When accounting goes unaccounted for
“We thought auditors and investors would like to have an avenue to report violations of accounting and auditing standards and financial fraud.”
~ Claudius Modesti, PCAOB Enforcement and Investigations Division director. Last year, the Board fielded 179 tips – a record – that alleged wrongdoing by audit firms and their employees.
As we mentioned late yesterday, the PCAOB has been working hard these days. Late nights, weekends, ordering in and whathaveyou. Adrienne told you about the new eight auditing standards that you’re all expected to have memorized by Labor Day, and we wrapped up with Dan Goelzer snagging QOTD for the Board’s move towards open enforcement proceedings. This move will, presumably, be used in order to shame the pants off of those of you that dare to break the rules.
But the Board had one more thing to serve up yesterday and that was to put it out there that they don’t think too highly of the job auditors are doing supervising the worker bees:
“Through its inspections and investigations, the PCAOB has observed that supervision processes within firms are frequently not as robust as they should be, and that supervisory responsibilities are often not as clearly assigned as they should be,” said PCAOB Acting Chairman Daniel L. Goelzer. “Today’s Release seeks to highlight the Board’s views on the scope for using the authority provided in the Act to address those problems.”
For an industry that depends so heavily on a hierarchal structure, this does not bode well. There are several possible scenarios that led the PCAOB to jump in with their thoughts, including but not limited to:
1. Dozens of audit engagements of publicly traded companies have aloof partners that pop in once or twice a week, observe a handful of staff people feverishly ticking and tying, only to assume everything appears a-okay.
2. The PCAOB has incredible “luck” picking the biggest shitshow engagements.
3. The PCAOB is just blowing the shortage of experienced SAs out of the water.
4. Inspectors don’t buy the “we got this” story from the A1 and A2 running an accelerated filer engagement.
If you’re on one of these free-for-all audits, for crying out loud, get in touch. We want details.
“I believe the time has come for us to ask Congress to change the law and make our enforcement proceedings public, unless there is some good reason for a particular matter to be closed.”
~ Dan Goelzer, Acting Chair of the PCAOB, would like to get things out there.
Since the PCAOB was only up to Audit Standard 7 last time we checked and seems to take the conservative approach when it comes to issuing new ones, we have to say we were more than shocked to see them almost double their audit standards overnight. Gee, must be serious.
The Public Company Accounting Oversight Board today adopted a suite of eight auditing standards related to the auditor’s assessment of, and response to, risk in an audit.
The suite of risk assessment standards, Auditing Standards No. 8 through No. 15, sets forth requirements that enhance the effectiveness of the auditor’s assessment of, and response to ial misstatement in the financial statements.
The risk assessment standards address audit procedures performed throughout the audit, from the initial planning stages through the evaluation of the audit results.
“These new standards are a significant step in promoting sophisticated risk assessment in audits and minimizing the risk that the auditor will fail to detect material misstatements,” said PCAOB Acting Chairman Daniel L. Goelzer. “Identifying risks, and properly planning and performing the audit to address those risks, is essential to promoting investor confidence in audited financial statements.”
What does this mean for auditors? Let’s check them out.
AS No. 8 – Audit Risk. This standard discusses the auditor’s consideration of audit risk in an audit of financial statements as part of an integrated audit or an audit of financial statements only. It describes the components of audit risk and the auditor’s responsibilities for reducing audit risk to an appropriately low level in order to obtain reasonable assurance that the financial statements are free of material misstatement.
AS No. 9 – Audit Planning. This standard establishes requirements regarding planning an audit, including assessing matters that are important to the audit, and establishing an appropriate audit strategy and audit plan.
AS No. 10 – Supervision of the Audit Engagement. This standard sets forth requirements for supervision of the audit engagement, including, in particular, supervising the work of engagement team members. It applies to the engagement partner and to other engagement team members who assist the engagement partner with supervision.
AS No. 11 – Consideration of Materiality in Planning and Performing an Audit. This standard describes the auditor’s responsibilities for consideration of materiality in planning and performing an audit.
