The PCAOB Has Conveniently Released 2011 Inspection Reports For Deloitte, Grant Thornton and Ernst & Young the Friday Before Christmas

Oh I bet you guys think you're slick for this one! Thanks so much for ruining my Doomsday.

So here's what we've got. Let's start with Deloitte:

The PCAOB identified a few particular deficiencies it didn't like:

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 ("ICFR"). In addition, one of the identified deficiencies, which occurred in an audit in which the Firm played a role but was not the principal auditor, was of such significance that it appeared to the inspection team that the Firm had not obtained sufficient appropriate audit evidence to fulfill the objectives of its role in the audit. The audit deficiencies that reached these levels of significance are described below. In this audit, the Firm failed to identify a departure from generally accepted accounting principles ("GAAP") that it should have identified and addressed before issuing its audit opinion. Specifically, the issuer inappropriately allocated to goodwill, rather than to a definite-lived intangible asset, a portion of the purchase price of a group of assets. For Issuer B, the PCAOB says Deloitte failed in the following respects to obtain sufficient appropriate audit evidence to support its audit opinion on the financial statements:

  • The Firm failed to perform sufficient procedures to test the valuation of certain long-lived assets, in that it failed to sufficiently evaluate the reasonableness of the three significant assumptions that the issuer used to calculate the depreciation of these assets.
  • The Firm failed to perform sufficient procedures to test the issuer's revenue and cost of sales (and certain related balance sheet accounts) for transactions accounted for under the percentage-of-completion method.

There are more. A lot more. But it's Friday afternoon before Christmas and no one has time to skim through the numerous deficiencies listed.

Moving on, let's glance at Grant Thornton.

Of 35 audits inspected, GT screwed up a couple. Like this one:

In this audit, the Firm failed to obtain sufficient appropriate audit evidence to support its opinions on the financial statements and on the effectiveness of ICFR. Specifically

  • The Firm failed to identify a departure from generally accepted accounting principles ("GAAP") that it should have identified and addressed before issuing its audit report. The issuer accounted for certain significant contracts using a revenue recognition method that was inconsistent with the requirements of GAAP.
  • In concluding on the severity of an identified control deficiency, the Firm failed to evaluate the risk factors that affect whether there was a reasonable possibility that the issuer's controls would fail to prevent or detect a misstatement.The Firm failed to sufficiently evaluate whether all requirements for recognizing the sale of certain lease receivables had been satisfied. Specifically, the Firm failed to evaluate whether the issuer had continuing involvement in the lease arrangements and failed to assess whether the "true sale" legal opinion that the issuer relied on, which had been obtained in the prior year, continued to be relevant.
  • The Firm failed to perform sufficient procedures to test revenue related to sales to resellers. Specifically, the Firm failed to evaluate (a) whether collectability was reasonably assured for sales to certain resellers, and (b) whether the issuer's history of providing financing to end customers indicated that the issuer should have deferred revenue for certain sales to resellers.
  • The Firm failed to sufficiently test the issuer's reserve for excess and obsolete inventory. Specifically, the Firm limited its testing of the valuation of certain potential excess inventory, for which no reserve was recorded and which represented approximately one half of the issuer's total inventory, to inquiring of management. In addition, the Firm failed to test the accuracy of certain system-generated data the Firm used in its substantive testing of the inventory reserve.
  • The Firm failed to sufficiently test the valuation of the issuer's deferred tax assets. Specifically, the Firm failed to evaluate the reasonableness of certain significant assumptions the issuer used in its projections to support the recoverability of the net deferred tax assets. Further, the Firm limited its testing of certain other assumptions to inquiring of management and considering certain industry trends. In addition, after the date of the issuer's balance sheet, but before the release of the Firm's audit opinion, the issuer had financial information available for the first quarter which appeared inconsistent with the high growth rate included in the projections. The Firm failed to take into account that financial information in assessing the reliability of the projections.

And that's just ONE audit.

It appears audit firms are still having trouble with fair value, as the PCAOB complained about three audits that deficiencies in testing the fair value measurements of, and/or the disclosures related to, hard-to-value financial instruments, including asset- backed securities, collateralized mortgage obligations, other mortgage-backedsecurities, and derivative collars, the Firm failed to obtain sufficient appropriate audit evidence to support its audit opinions.

And then there's the Ernst & Young inspection report, which looked at 55 audits. Of those, Issuer A:

In this audit, the Firm failed in the following respects to obtain sufficient appropriate audit evidence to support its opinions on the financial statements and on the effectiveness of ICFR

  • The issuer's revenue was produced from numerous locations, each with its own accounting personnel and general ledger systems. Each location processed similar classes of routine transactions. The engagement team identified risk factors associated with individual locations, including ineffective controls over access to the general ledger system used at the locations and instances of fraud at certain of the locations.
  • The Firm and the issuer's internal audit ("IA") identified multiple control deficiencies, including deficiencies at several locations tested, but these control deficiencies were not the same at all locations. In planning and performing tests of controls, the Firm assumed that risks and controls were the same across all locations and, therefore, reduced the number of locations selected for testing. As these assumptions were incorrect, the Firm's testing was insufficient.

The Firm relied on the effective operation of certain of the issuer's review controls to reduce the scope of its testing, and it identified these review controls as compensating controls for certain of the identified control deficiencies. The Firm's testing of the review controls was deficient, as follows

  • The Firm failed to perform sufficient procedures to test the effectiveness of the review controls, including whether they operated at a level of precision to prevent or detect errors that could result in a material misstatement to the financial statements.
  • Specifically, the Firm's procedures were limited to inquiring of management, verifying that certain actions performed as part of the controls had occurred, and, for each control, attending one meeting at which reviews occurred. The Firm understood that the nature and extent of the reviews varied, as several individuals performed the reviews, and the issuer had not prescribed the performance indicators to be reviewed or the thresholds to be used. The Firm failed to evaluate the specific performance indicators reviewed, the criteria for follow-up of variances, and the appropriateness of the actions taken as a result of the reviews.
  • The Firm failed to identify and test any controls over the manually generated reports that the issuer used in the operation of the review controls.
  • The Firm failed to sufficiently evaluate whether the control deficiencies that it and the issuer's IA had identified at the issuer's locations were, in combination, material weaknesses. Specifically, the Firm failed to evaluate the extent to which the identified control deficiencies would be applicable to the issuer's locations that were not tested. In addition, the Firm identified, as compensating controls for certain of the deficiencies, the review controls discussed above, of which the Firm's testing was deficient.

Again, that's just one audit the PCAOB looked at.

Seriously, you guys get the point. We'll analyze this further when we aren't trying to dodge out for the holiday. Thanks for nothing, PCAOB.

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