While we were ragging on EY yesterday for taking it up the AS5 from the PCAOB, we happened to notice some interesting new language in the inspection report. Now, this is not surprising as the PCAOB clarifies itself often, but let's see what you think about this:
Certain of the deficiencies identified were of such significance that it appeared to the inspection team that the Firm, at the time it issued its audit report, had not obtained sufficient appropriate audit evidence to support its opinion that the financial statements were presented fairly, in all material respects, in accordance with applicable financial reporting framework and/or its opinion about whether the issuer had maintained, in all material respects, effective internal control over financial reporting ("ICFR"). In other words, in these audits, the auditor issued an opinion without satisfying its fundamental obligation to obtain reasonable assurance about whether t he financial statements were free of material misstatement and/or the issuer main tained effective ICFR.
The fact that one or more deficiencies in an audit reach this level of significance does not necessarily indicate that the financial statements are misstated or that there are undisclosed material weaknesses in ICFR. It is often not possible for the inspection team, based only on the information available from the auditor, to reach a conclusion on those points.
Whether or not associated with a disclosed financial reporting misstatement, an auditor's failure to obtain the reasonable assurance that the auditor is required to obtain is a serious matter. It is a failure to accomplish the essential purpose of the audit, and it means that, based on the audit work performed, the audit opinion should not have been issued.
The first part is completely standard but did you catch that last part? They are essentially saying that while audit failures aren't necessarily audit failures, they are audit failures. Let that one sink in for a minute.
We asked the PCAOB about this and they pointed us to a speech earlier this year by PCAOB chairman Jim Doty, who said:
I believe the nub of this commoditization is that it is difficult to observe the full benefit of a good audit. We can't tell which companies would or might have collapsed under management misreporting, but for the auditor's watchful eye. All the public knows comes after an issuer has collapsed, or had to restate materially misstated financial statements, and then the audit is judged a failure.
Let me say a word about that, because there has been some discussion in the press about the term "audit failure." Audit failures are, of course, of great concern to the PCAOB, whether or not the financial statements are misstated, and they are emphasized in PCAOB inspection reports for that reason.
Some have expressed concern that the term "audit failure" could be understood to mean that PCAOB inspectors have determined that the financial statements were incorrect; that is, that the audit must have failed to detect a material misstatement. This is not necessarily the case, and inspection reports have appropriately made this point clear.
Before the audit inspection regime established by the Sarbanes-Oxley Act, an "audit failure" could only be discovered if there were a restatement or other problem in the financial statements. Independent audit oversight and inspections, however, have allowed for new, independent insight into the performance of all audits. In that environment, it is both appropriate and useful to distinguish between a financial reporting failure and an audit failure.
In my view, most people can, in this new environment, understand that distinction. But I also think that a debate over a label needlessly distracts from the critically important substantive point about which there must be no confusion: that the auditor has issued an opinion without satisfying its fundamental obligation to obtain reasonable assurance about whether the financial statements were free of material misstatement.
Whether or not associated with a disclosed financial reporting misstatement, an auditor's failure to obtain the reasonable assurance that the auditor is required to obtain is a serious matter. It is a failure to accomplish the essential purpose of the audit. It means that, based on the audit work performed, the audit opinion should not have been issued, and more work consistent with applicable audit standards was necessary for the opinion to stand.
Notice how he used the exact wording that is now in the inspection report.
So, audit failures mean that the auditors failed to do the one thing they are supposed to do, but that doesn't mean the financial statements audited should not be relied upon. It simply means the auditors suck at their job.
Now you know!