Peeling away financial reporting issues one layer at a time

The PCAOB Should Name Names – All of Them

Yesterday's blog post from Jim Peterson (Re:Balance) excoriated the PCAOB for proposing to require audit firms to disclose the names of the responsible engagement partners. Jim claims that the PCAOB is wasting its time: the name of the engagement partner is not relevant information to sophisticated users of financial statements; it's one more piece of information that the average investor won't attend to; and it would only fuel the fires of the "unremitting critics of the profession."

Yesterday, I might have been inclined to agree with Jim; but today, I don't. For today brought news (here, here and here) that PCAOB inspectors had concluded (in 2008) that Deloitte & Touche's quality control system was flawed, and that the firm still has not corrected the problem. Specifically, the inspectors found too many instances were DT auditors placed too much reliance on management's representations – what some would derisively call "auditing by inquiry" – without adequately testing the accuracy of those representations.

Based on what I have read so far, here is what I think an investor is entitled to know in a timely manner, and which has never been disclosed:

  1. Which companies were affected by the allegedly flawed audits?
  2. Who were the responsible engagement partners?
  3. Were the responsible engagement partners disciplined or re-trained in any way?
  4. Which other audits could be flawed because the responsible engagement partners were involved?

Unfortunately, my entire line of questioning falls apart at the beginning because of the PCAOB's longstanding (and controversial) policy of not identifying the companies affected when its inspectors have identified a flawed audit.

And, as for timeliness, I have one more question: The original Part I of the PCAOB report was issued in May 2008. By law, DT had until May 2009 to remedy the problems and in doing so, keep them confidential. Thus, the PCAOB could have issued the report it issued yesterday 30 months earlier. What took them so long?

If the PCAOB truly wants the naming of responsible engagement partners to have information and deterrent value, it needs to be more forthcoming itself about the results of its inspections, and to publish the information in a timely manner.

6 Comments

  1. Reply CP October 19, 2011

    Your thinking is flawed in several ways, but most importantly is the disconnect in your argument about what was actually released yesterday. The PCAOB released its findings on the firm’s system of quality controls. In other words, outside of the findings in Part I which have been public for a long time, no new information about a particular audit or audits was released yesterday. Instead, the PCAOB is criticizing the firm’s system and process, not its performance on any one audit.
    I am not saying that the QC findings are not important. In fact, they are almost assuredly more important than the Part I findings. But when you say that the PCAOB should name names now, and your opinion changed because of what was released yesterday, you are either misinformed as to what was released, or you are intentionally trying to stir up support for an ill-conceived concept based on something that has little connection to the engagement partner signature proposal.
    Each of the four questions you ask are relevant to Part I information, not Part II information. What the PCAOB released really has no logical connection as to whether partner signature will be appropriate.

  2. Reply Bitter Audit Partner October 19, 2011

    Very few of the audits in these inspection reports yielded restatements, especially in 2008 and 2009, so what is the point of naming names for deficiencies that are detected by the PCAOB? In fact many of the issues called out by the PCAOB just came down to the fact they wanted more documentation in the papers, and the PCAOB always tells us “if it is not contained in the papers, then we can’t give you credit for the work or considering the issue”. Keep in mind also that it takes the PCAOB longer to inspect that doing the audit procedures themselves.
    I’m in favor of having inspections and ensuring that auditors are doing audits and giving them tools to improve.
    But the PCAOB, as it relates to the Big 4, has decided to make theatrics on small issues, and the biggest find they actually have is that we need to keep more info in the papers.
    One way to illustrate my point – prior to 2007 or so, my large engagement has a pretty good planning memo that was about 50 pages long. Now, because of all the comments, that same planning memo for 2011 will be 500 pages. That is right, 500 pages. Other sections of the audit have increased as well.
    Madness. This is not what Congress intended or what investors care about.

  3. Reply Jim Peterson October 19, 2011

    Tom — We’re not apart on wishing a lot more from the PCAOB inspection process. But as the two earlier comments would indicate, I think, there’s a disconnect between that desire and the contemporaneous identification by name of the audit partner on an audit report issued in the normal course — which I don’t see bearing on any of your four entirely legitimate questions.

  4. Reply Independent Accountant October 20, 2011

    TS:
    For many years I favored CPA firm partners signing reports personally. About ten years ago I changed my mind. I now believe it will make no difference. Only changing CPA firm incentives will.
    Auditor rotation will make no difference. Having say PWC replace KPMG at Citigroup and KPMG replace PWC at Goldman Sachs will accomplish nothing in my opinion. Why? Will Big 87654 firm A “rat out” Big 87654 firm B? Sure. And pigs will fly.
    As for the PCAOB who cares what it thinks? Why do you believe PCAOB “inspectors” are competent? I don’t, having handed SFAS 13 paragraphs 5-7 to some of them and failed to explain the differences between lessor and lessee accounting for capital leases! Not one of them understood DCF analysis and the concept of the “interest rate implicit in the lease”! Not one!
    I agree with Bitter Audit Partner (BAP). I go further. If the PCAOB is so competent, it has an opportunity for its soon-to-be-alumni: form a CPA firm to audit SEC registrants. Imagine this CPA firm will be so good that its audits will be free! Free? Sure, since this firm’s work will be so good, its clients will have their costs of capital fall. Their costs of capital will fall so much that their audits will be “free”! The investment banking community will demand PCAOB audits.
    Sure. On the other side of the looking glass. I am disgusted with the PCAOB. It’s another scam. When the PCAOB tells us that the TBTF banks are UNAUDITABLE I will take it seriously. Maybe.
    Agreeing with BAP, In MY PROFESSIONAL JUDGMENT the PCAOB loves “file stuffer”. It cannot form judgments as to which matters are substantial versus inconsequential.
    I await the PCAOB subjecting itself to the “judgment of the market place”.
    BAP, I sympathize with you. If your firm does something wrong, you’ll get sued. If you haven’t gotten sued, no one with his own money on the line thinks you’ve done anything wrong worth bothering with. Disagreeing with you BAP, I would shut the PCAOB tomorrow.
    IA

  5. Reply Superheater October 25, 2011

    I think Independent Accountant pretty much nailed it. Personal signatures are useless, as is the PCAOB.
    Until auditor procurement is removed from management,and we stop FASB from issuing ridiculously long standards that are reissued a few years later, nothing else will improve audit quality.
    As for the PCAOB, its inspectors are largely ex-big 4 staff steeped in its monoculture. Then again, the principal qualification for most of the PCAOB board is to be unqualified. It is a sham,designed to create the appearance of action, but mostly conjured up by a legislature comprised overwhelming of lawyers designed to provide more power, authority and prestige for lawyers.

  6. Reply Nettles October 28, 2011

    “Thus, the PCAOB could have issued the report it issued yesterday 30 months earlier. What took them so long?”
    Perhaps they sent the report via ‘snail express’?
    🙂
    Good Read.

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