• Big 4

    Ernst & Young Latest Big 4 Firm to Have Part II of PCAOB Inspection Report Released

    By | May 23, 2013

    Okay, remind me — there's a saying about "three" and "trend" or "pattern" or something? Forget it, not important. What is important — at least we've made the argument that it is — is that the PCAOB released Part II of Ernst & Young's 2009 inspection report. That makes three out of four Big 4 firms, Deloitte and PwC being the other two, to have Part II released and something tells me KPMG will be getting its own in the very near future.

    You can read the report in full on the next page, but since this is the third go round, you guys probably know the drill. This morning Dow Jones report keeps things succinct:

    [The Board] said it had "cause for concern" about whether the firm's auditors were skeptical enough of their clients' assertions. The board also questioned whether some of E&Y's audits had been thorough enough, and whether it did enough testing in some areas where there was a risk of fraud. The board's move to unseal the material doesn't carry any fines or sanctions for Ernst & Young. But it amounts to an official public rebuke of the firm, and indicates the board feels E&Y didn't do enough, and was slow, to address those criticisms.
    I guess that skepticism one could be interesting, couldn't it? Here's what the report says:
    The inspection results provide cause for concern that the Firm's system of quality control may not do enough to assure that accounting and auditing issues are evaluated with the degree of professional skepticism that is contemplated in the auditing standards. 
    In numerous instances, the inspection team observed that the Firm's support for significant areas of an audit consisted of uncorroborated management's views or the results of inquiries of management. The Firm's apparent failure to appropriately challenge management occurred in several areas, including when the Firm evaluated * * * * management estimates and assumptions related to accruals and reserves; * * * *. The Firm did not appropriately test these representations by, for example, reviewing appropriate source documentation or comparing the representations to relevant industry or other public information, including in certain cases when such assumptions were contrary to historical results
    Alright, so maybe I spoke too soon — everyone knows that auditors are too willing to trust management! It's been noted before, it's being noted here. It will be noted again. Frankly, the fraud one doesn't blow up many skirts either:
    The inspection team's observations provide cause for concern regarding the nature, timing, and extent of audit testing performed in areas where the risk of material misstatement due to fraud ("fraud risk") has been identified. In nine engagements with deficiencies that are discussed in this report, including two engagements discussed in Part I.A, the Firm had identified a particular fraud risk in the audit area in which the inspection team noted a deficiency, and the Firm's procedures did not sufficiently address the identified risk. For example, in one engagement, the Firm identified a particular fraud risk relating to management manipulation of the work in progress inventory file to affect gross margin, but the Firm limited its tests of controls over inventory costing to verifying management's review and approval.
    Maybe I've mailed it in for the week or maybe I'm souring on the PCAOB's process but as far as an "official public rebuke" goes, this is pretty weak. Deloitte's was a big surprise because it was the first one. PwC had two Part IIs released. Ernst & Young's just falls flat for me and it's mostly because of the reasons lots of people think Part IIs aren't all they're cracked up to be. Here's a rundown of those again:   
    • The issuers are not named.
    • The partners in charge of the engagements with deficiencies are not named.
    • There are no civil penalties or other measurable form of punishment for audit firms that don't comply.
    • The process is too long. "Oh, the faceless partner on an unnamed audit client from four years ago didn't properly supervise the engagement? That's dynamite, guys."
    • The PCAOB doesn't analyze the year-to-year improvements (or lack thereof) for each firm nor does it put the inspection reports in context by comparing them to peer firms. All it does is report findings.  

    I'll stand by previous contention that the Part II is important because it is a Scarlett Letter for audit firms, but if all of them have it, then is it all that meaningful? Public companies will be like, "Oh, you all have a case of crabs? Well, I guess we'll just live with it."

    The Part IIs need to tell us more. At the very least they need to: 1) Name names — issuers and partners; 2) They have to speed up the process so it's relevant and 3) They have to analyze the performance from year to year in order to give the results some context.    

    Until then, I'll be sitting here twirling my finger in the air.


    • Francine McKenna

      Great summary of problems with how this is shaping up. You may have fingers twirling in air, but firms are flashing two fingers in V sign and PCAOB/SEC has fingers where the sun don’t shine when it comes to enforcement against firms.

      • Guest

        Francine from re:theauditors or troll?

        • PwCASSociate

          I’m going with “both”

          • Calmer than you

            Hilarity ensued.

        • Guest

          Isn’t that question redundant?

      • Twiddling the Day Away

        I think your fingers might be doing the twirling, but not in the air…

        As usual, the cat lady has nothing constructive or productive to say.

        • Calmer than you

          as usual, anonymous Internet nothing’s have no substantive response to the fact that audits suck. Maybe you should stick to the “that was 2009, who cares now” excuse.

