The U.S. Public Company Accounting Oversight Board on May 10, 2023, issued long awaited audit inspection reports on two affiliates of Big Four accounting firms based in China, showing a troubling number of audit deficiencies. The board said it is not uncommon for PCAOB inspectors to find problems in the audit work when the firms are inspected for the first time, which was the case for KPMG Huazhen LLP in China and PricewaterhouseCoopers in Hong Kong.
The PCAOB inspected a total of eight engagements, four at each firms, including the types of engagements—such as state-controlled companies and corporations in sensitive industries—that China blocked access on before.
“Both reports show unacceptable rates of Part I.A deficiencies, which are deficiencies of such significance that PCAOB staff believe the audit firm failed to obtain sufficient appropriate audit evidence to support its work on the public company’s financial statements or internal control over financial reporting,” PCAOB Chair Erica Williams said.
The inspections found Part I.A deficiencies in four out of four of the audits reviewed at KPMG Huazhen, which is a 100 percent rate, while the rate of deficiency was 75 percent at PwC Hong Kong, or three out of four audits reviewed. And the two firms that were inspected audited 40 percent of the total market share of U.S.-listed companies audited by Chinese and Hong Kong accounting firms. Williams said that the PCAOB is on track to hit 99 percent of the total market share by the end of this year.
“So, there is no question that the PCAOB is prioritizing inspections that are the most relevant to investors on U.S. markets – because protecting investors is what this is all about,” she added.
After Congress passed legislation—the Holding Foreign Companies Accountable Act—which threatened a trading ban on the Chinese audit clients that trade publicly on U.S. exchanges, the PCAOB finally signed a historic agreement to inspect these firms. And the PCAOB was able to for the first time inspect the firms in the fall last year.
“The fact that our inspectors found these deficiencies is a sign that the HFCAA was effective and the inspection process worked as it is supposed to. We identified problems so now we can begin the work of holding firms accountable to fix them,” Williams said. “Today’s reports are a powerful first step toward accountability. By shining a light on deficiencies, our inspection reports provide investors, audit committees, and potential clients with important information so they can make informed decisions and hold firms accountable. And the power of transparency applies public pressure for firms to improve.”
KPMG Huazhen LLP
According to the inspection report, KPMG Huazhen had 30 publicly-traded company clients and participated in the audit of 77 other companies.
Of the four audits reviewed, the PCAOB reviewed three audits in which the firm was the lead auditor and one in which the firm was not the principal auditor.
For example, for Issuer A, the PCAOB found deficiencies in testing controls over certain accounts related to certain revenue and unearned revenue and certain long-lived assets.
The PCAOB last week started putting a new part in the inspection report that highlights any independence problems found. These would be described in Part I.C. And the board did not identify any violations of SEC or PCAOB independence rules. The firm also did not bring any non-compliance to the inspector’s attention. The SEC as the capital market regulator oversees the PCAOB.
In a response letter that is included in the inspection report, Jacky Zou, a senior partner at KPMG Huazhen, said the firm did a thorough evaluation of issues identified and took appropriate actions to address them.
PwC Hong Kong
PwC Hong Kong was the principal auditor of three companies and participated in the audit of 27 other companies. Of the four audits reviewed, the firm served as the principal auditor of two companies and participated in the audit of two other companies.
Audit areas most frequently reviewed were cash and cash equivalents, revenue and related accounts, goodwill and intangible assets, significant transactions and inventory. According to the report, PwC Hong Kong also did not properly test controls when the issuer used multiple IT systems to process transactions related to revenue for Issuer A, for example.
The PCAOB’s practice is to not identify the name of clients in the inspection reports.
As for independence violation, the PCAOB found potential non-compliance.
“Under Rule 2-01(c)(1) of Regulation S-X, certain financial relationships impair an accountant’s independence,” the PCAOB said. “We identified multiple instances for two issuers in two audits reviewed where certain of the firm’s personnel had a financial relationship, other than an investment in an audit client, in which this circumstance appears to have occurred.”
In a response letter, Chairman Raymund Chao and Assurance Leader Daniel Li of the firm evaluated each of the finding and took steps to fix the problems. As for independence findings, they noted that the firm is committed to maintaining a system of quality control to make sure they comply with applicable regulatory requirements. It is unclear if the PCAOB found quality control problems on independence related issues as the board does not make them public unless the firm fails to fix the problem within 12 months.
“Where appropriate, our inspectors will refer inspection findings to our enforcement team for possible action,” Williams said. “If violations are found, our enforcement staff will not hesitate to recommend sanctions, including imposing significant money penalties and barring bad actors from performing future audits.”
This article originally appeared in the May 11, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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