AS No. 12 – Identifying and Assessing Risks of Material Misstatement. This standard establishes requirements regarding the process of identifying and assessing risks of material misstatement of the financial statements. The risk assessment process discussed in the standard includes information-gathering procedures to identify risks and an analysis of the identified risks.
AS No. 13 – The Auditor’s Responses to the Risks of Material Misstatement. This standard establishes requirements for responding to the risks of material misstatement in financial statements through the general conduct of the audit and performing audit procedures regarding significant accounts and disclosures.
AS No. 14 – Evaluating Audit Results. This standard establishes requirements regarding the auditor’s evaluation of audit results and determination of whether the auditor has obtained sufficient appropriate audit evidence. The evaluation process set forth in this standard includes, among other things, evaluation of misstatements identified during the audit; the overall presentation of the financial statements, including disclosures; and the potential for management bias in the financial statements.
AS No. 15 – Audit Evidence. This standard explains what constitutes audit evidence and establishes requirements for designing and performing audit procedures to obtain sufficient appropriate audit evidence to support the opinion expressed in the auditor’s report.
Now don’t get me wrong, I love rules and regs as much as the next girl – if not more – but I am of the thought that users of financial statements would be better served not by more rules and regs but by a more comprehensive auditor training program that starts in college. Am I asking too much?
Did we really need clarity on audit evidence? The PCAOB seems to think so and that’s fine, they are well-intentioned in their motive and you can’t fault them for that.
Since the PCAOB is here to stay, the SEC figured it was probably best that they get some people sit on this thing to, ya know, help protect the investors, the public at large, so on and so forth.
The problem, as it appears to us, is that Mary Schapiro and the gang are plumb out of ideas for nominations. Accordingly, they’re out there looking for help from some of the best and beardest, including the Beard, acting PCAOB chair Dan Goelzer, AICPA President and CEO Barry Melancon and a few other noted notables.
However! Just because Mary Schapiro sent these people personal letters begging for some ideas, that doesn’t mean she won’t listen to yours. You can fire any names you have in mind to Board-recommendations@sec.gov. The Commission appreciates the help.
The SEC does point out that the appointees need to be “prominent individuals of integrity and reputation who have a demonstrated commitment to the interests of investors and the public, and an understanding of the responsibilities for and nature of the financial disclosures required of issuers under the securities laws and the obligations of accountants with respect to the preparation and issuance of audit reports with respect to such disclosures,” but we feel that’s subject to interpretation.
Hopefully the noms will include a few wild cards that could stir things up a bit. Sam Antar comes to mind, although the criminal record could be a bit of a problem. Francine might be up for it? We haven’t asked her yet, just throwing it out there. More suggestions welcome.
~ Includes statement from PCAOB spokesperson
Hey! Did you hear? Dodd-Frank got signed into law yesterday and plenty of people are excited (namely Dodd, Frank, BO) and there are plenty who are not.
The PCAOB, it seems, lands somewhere in the middle. Sure the dopes exempted public companies with market caps under $75 million from complying with 404 but putting things in perspective, the Board is probably just amped that the SCOTUS didn’t kick them off the playground.
To show their gratitude, the PCAOB doesn’t bother mentioning the exemption in their press release from yesterday, instead focusing on…foreign auditor oversight (pretty much a black hole) and authority over auditors of broker-dealers. We understand that playing nice is part of the game but COME ON.
We emailed the nice folks over at the Board to ask them about the 404 exemption but we’re still waiting to hear back from them. Perhaps they’re putting on their smiley faces to address this one since they’ve probably been gritting their teeth for the last 20 or so hours.
A PCAOB spokesperson provided us with the following statement:
The PCAOB believes that the internal control audit report required under SOX Section 404(b) has improved the reliability of financial reporting and audit quality. The Board has taken steps to make sure that the internal control auditing standard is scalable to companies of all sizes and has issued guidance and held educational forums to assist smaller company auditors in understanding how to apply that standard to smaller companies. The internal control audit requirement relates to the content of SEC filings, and SEC Chairman Schapiro opposed the exemption for non-accelerated filers.
So, in other words, the compliance technically falls under the SEC and the PCAOB issues the audit standards but it still has to hit a little close to home.
