he was the person who brought in the contract to do JAMS taxes.
KPMG has been kicked to the curb by Enterprise Financial according to an 8-K that was filed on Friday by the company. The ubiquitous claim of “no disagreements with [insert firm]” was there along with a mention of a material weakness that was related to the restatements issued for both 2008 and 2007 but that couldn’t possibly have anything to do with the dismissal of the auditors:
In connection with the identification of the loan participation accounting error described in Item 7, Management Discussion & Analysis and in Item 8, Note 2 of the consolidated financial statements and elsewhere in the Form 10K dated March 16, 2010, the Company also determined that a material weakness in its internal controls over financial reporting existed during the periods affected by the error, including as of December 31, 2008. The Company’s management concluded that the material weakness was the Company’s lack of a formal process to periodically review existing contracts and agreements with continuing accounting significance. To remediate this material weakness, during the fourth quarter of 2009 the Company implemented a formal process to review all contracts and agreements with continuing accounting significance on an annual basis. As a result of the review conducted in the fourth quarter, management did not identify any other errors in its previous accounting for such contracts or agreements. Management believes that this new process has remediated the material weakness in the Company’s internal control over financial reporting.
So in other words, “Yeah, maybe we should have been looking at these contracts but we weren’t and so some material misstatements slid through. We’ve slapped some duct tape on it and it’ll be fine from here on it. End of story.”
The esteemed pleasure of auditing Enterprise now belongs to Deloitte who has now snagged three clients from KPMG this year (by our count) – picking up Jefferies and Select Comfort back in March.
Enterprise Bank parent dismisses KPMG [St. Louis Business Journal]
In a bizarre piece of auditing news released late on a Sunday night, KPMG has verbally resigned as Nebraska-based TierOne Bank’s independent auditor, withdrawn its audit opinion for 2008 and taken back its review of TierOne’s financials for the quarter ended March 31, 2009.
Well damn, we’re fairly sure it couldn’t get any worse than that for TierOne, could it?
Citing risk of material misstatement, KPMG has also warned the audit committee that TierOne’s financials are not to be relied upon by investors. Even Overstock.com doesn’t get that kind of treatment.
Last month the Office of Thrift Supervision – TierOne’s primary regulator – gave it until April 30th to merge with or sell its assets to a healthier financial institution so we’re going to go out on a limb here by assuming that they aren’t going to have good news come Friday and KPMG is just doing the responsible thing by backing away from the mess with a week left.
There’s been a fair amount kvetching, Monday-morning QBing, and just plain hating on auditors lately. Most of it deserved. That said, there are still laws on the books that say you can’t dismiss them entirely and tell them bald-faced lies whenever you want.
Bruce Karatz was the CEO of KB Homes and he was convicted for, among other things, lying to Ernst & Young:
Karatz was involved in a backdating scheme in which he awarded himself and other execs millions of dollars in stock-based compensation, a jury found. Background on Karatz is here and here.
The 64-year-old faces 80 years in prison after being convicted of four felony counts including wire fraud and lying to his company’s auditor, Ernst & Young, about the matter, according to the U.S. attorney’s office in Los Angeles. He was acquitted on 16 other counts.
Jesus, 80 years? We’re no expert on sentencing guidelines but using simple arithmetic, that’s 20 years per count. We’re all for justice but that’s some serious FPMITA prison time. And the way judges have been handing out sentences lately, we wouldn’t expect leniency.
After Backdating Setbacks, Feds Chop Former KB CEO Karatz [Law Blog]
The PCAOB issued a friendly reminder yesterday to auditors that sometimes unusual transactions can be cause for alarm and should send the risk red flags flying. Unfortunately, the friendly reminder did not actually mention anything about what “unusual transactions” are but regardless, you better be on the lookout for them.
“The PCAOB’s message to auditors, in this challenging economic environment, has consistently emphasized attention to audit risk and adherence to existing audit requirements,” said Martin F. Baumann, Chief Auditor and Director of Professional Standards.
Since Practice Alert No. 5 (makes it sound kind of hot, don’t it?) warns of the risk of material misstatement inherent to unusual transactions without mentioning what those transactions could be, we came up with three unusual transactions to which the PCAOB could possibly be referring. It isn’t called guidance for nothing, you’re on your own when it comes to determining what qualifies as unusual, little auditors. Hopefully this helps.
• Large and frequent A/P entries to an entity known only as “Candy” (substitute “Bubbles”, “Kitty”, or “Roxy” as appropriate) This is why you have professional judgment so use it, we’re pretty sure even if you haven’t been to a strip club you know what strippers look like on the books and records.
• If you find yourself in a warehouse on December 31st counting an inventory full of dirty bombs, AK-47s, plutonium rods, chances are your entity is engaged in “unusual transactions.” Bonus points for extra unusual if you’re counting that crap and your entity is a church. Red flag, dear auditor, red flag!
• Recurring transactions for “crack” are definitely unusual. You don’t need us to tell you that’s a giant red flag, unless you are auditing under the influence yourself and concerned mostly with where the entity’s CFO hides his stash. Remember also that crack is pretty cheap on the street so repeated transactions will likely fall outside the scope of materiality though a raging crack habit will be material in the aggregate. Adjust scope accordingly.
