September 23, 2020

If the PCAOB Thinks Firms are So Deficient, Can We Rely on Audits or Not?

A nearly 40% "deficiency" rate for the big firms according to the PCAOB is news to no one (at least no one around here) but let's look at this post by Emily Chasan in CFO Journal for WSJ anyway:

The Big Number: 37.5%

That’s the proportion of audits by large accounting firms found to have deficiencies.

Auditors at the seven largest U.S. accounting firms were cited for deficiencies in 37.5% of audits inspected by U.S. regulators in 2011, according to an analysis of the most recent data from the government’s audit watchdog.

That figure, which includes audits completed by PricewaterhouseCoopers LLP, Deloitte & Touche LLP, Ernst & Young LLP, KPMG LLP, BDO USA LLP, McGladrey LLP and Grant Thornton LLP, was up from 32.6% in 2010, and has more than doubled from 14.8% in 2009.

Yeah, we got all that. But if you check out the comments, you get this enlightened bit:

So what? Neither you nor the PCAOB have demonstrated that these failures to follow the letter of PCAOB auditing standards has resulted in an incorrect opinion being given. Nor have either of you shown that these failures to follow the letter of PCAOB auditing standards have allowed a material misstatement to go undetected.

If the right opinion was given and the accounts were fairly presented in accordance with GAAP, how can you legitimately describe these as “deficiencies”? It’s unclear even that audit quality was compromised.

Of course, sloppy journalism and sloppy regulation are incredibly damaging to public confidence in audit. Far more than sloppy auditing, I’d argue.

NOW, I love Emily Chasan so let's throw the hate directed toward her out the window and focus on the meat of this comment. As Christie so poignantly requested: could the PCAOB just tell us if these deficiencies mean investors can or cannot rely on the financial statements? That is really all anyone needs to know. I mean, if a regulator looked at a vehicle seat belt system that didn't do what it was supposed to do 37.5% of the time, do you think they'd allow that car on the market? Or what if the FDA were to allow a drug that killed 37.5% of its patients on the market?

So, can we rely on these audits or not? And if we do and we shouldn't have, can we blame the PCAOB?

Of course, we could get into a big long discussion about the farce that is "audit quality" but ain't no one got time for that.

According to this CAQ "Guide to PCAOB Inspections [PDF]," the "inspections focus on how a firm conducted selected audits and on the effectiveness of the firm’s quality control policies and procedures. Inspections are designed to identify whether there are deficiencies in how the accounting firm performs public company audits and whether there are weaknesses in its quality controls over public company auditing."

Fab. That still doesn't explain if a 37.5% "deficiency rate" impacts the average investor who has absolutely no idea what any of this means and is looking to the PCAOB to make sense of it.

As previously discussed, if the PCAOB is supposed to protect the public interest, why don't they just tell us which audits got bungled? I mean, obvious unintended consequence of crashing stock prices aside.

Considering the PCAOB so loosely throws around the word "deficiencies" and "failures" as if that isn't something investors should worry about (HELLO, failure is a bad bad thing when my money is involved), shouldn't they take this a tad more seriously?

This should not be boilerplate:

The inspection team considered certain of the deficiencies that it observed to be audit failures. Specifically, certain of the identified deficiencies were of such significance that it appeared that the Firm, at the time it issued its audit report, had failed to obtain sufficient appropriate audit evidence to support its audit opinion on the financial statements and/or on the effectiveness of internal control over financial reporting.

Circling back… so… can we "trust" these audits or what? Maybe trust them 37.5%?

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