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Doty Calls Inspection Reports a Key Part of Investor Protection Regime

June 19, 2014

PCAOB inspectors continue to find serious problems when they review the work public accounting firms do for their clients. The inspection reports that provide details about the problems aren’t always well received, but the audit regulatory board’s leadership believes that the revelations about flawed audit work are needed to shield investors from the harm done by poor and fraudulent financial reporting.

In the 11 years since it was founded, the PCAOB’s inspections have uncovered severe problems at many accounting firms.

Some quarters have criticized the audit regulatory board for pushing its inspectors into being too keen to find problems, while ignoring auditor actions that improve a client’s financial reports. The criticism has drawn attention to the purpose the inspection reports are supposed to serve.

“My colleagues and I are sometimes asked why we don’t issue reports on successful, or exemplary, audits,” PCAOB Chairman James Doty said at a June 13, 2014, conference in Houston. “The PCAOB’s main work is to inspect, and when necessary discipline, auditors of public companies and broker-dealers, against standards established to protect the public interest. This work necessarily, and quite intentionally, focuses on identifying both individual audit failures and weaknesses in quality controls, and whether firms correct them. We do not set out to write a balanced scorecard of strengths and weaknesses.”

The number of problems found in inspection reports issued for the 2013 on 2012 audit work of the Big Four accounting firms ranged from 13 to 25, Doty said. The inspection staff reviewed portions of 208 audits across the four largest firms after assessing the areas that were most likely to have problems.

“We cannot say whether the unselected audits were exemplary. I have no reason to doubt that many were,” Doty said. “But 76 of the 208 audits reviewed were sufficiently flawed that the PCAOB’s inspectors determined that the audit opinion was not supported when issued. The trend at smaller firms and non-U.S. firms is also concerning.”

Doty also repeated his support of the use of the term “audit failure” when inspectors find problems. He made similar remarks in a May speech.

The audit regulator’s use of the term has been controversial among auditors, and at least one board member wants the term eliminated from inspection reports.

“Calling every such deficiency an ‘audit failure’ appears to have caused confusion among investors, audit committees, and others, some of whom have interpreted our findings as meaning that the financial statements are misstated, or that there is a problem in the company’s accounting or internal controls,” said PCAOB member Jay Hanson in March. “Only very few of our inspection findings ultimately can be linked to a problem in the company’s financial statements, and restatements arising out of our inspection process are rare, although they do occur.” (See Board Member Hanson Wants Term ‘Audit Failure’ Eliminated in the March 24, 2014, edition of Accounting & Compliance Alert. )

Doty said the term means that the inspection staff determined that the audit firm “failed to fulfill its fundamental responsibility in the audit: the firm failed to obtain reasonable assurance about whether the financial statements are free of material misstatement.”

“The audit opinion should not have been issued, and more work consistent with applicable audit standards was necessary for the opinion to stand,” Doty said. “Such a finding is indeed a serious matter.”

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