          • Why So Bitter

            you could not be more incorrect. the undeniable reality is that audits serve a useful purpose in the capital markets. it is people like (you) and the cat lady who constantly scream the sky is falling. the only logical outcome from the cat lady rants would be to do away with the audit function or to nationalize the thing and let a gov’t function like the IRS take over.

            so what is your solution to a problem that you and the cat lady want to create? the bottom line is that auditing has improved and the improvements are satisfactory, and the Part II comments merely point out some additional improvements are necessary.

            but there is zero evidence to support the assertions from the cat lady of the giant conspiracy theories and/or that the regulators are in bed with the audit firms.

            • As a true cat lady I have to chime in here… are you calling Francine a cat lady? She’s a dog lady.

              Also, who gives a shit? Her points can be valid with or without her affiliation with any animal.

            • Calmer than you

              Lol, can’t say I’m very bitter. If you knew how different my work is now, and how I can actually justify my work, you’d be bitter yourself.

              But if you think Big 4 audits serve a purpose other than slapping a big name on the opinion, I cannot help you.

    • SouthernCPA

      1) As a large local firm tax guy I find it hysterical that everyone on here likes to bash KPMG, and yet, they are the only Big Four to not get dragged in the mud here. Of course, time may fix that.
      2) Maybe the PCAOB doesn’t name partner/issuer names because they are afraid a downward run on the stock would occur, through no fault of the issuer?

      • future gopher

        i think its hysterical you think KPMG is still part of the big 4

        • paranoidandroid

          I think it’s hysterical that one of the B4 hired you…what a waste of resources….=]

          • future gopher

            i actually work for mcdonalds as a burger flipper and its hysterical that i make the same as staff per hour

            • paranoidandroid

              I prefer making $4/hr, but $75,000 annually with 1 month of vacation. I don’t know why so many people complain about this. My guess is that these people were accustomed to having everything from mommy and daddy and think they deserve to be treated like Justin Biever. Grow up!

      • cool story brah

        It’s expected for KPMG reports to come out slower since the PCAOB has to rifle through physical workpapers instead of Excel spreadsheets.

        “Is that a 6 or a 0? I can’t tell from the coffee stain”

        • hmmm

          Hey Dipshit, they’ve been electronic for quite a few years now…. also the format of the workpapers has nothing to do with the quality.

          • timreynolds

            How’s the kool-aid taste?

          • Just curious

            Okay, but in 2008 was it electronic or paper? a few years would be like 2010

            • ex KPMG

              My 2008s were mostly paper

            • keepin_it_real

              2008 was still paper. eA didn’t come fully online until 12/31/2010 YE audits.

    • big4life

      timely report regarding 2008 audits

      • timreynolds

        Already counting down until 2017 for this year’s results!

    • Hj

      Francine you are quite boring…

      • Calmer than you

        And yet, none of you weasels refute her. Now THAT is boring.

    • try again

      They should not name names, as you say. Frankly, a lot of the issues that the PCAOB deems an “issue” are ridiculous. For example, our firm had a client with a reserve for which all inputs were not “adequately evaluated.” The team had performed a sensitivity analysis which showed that management could be off by as much as 50% and the result would be less than $100k on a multi-billion dollar in revenue company. The team had to fight tooth and nail against that finding, unsuccessfully. Providing the name of the partner and the company does not solve the issue and would needlessly shame those partners for issues that might not be severe enough to warrant that treatment.

      I would agree that the process needs to be more timely, but how would you propose that the PCAOB go about that? The audits occur in Q1 the following year, PCAOB inspections follow within the next 9-12 months of the audit. The PCAOB then needs time to evaluate the findings across all of the inspections and communicate those findings with the audit firm at which point you must allocate time for the firms to analyze the findings and prepare a response. Then they have 12 months to remediate any issues. After the 12 months, the PCAOB must re-evaluate the findings to determine if they were properly remediated and give the firm a chance to respond to any of those findings. There is also an appeals process, if the firm so chooses.

      It’s not as black and white as you make it seem.

      • Big4escapee

        We’d hate for the government to have to work equivalent hours to bash those they are evaluating in a timely manner

    • PermaGuest

      What the firms really ought to do to destroy the PCAOB’s credibility is release the full story on each of the findings side by side with the report – if it became (more) widely known that the PCAOB was failing audits over clearly irrelevant or immaterial “issues,” or because they don’t understand customized audit approaches, they *might* be incentivized to be more reasonable.

    • Guest

      PCAssclownsOB. This didn’t even warrant an internal e-mail at EY, and small wonder reading it. They’ve passed beyond annoying, through irrelevant and now they’re simply boring. How much are we paying for this tripe? Does anyone think it makes a difference?

    • commoner

      Don’t forget about the other problem with the PCAOB process – the PCAOB specifically looks for high risk audits for testing, rather than random selection. While this is good in terms of improving the likelihood that firms will get caught screwing up (and, hopefully, get better with that testing in future audits), it results in an artificially high exception rate compared to a random sample. So, an exception rate of 50% with high risk audits might drop down to 10% if a totally random sample were pulled.
      That said, I agree that issuers should be named. Investors have a right to know, and if the audit failure is insignificant, then that’s up to the investor. If it hurts client stock prices, then the auditors will have a much better incentive to improve their work product than just the PCAOB’s lashings with a wet noodle.