• Rangel Challenged by a Historic Foe [WSJ]
Someone finally realized that Charlie Rangel’s constituents in New York’s 15th District have maybe had enough of Chuck and his “pay taxes as I wrote them, not as I pay them” ways. Rangs will be challenged in the primary by New York State Assemblyman Adam Clayton Powell IV, according to the Journal. Not only does Mr Powell have an upper hand in the ad campaign department but there’s a bit of history here.
Powell Number III, sire of IV, was defeated by ChaRang back in 1970 amid his own ethical trubs. ACP 4th Edition insisted to that this had nothing to do with sweet, sweet revenge, “It has nothing to do with revenge or anything like that. Anyone with that record in public service would be interested in higher office.”
It won’t be easy for ACP4 however. He was flicked away by Rangs in a primary challenge back in 1994 and was recently convicted of “driving while impaired,” which actually seems worse than hogging rent-controlled apartments, since that could result in, you know, someone getting killed.
• My Paycheck, My Self? [FINS]
Does your salary define you as a human being? Or, at the very least, does it feel that way? Master pay czar Ken Feinberg had to snoop around some people that pull down some hefty scratch and he found out that the human psyche can easily be affected by their pay stub.
• PCAOB Issues Staff Audit Practice Alert on Auditor Considerations of Significant Unusual Transactions [PCAOB]
Don’t worry about the plain old vanilla transactions auditors, the PCAOB needs you to be on the lookout for significant unusual transactions. What that entails, we don’t really know but we’ll assume that means any transaction, and the PCAOB means any transaction, that looks remotely out of the ordinary, has a funny name (that may or may not include a “105”), requires smokey-filled room approval etc., definitely give it a second look. Or a third.
Last week the PCAOB announced that it was getting serious about audit committee communication after it was revealed that Ernst & Young kinda sorta didn’t think the Repo 105 sitch was worth brining up to the Lehman Brothers audit committee. Granted, Dick Fuld is pretty scary dude and has probably eaten plenty of Big 4 partners for breakfast in his day but avoiding the awkward convo this time around almost resulted in everyone fighting over stale hot dog buns in the street.
Oh sure, the PCAOB has been kicking this around for awhile but something needed to happen to get their motors going and it appears that the LEH/E&Y fallout has done the trick. We might be completely wrong on this but it’s becoming increasingly obvious that the PCAOB has lost faith in auditors to do their jobs and will continue to inundate them with rules until they get an “Uncle.”
How about that statement? It’s the typical press release whathaveyou including quotes from the bigshots:
“The proposed standard on audit committee communications is intended to enhance the relevance and effectiveness of the communications between an auditor and audit committee throughout the course of an engagement,” said PCAOB Acting Chairman Daniel L. Goelzer.
“The proposed standard contains appropriate requirements to achieve effective, two-way communication between the auditor and the audit committee, which we believe would improve audit quality,” said Chief Auditor, Martin F. Baumann.
So if we take Goelzer and Baumann at their word, audit committee communication has been pretty ineffective up to this point? That’s good to know.
And here’s the gist of the required communication:
• Communication of an overview of the audit strategy, including a discussion of significant risks, the use of the internal audit function; and the roles, responsibilities, and location of firms participating in the audit;
• Communication regarding critical accounting polices, practices, and estimates;
• Communication regarding the auditor’s evaluation of a company’s ability to continue as a going concern; and,
• Evaluation by the auditor of the adequacy of the two-way communications.
So there’s your checklist people. Sorry to ask but were these items not being discussed previously? One could assume that since these items are on the list, they weren’t always being discussed in practice. Does standard audit committee communication revolve around Gossip Girl? Tiger Woods’ mistresses?
This really appears to be an example of the PCAOB taking away auditors’ “professional judgment” and making them “professional inquisitors.” Further, as Jim Peterson has pointed out, checking off required communication will do nothing to protect auditors from liability in the future, “there is no legal defense or ‘safe harbor’ in American law based on proof of compliance with professional standards – box ticked or otherwise.”
In other words, make all the professional requirements you want, auditors are still going to get sued and claiming “But we checked the box!” will not work as a defense. So the rationale must have been checklists are fun and easy to follow? Sigh. You’ve got until May 27th to get your thoughts in on this thing before it gets rubber stamped. Get on it.
Press Release [PCAOB]
Accounting firms take a lot of grief for bending over backwards for their clients. They’re in the client service business after all and keeping them as happy as possible is priority numero uno (despite what you might hear). Considering this factoid, when an accounting firm decides to cut a client loose for a “disagreement” over an accounting practice, we feel that’s a pretty good reason for any future accounting firm to think long and hard before taking on said client (case in point: KPMG taking the Overstock.com audit).
PricewaterhouseCoopers notified Old Republic International Corp. on March 19th that they would be “declining to stand for re-election as Old Republic’s independent registered public accounting firm for 2010.” That’s nice SEC filing language for “We’re so grossed out by you that we refuse to audit you any more.”