BPR:
PCAOB STATEMENT UPON SIGNING OF THE DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT
Washington, D.C. , July 21, 2010Today’s enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act facilitates the PCAOB’s ability to share information with foreign auditor oversight authorities and closes gaps in the Board’s authority to oversee audits of brokers and dealers.
While the Sarbanes-Oxley Act of 2002 protects the PCAOB’s inspection and investigative processes from public disclosure, it permits the Board, in certain circumstances, to share information with federal and state authorities. However, at the time the Sarbanes-Oxley Act was enacted, very few other countries had audit oversight bodies and, therefore, there was no provision in the Sarbanes-Oxley Act authorizing the PCAOB to share information with foreign authorities. Since that time, many countries have established or are in the process of establishing audit oversight bodies. The Dodd-Frank Act allows the Board, under certain circumstances, to share information with such foreign auditor oversight authorities.
The Dodd-Frank Act also expands the PCAOB’s authority to oversee auditors of brokers and dealers. Under the Sarbanes-Oxley Act, auditors of brokers and dealers were required to register with the Board. The Dodd-Frank Act provides the PCAOB with standard-setting, inspection and disciplinary authority regarding broker-dealer audits.
More information about the PCAOB’s plans to implement this authority and guidance for auditors of brokers and dealers will be forthcoming.
Yesterday, the PCAOB released a 90 page proposal on confirmations because, presumably, auditors collectively suck at using them.
If you take exception with that notion, so be it, but the Board thought that rolling out a standard was necessary to give the opiners out there some guidance so they can get a little more bang for the buck (and give interns and A1s something to do when there is absolutely nothing going on) from confirmations.
Tammy Whitehouse over at Compliance Week fills us in on some of the details:
PCAOB member Steven Harris said the proposed standard expands the use of the confirmation process by requiring auditors to confirm receivables that arise from credit sales, loans, or other transactions; cash and other relationships with financial institutions; and other accounts or balances that pose a significant risk to the financial statements. Currently, auditors are required only to verify receivables if they arise from the sale of goods or services in the normal course of business.
The standard also would relax the requirements for confirmations written on paper, reflecting advances in electronic communication. The proposal would allow auditors to use electronic media to send confirmation requests and receive confirmation responses, and it would make provisions under certain circumstances for auditors to use direct access to a third party’s records to obtain the audit evidence they need.
Throw in your 2¢ by September 13th and gird your loins for audits after Dec. 15, 2011.
PCAOB Proposes New Auditing Standard on Confirmation [PCAOB]
PCAOB Plans New Requirements for Audit Confirmations [Compliance Week]
The PCAOB has issued its annual report on Ernst & Young having given the firm the third degree at its national office and 30 of its 80 U.S. offices. It inspected 58 audits performed by the firm but exactly who is, of course, a big secret (unless you tell us).
There were five “Issuers” that were listed in the report and some form of the word “fail” was used 25 times (that includes the footnotes).
[Issuer A] The Firm failed to adequately test the issuer’s loan loss reserves related to certain loans held for investment. Specifically, the Firm failed to reconcile certain values used in the issuer’s models with industry data, failed to test the recovery rates used in the issuer failed to test the qualitative components of the reserves.
Damn those loan loss reserves!
[Issuer C] The Firm failed to perform sufficient procedures to test the issuer’s allowance for loan losses (“ALL”). The issuer determined the general portion of its ALL estimate, which represented a significant portion of the ALL, using certain factors such as loan grades. Data for this calculation were obtained from information technology systems that reside at a third-party service organization. The Firm relied on these systems, but it failed to test the information-technology general controls (“ITGCs”) over certain of these systems, and it failed to test certain of the application controls over these systems. Further, the Firm’s testing of the controls over the assignment and monitoring of loan grades was insufficient, as the Firm failed to assess the competence of the individuals performing the control on which it relied.
This loan thing appears to be a trend…
[Issuer D] The Firm failed to sufficiently test the costing of work-in-process and finished goods inventory. Specifically, the Firm’s tests of controls over the costing of such inventory were limited to verifying that management reviewed and approved the cost allocation factors, without evaluating the review process that provided the basis for management’s approval.
