If you're like us, you've been anxiously awaiting comment letters on the PCAOB's auditor reporting model proposal. There's nothing better than self-righteous firms penning letters filled with thinly-veiled condescension. Plus, the U.S. Chamber owes us all an honest effort after phoning in their initial response.
So far none of the major accounting firms, the AICPA, CAQ, Chamber or other heavy hitters have their comments posted on the PCAOB's website. We're on the look out but in the meantime, there is an extensive joint letter from the National Asian American Coalition and African Methodist Episcopal Church.
Yeah, I don't know, but hey, it's something.
The letter sides strongly with Board member Steven Harris, who expressed quite a bit of disappointment with the proposal, stating:
We would urge that the Board take seriously all of Board Member Harris’ perceptiveobservationsabouttheinfirmitiesandweaknessesoftheproposedchanges.
One of the biggest problems that Harris has spoken about over the years is the issuer-pay model. That is, the companies that are required to obtain an independent audit pay the auditors who perform the independent audit.
This arrangement defies comprehension. Yet at some point, some supposedly smart people concluded that this arrangement was perfectly fine and that the audit business would attract individuals who were impervious to the temptation of pleasing clients that were giving you millions of dollars for your services. "Oh, you want to pay us to independent? Right away, sir!"
Even the NAAC and AME Church who, at best, have a marginal interest in this topic, know that expecting audit firms to be independent is like expecting a dog not to eat a plate of bacon you left on the counter:
[W]e strongly urgean historic change from the pastas to howauditors should bepaid.Ratherthanbeingpaidbythecorporationtheyaudit,allpaymentsshouldcomefromacentral PCAOB-controlled fund. This would enable the auditors to be totally free ofcorporateinfluence,atleastasitaffectsthelevelofcompensationforservices.Weestimatethat this PCAOB central fund would be approximately $2.5 billion just for Fortune 500corporationswhowouldcontribute to the fundbasedupon thecomplexityandsizeoftheaudit.
WebelievethatmanylargeCPAfirmswouldpreferthisifthegenerallevelofcompensationtothemwasfairandrelatedtothesizeandcomplexityof theaudit.Pleasenote,wedonotcontend that present compensation is excessive. We are merely trying to maximize theindependenceofandperceptionsofindependencefrommanagement.
A PCAOB central fund probably isn't politically plausible and like most things in the accounting world, disrupting the status quo is always a non-starter.
Unless more stakeholders start asking for a solution that doesn't involve issuers lining auditors' pockets, independence will remain nothing more than lip service.
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.
For some time now, the PCAOB has been talking about making audit partners famous (at least to investors that are paying attention) in ways that they aren’t too thrilled about. Earlier today the Board issued a proposal for comment that will do just that.
The proposed amendments would:
• require registered public accounting firms to disclose the name of the engagement partner in the audit report,
• amend the Board’s Annual Report Form to require registered firms to disclos gagement partner for each audit report already required to be reported on the form, and
•require disclosure in the audit report of other accounting firms and certain other participants that took part in the audit.
So if you can consider yourself an astute observer of auditing policy and regs, they’d love to hear your thoughts. However, it would be greatly appreciated if you didn’t take your cues from the FASB letters and kept things constructive.
All of the Board Members made statements, including PCAOB Chairman Jim Doty (full statement on page 2) who sees this latest proposal as good sense:
I fail to see why shareholders in BNP Paribas, listed on the Euronext Paris exchange, should be able to see the name of the engagement partner in the audit report, but shareholders in Citigroup, listed on the New York Stock Exchange should not. Indeed, the names of engagement partners for some European companies that are listed on the NYSE are disclosed in U.S. filings. Why are shareholders in France Telecom to be favored over shareholders in AT&T?
And then there’s Steven Harris’s statement (in full on page 3). Harris, who is known to speak frankly about auditors, finds the proposal okay enough but would really like to see the audit partners’ John Hancocks:
While I support an identification of the engagement partner, I continue to strongly support, and would have preferred, a requirement for the engagement partner to actually sign his or her name on the audit report. My views, which I stated when the Board last publicly discussed the issue in July 2009, have not changed. Very fundamentally, I believe that nothing focuses the mind quite like putting one’s individual signature on a document.
And for good measure, he threw in this:
Many find it ironic that auditing firms in the United States, whose business is providing assurance about the transparency provided by others, resist publicly providing their own financial statements. There is no apparent reason that the auditing firms that act as gatekeepers to our securities markets should not be as transparent to investors as the companies they audit.
If you agree with Mr. Harris and happen to have a copy of your firm’s financial statements, feel free to pass it along. Or if you’d rather not wait to make your thoughts known on the Board’s proposals, you may drop them in the comments below.