The two firms disagreed about the accounting treatment of “certain mortgage guaranty reinsurance commutation transactions with captive reinsurers owned by lending institutions.” That description alone makes us nauseous. The gist from Old Republic’s 8-K filing:
Old Republic had concluded that, in accordance with traditional reinsurance accounting practices, funds received ($82.5 million) in excess of amounts owed to it by the captive reinsurers should be deferred and recognized in the income statements of the future periods during which the related claim costs were expected to occur. PwC believed that generally accepted accounting principles (“GAAP”) required that the $82.5 million be recognized immediately as income from a contract termination.
So you have “traditional accounting practices” versus almighty GAAP. The tradish accounting wasn’t good enough for PwC, so they brought the probelme to the attention of the audit committee. The AC ultimately decided…wait…that management was correct. Shocked? Us too. The disagreement was brought to light back in November and in a press release when the company said that the transactions in question “which resulted in little consequential effect on the pretax loss.”
Apparently PwC wouldn’t let it go and the Company called in the SEC to get their $0.02 on the matter. Lo and behold, the Commission sided with PwC. After a lot profanity-laced belly aching (that’s what we imagine, anyway) and sleepless nights for both OR’s accounting department and the PwC audit team (that’s not debatable), Old Republic filed the delayed 10-Q last month with restated financial statements.
After what was surely 5 or so months of pure hell, PwC figured that this was an awkward enough situation that a break up was warranted. This was probably the perfect opportunity for PwC to get out of this engagement. They figured Old Republic wasn’t going to change their less-than GAAP-y ways, the audit committee is obviously no help, and God knows you don’t want to get the SEC involved every single time there’s a disagreement. If you were to ask us, its seems like a pretty logical reaction.
Now the only question is, which audit firm picks up Old Republic? PwC will certainly have some interesting things to share with the firm that decides they’re up for this particular headache.
PricewaterhouseCoopers drops Old Republic [Chicago Breaking News/CT]
8-K [SEC.gov]
So maybe you heard about Ernst & Young and how they kinda, sorta didn’t bring up the shady accounting going on over at Lehman Brothers to the audit committee until a Matthew Lee, your fired whistleblower du jour, brought it up. Some people have suggested that if E&Y had made a single peep about this prior to, say, 2008, maybe we wouldn’t be having this discussion (okay, we’d probably still be having it).
The controversy over this incommunicado has now jolted the PCAOB into action as the they have announced an open meeting for Monday at 9:30 am sharp. Basically, they want to feel everyone out on a standard for required communication for auditors with the audit committees.
As Emily Chasan of Reuters notes, “The PCAOB has considered issuing rules on this issue for the past several years to formalize ways that auditors are expected to communicate with the audit committee of the company they are auditing,” but in classic reactionary fashion, nothing has been done up to this point. Now that we’ve had bankruptcy reports, recycled stories in the press, E&Y hating back the haters, and everything else in this shitstorm, the PCAOB is ready to talk about this.
So, if you’ve got no plans on Monday morning and happen to be in DC, head over to hear the discussion and throw in your $0.02. In the meantime, we’d love to hear some of your suggestions for mandatory talking points from the serious (e.g. accounting treatment that makes the partner even slightly queasy) to the über-ridiculous (e.g. biggest whore on the audit team).
Let it be known that if you are peddling porn and engaged in online pimping, you do not want the SEC on your back.
WebCPA reports that Stephen Corso of Las Vegas and Brian Rabinovitz of Oak Park, CA got the SEC smack down in a Nevada federal court for filing materially false and misleading financial statements from 1999 – 2002 (that’s quite a backlog) and that audit staff – under the boys’ supervision – omitted important info and violated the sanctity of auditor independence during audits of Exotics.com
While the enforcement doesn’t go into specifics, we’re happy to. Exotics.com bills itself as the world’s premiere source for – wait for it – beautiful female adult entertainers. Not to be outdone, Exotics also boasts a veritable cornucopia of escort options including “BDSM & fetish providers, exotic dancers, strippers, sensual and erotic massage specialists, TSTV and other adult entertainment.” It’s that “other that really scares me. Self-billed as the Quicker Pecker Upper (kid you not), the site headline right around the time the SEC brought the heat was “Better than Wives, Girlfriends, and Porn” – and apparently above performing audits according to GAAS?
So, who wants to wildly speculate as to how audit staff violated auditor independence?
Here’s the 2005 release from our friends at the SEC:
[T]he accountants fraudulently participated in audits of Exotics-Nevada’s year-end financial statements and in a review of its quarterly financial statements and failed to conduct those engagements in accordance with GAAS, as required. The Commission also alleges in its complaint that, among other things, the accountants prepared or created many of Exotics-Nevada’s books and records and then audited the financial statements they created. According to the complaint, they also caused their firms to issue false audit reports which, together with the underlying financial statements, were incorporated in Exotics-Nevada’s public filings with the Commission.
Now listen, little auditors, you don’t shit where you live and you don’t audit your own statements. Audit sampling? I could see how it would be hard to resist in this particular instance.
CPAs Disciplined for Porn Site Accounting Fraud [Web CPA]
SEC Complaint