The Number of Financial Statement Audit Deficiencies Is Blowing Up

So says an analysis of PCAOB inspection report data:

The Survey of Fair Value Audit Deficiencies was released Wednesday by Acuitas, Inc., an Atlanta CPA firm that practices litigation and business valuation services. The analysis found that fair value measurement and impairment deficiencies accounted for 52 percent of all the audit deficiencies cited in the PCAOB’s 2010 inspection reports. The number of cited deficiencies has more than tripled since 2009. Fifty-two percent of audit deficiencies related to fair value measurement were the result of inadequate testing of asset prices provided by outside pricing services. In addition, 63.6 percent of impairment-related audit deficiencies related to the testing of management’s prospective financial information.
Okay, so that's not so good and there are two possible reasons that immediately come to mind:
 
1. Auditors suck at their jobs – It's hard to argue against this premise with all the audit failures that have occurred in the past 4-5 years. The PCAOB inspection reports didn't look great. Actually they were pretty GODAWFUL. Even the firms with the best results (this year it was KPMG and E&Y) had deficiencies in more than 20% of the audits inspected. Think about that – if a business was pitching you their services and said, "One out of five Roughly eighty percent of our projects is done at an acceptable level," you'd laugh them right out of your office. If they were to say "nearly one out of two" like in the case of Deloitte and McGladrey you'd wonder how they were still in business. However, the firms have argued – before the PCAOB and the AICPA – that partners are overrun with responsibility as well as regulatory and compliance pressures. Add to the complexities of financial reporting and it's not that hard to make mistakes since, contrary to popular belief, partners are human.
 
2. The PCAOB is getting really, really, really nit-picky – This has some weight too since the Board has been under immense pressure to, ya know, do something from politicians and people are hip to scene. It's been nearly ten years since it came into existence and it just issued Part II of an inspection report for a Big 4 firm last fall. Its largest civil penalty against a firm was $2 million and that just happened in February. That hasn't impressed the audit hawks. Chairman Jim Doty is trying to shake things up, but the most radical idea – auditor rotation – is universally hated. Given that, it's conceivable that inspectors are going to give audits an extra good look. The other problem is that the Board is overseen by the inept SEC, which is overrun with Big 4 stooges in regulators clothing. The Commission isn't going to let the Board go off the reservation, so digging up deficiencies may be the only way for the PCAOB to demonstrate their usefulness.
 
It'd be difficult to place the blame firmly in one camp or the other and it's been pointed out that both groups' dynamics are equally deplorable, so to say that blame should be split equally wouldn't be inappropriate. But since an even hedge is pretty boring, I'll put the blame at 70/30 with the audit firms getting the lion's hare. They have far better access to resources and talent than the PCAOB and have the added pressure from clients to perform the services fast and cheap. Most partners would rather HTFU than GTFO so procedures get missed, documentation gets lost, signatures don't happen. Deficiencies. Lots and lots of deficiencies. 
 
Other theories? I'm sure there's a difference of opinion out there somewhere.

 

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