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February 2, 2023

EY’s Auditing Has Reverted Back to Being Bad, 2021 PCAOB Inspection Report Shows

Next up on the PCAOB’s hit list is EY, whose 2021 inspection report was released on Dec. 19. The Black and Yellow had been slowly but surely not screwing up as many audits in recent years. After having a not-great audit deficient rate of 31% in its 2017 inspection report, EY’s error rate had dropped to 26% in its 2018 report, 18% in 2019, and 15.4% in 2020.

In its 2022 Transparency Report, which was released in late October, EY noted that the PCAOB would be issuing Part I of its report on the 2021 inspection of EY US in the coming months, but the firm provided no hints as to how well it did or what to expect. Now that its 2021 auditing report card is out, we know why EY stayed mum on its results: they weren’t very good (bold part added by us for emphasis):

In the 2021 inspection of Ernst & Young LLP, the PCAOB assessed the firm’s compliance with laws, rules, and professional standards applicable to the audits of public companies.

We selected for review 56 audits of issuers with fiscal years generally ending in 2020. For each issuer audit selected, we reviewed a portion of the audit. We also evaluated elements of the firm’s system of quality control.

We also selected for review three reviews of interim financial information (“interim reviews”). Our reviews were performed to gain a timely understanding of emerging financial reporting and auditing risks associated with issuers that were formed by mergers between non-public operating companies and special purpose acquisition companies (SPACs). We did not identify any instances of non-compliance with PCAOB standards related to the interim reviews that we reviewed.

[…]

Twelve of the 56 audits we reviewed in 2021 are included in Part I.A of this report due to the significance of the deficiencies identified. The identified deficiencies primarily related to the firm’s testing of controls over and/or substantive testing of revenue and related accounts, long-lived assets, and equity and equity-related transactions.

So for those of you scoring at home, that’s a deficiency rate of 21.4%—the firm’s worst since 2018. Nine audits had problems in both internal control over financial reporting and in the financial statement, one had deficiencies in the financial statement only, and two had deficiencies in ICFR only. The most common Part I.A deficiencies in 2021 related to testing the design or operating effectiveness of controls selected for testing, identifying controls related to a significant account or relevant assertion, and testing the accuracy and completeness of information used to make selections for testing controls, according to the PCAOB.

There were four areas of the audit that confounded EY auditors the most:

  • Revenue and related accounts: The deficiencies in 2021 (as well as in 2020 and 2019) primarily related to substantive testing of, and testing controls over, revenue, including controls over information technology systems associated with revenue.
  • Long-lived assets: The deficiencies in 2021 related to testing controls over the valuation of long-lived assets and the evaluation of misstatements related to long-lived assets.
  • Equity and equity-related transactions: The deficiencies in 2021 related to substantive testing of, and testing controls over, the appropriateness of the issuer’s accounting for certain warrants and transactions.
  • Inventory: The deficiency in 2021 related to substantive testing of, and testing controls over, inventory.

Three of EY’s 10 audits of issuers in the industrials sector were screwed up, while two of its eight audits of issuers in health care and two of its 10 audits of issuers in the consumer discretionary sector had mistakes. Errors were found in one audit each for issuers in the energy, financials, materials, and real estate sectors. EY auditors did get a 100% on their four audits of issuers in communication services, so they got that going for them.

If you’re looking for something to read over the holiday weekend, we’ve included EY’s 2021 inspection report below.

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