Hopefully that doesn’t blow back on an A1.
Anyway, you get the picture. The whole report is below for your reading pleasure. E&Y’s got its $0.02 in, however it was short and was mostly concerned about the firm’s right to keep its response to Part II (the non-public part)…non-public:
We are enclosing our response letter to the Public Company Accounting Oversight Board regarding Part I of the draft Report on 2009 Inspection of Ernst & Young LLP (the “Report”). We also are enclosing our initial response to Part II of the draft Report.
We note that Section 104(g)(2) of the Sarbanes-Oxley Act requires that “no portions of the inspection report that deal with criticisms of or potential defects in the quality control systems of the firm under inspection shall be made public if those criticisms or defects are addressed by the firm, to the satisfaction of the Board, not later than 12 months after the date of the inspection report.” Based on this statutory provision, we understand that our comments on Part ii will be kept non-public as long as Part ii of the Report itself is non-public.
In addition, we are requesting confidential treatment of this transmittal letter.
So this doesn’t mean much other than E&Y would prefer that no one know how it managed to tell the PCAOB to fuck right off as nicely as it could.
If you had the pleasure of being on one of these 58 engagements, we’d love to hear about your experience.
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
“Beckstead and Watts, LLP, and the Free Enterprise won, but there is no prize for them.”
~ Professor David Albrecht (guest posting at JDA), pointing out that despite a victory, the petitioners basically get jack squat.
This story is republished from CFOZone, where you’ll find news, analysis and professional networking tools for finance executives.
We’re not quite as sure as others are that yesterday’s Supreme Court decision regarding SarbOx is so utterly meaningless regarding the future of the Public Company Accounting Oversight Board.
Sure, the court said the law is still fully in effect, blah, blah, blah.
But letting the Securities and Exchange Commission fire PCAOB board members for any reason instead of “for cause” could easily subject the board to significantly more political influence.
While Floyd Norris says the commission is unlikely to fire anyone on the PCAOB, the fact is the has commission has thrown its weight around in similar fashion in the case of the Financial Accounting Standards Board when companies have complained to Washington about FASB’s accounting rule making.
What’s to stop them from complaining to the SEC that the PCAOB is being too hard on its auditors, and the SEC from succumbing to that pressure?
Much depends, of course, on who’s leading the commission. Mary Schapiro might not easily bend to the political winds, but her predecessor, Christopher Cox, clearly did just that in connection with FASB.
After all, when during a conference on accounting I asked Conrad Hewitt, the SEC’s last chief accountant under Cox, about the SEC’s threat to hold up approval of FASB’s budget unless it let the commission vet nominations to the board in advance, Hewitt said the SEC was acting properly in its heightened role as the FASB’s overseer under SarbOx.
Yet a FASB member privately insisted to me afterward that the SEC had no authority to do what it did.
And at another conference a few months later, I asked Hewitt what the White House was telling the SEC to do about exemptions for small companies from SarbOx’s requirements for internal controls, the infamous provision known as Section 404. At that, Hewitt, as somnolent a figure as ever occupied the job, sat up in his chair as if he’d just had a bucket of cold water thrown in his face, and insisted that the SEC was an independent agency.
But given what happened to Cox’s predecessor, William Donaldson, I think Hewitt’s reaction to this question was disingenuous.
And both of his answers help explain why the big argument on the court yesterday over the theory of “the unitary executive” and the ability of the president to fire “independent” agency personnel isn’t quite as irrelevant to the PCAOB’s future as most everyone else seems to think.
Now that FEF v. PCAOB has come and gone, the PCAOB didn’t waste any time getting right back to work, as they posted ten new inspection reports today for firms including some of those pesky international firms that have been so resistant.
That should make bring a smile to everyone’s face who was thrilled with today’s decision.
In slightly related news, Elana Kagan, who argued on behalf of the PCAOB, sat and listened to a bunch of old men talk about her today. ATL has the live–blog coverage.
Firm Inspection Reports [PCAOB]