      Naming partners is a bit dicier, I think. If a partner has one client with an issue, then I don’t think that partner should be called out. Also, which partner do you call out? Multiple partners could work on a single client engagement. There’s also the matter of how many clients a given partner serves. And I can see other problems there. But if the partner has a number of clients with a number of issues and there’s a pattern, then perhaps there should be a point where the partner gets named.
      I doubt there’s really a way to speed up the process. As such, the PCAOB should be a bit more flexible with calling out firms. It’s a simple fact that it’s going to take a few years from the time a PCAOB finding is brought to the firm’s attention and when the firm can truly address the issue. The firm probably knows about the issue way before the initial PCAOB report is published, but even so, the high level people need to figure out if the issue is isolated or a broad problem. Then they need to figure out how to fix it, esepcially if it’s a wide-ranging problem. Then they need to roll out communications across the firm, changes to policies, changes to audit programs, training for staff across all levels. Then, it may take another year before the managers and quality control reviewers iron out all the kinks and get the staff doing things right. That could easily take a year or two after the original audit witht he finding was issued.
      And, of course, more context would also help. And giving the PCAOB some real teeth would also help – fines, etc.

      Until then, and especially if everyone gets a scarlet letter, then the PCAOB Part II releases won’t be of any particular value. Until some company goes down, and some lawyer figures out that some audit failure mentioned in the PCAOB report for that company’s auditor involved an issue that is germain to the failed company’s failure. Then the PCAOB report will become evidence against the auditor. That’s when the firms will really start getting their acts together.

      • Quixote

        I think the point about PCAOB cherry picking audits that are more likely to fail is a good one. If this is truly the case (I’ve never been part of a PCAOB review and don’t care enough to check this fact out) then there’s no wonder that their part 2 is met with a collective shrug.

        If you want a true idea of the proficiency of the firm and its audits overall, one should randomly sample instead of saying, “Yah, those hard as shit audits with all kinds of space cadets as accountants and controllers, yah we want those”.

        The whole argument of, “Hey where there’s smoke there’s fire”, isn’t valid at all if you’re looking for smoke in the kitchen or the BBQ pit.

    • Guest

      Yea, name the issuer. I’d like to get on an engagement that only perform inquiries!

    • Guest

      Since the PCAOB issues inspection reports in 2013 on 2009 audits, perhaps audit quality would be better if the firms can also take 4 years to audit.

    • Guest

      How many restatements were there due to these findings?

      • Proud Big 4 Auditor

        It is exceedingly rare for a PCAOB review to result in a restatement, although it happens from time to time. As one commenter above mentioned, if audits are selected for review by the PCAOB staff based on higher risk indicators, and if restatements from reviews are rare, what does that tell us about the type of work that the Firms are actually doing?

    • JD

      The thought that the PCAOB doesn’t have teeth is a mystery to me. Most of my extra, non-value added work comes at the gun of the PCAOB. A good example is the renewed emphasis on internal control on integrated audits.

      • JohnQPublic

        No kidding, what a joke. The PCAOB does a lot of good work, but they need not create extra work for the sake of creating extra work.

    • Kiki

      It seems to me that GAAP is a process of sticking one’s head in the sand. You spend some much time make sure that every little rule checks out, but the big picture is lost. My valuations are reviewed by Big 4, and I can attest, that they very often go overboard with it. Yet PCAOB still thinks it is not enough. There needs to be a common sense filter to all these countless hours of check-marking and PCAOB should not use weight as a measure of quality for audit reports.

    • Guesr

      I think most people in the know realize that the PCAOB has outlived it’s usefulness. Every audit committee meeting I go to (multiple public clients), they recognize how stupid the PCAOB rules have become. It’s ho-hum, more government regulation run amok. These guys and gals are smart business people and understand the uselessness of oppressive government regulation. The latest example is AS 16…not one AC member has expressed one iota of giveashit as it relates to these new required communications. Doty is all excited about his new standard, but AC members couldn’t care less.

    • Navitimer

      The PCAOB really needs to be abolished. They add no benefit to the industry or to the public’s confidence in the public accounting firms. I’ve had the pleasure of going through a PCAOB “inspection,” if you want to call it that. Let’s not exaggerate here, but at least 3/4s of the questions they asked were absurd, just proving our suspicion that they had no idea of what they were doing. The PCAOB is staffed and led by folks who couldn’t make it in the real public accounting world. I mean, nearly all of the clowns on our “inspection” team couldn’t even carry on a general conversation. Audit Senior Manager’s general small-talk question: “Are you guys enjoying the nice weather today?” Or, “were you guys able to get out and enjoy ABC restaurant last night?” (after they inquired about good restaurants in town) Response: “Did you have a chance to reconcile the $34.72 irreconcilable difference in your workpaper on fixed assets that we asked about last night?” Imagine taking those folks on a proposal with you. As the article mentions, how in the world can they consider themselves even the least beneficial to the industry if it takes them three or four years just to issue their reports. Another example of government waste and useless spending.