Here We Go Again – Recurring Deficiencies in PCAOB Inspection Reports
here-we-go-again-recurring-deficiencies-in-pcaob-inspection-reports

Here We Go Again – Recurring Deficiencies in PCAOB Inspection Reports

As the 2015 inspection cycle winds down and the remaining PCAOB inspection reports based on their inspections of the 2014 audits trickle in, I am reminded of sage advice from the English rock-poets of Whitesnake, embodied in the award-winning single Here I Go Again. I don’t know where I’m going, but I sure know where we’ve been when it comes to audit deficiencies! All the greatest hits continue to pop up again, year after year. Auditing internal control over financial reporting (ICOFR) in accordance with PCAOB AS 5 headlines the reunion tour. Following closely behind, the risk assessment standards make an encore. And, don’t forget the opening act, auditing accounting estimates, ready to make a serious climb up the charts with its new single, auditing fair value measurements!

The statistics below were based on review of the PCAOB inspection reports of the annually inspected firms. However, at the time of this post, the PCAOB had not yet released their 2014 inspection report related to Grant Thornton LLP.

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Auditing Internal Control over Financial Reporting

An oldie but a goodie, this standard leads the way again this year for most common audit deficiency. Out of the 271 audits reviewed by the PCAOB, 31% of audits were deficient when applying PCAOB AS 5 related to audits of internal control over financial reporting (ICOFR). This distinction makes it the third year running that this standard took the top spot!

To better illustrate the challenges firms had in this area, here’s an example of a recent inspection comment:

For certain controls that the Firm selected for testing, the Firm's testing did not include ascertaining the nature of the procedures performed by the control owners and/or evaluating the criteria used by the control owners to identify matters for investigation; therefore, the Firm failed to evaluate whether the controls operated at a level of precision that would prevent or detect material misstatements.”

This finding questions the audit firm’s opinion that a control is operating at an appropriate level of precision if the firm does not understand or document how the control triggers additional investigation for potential errors that this control purports to identify! To conclude that the control operates effectively, the auditor needs to know:

  1. How the control or control operator flags items for follow-up, and
  2. How this identification and further investigation prevent or detect material misstatements.

If this understanding isn’t documented, the auditor hasn’t gathered enough evidence!

Assessing and Responding to Risks of Material Misstatement

If you want to hype up the crowd, or the PCAOB, look no further than assessing and responding to risks of material misstatement. Findings related to risk encompass eight different auditing standards (AS 8 through AS 15) and, in total, the PCAOB noted deficiencies in 32% of the audits inspected. Continued findings led to the release an entire report dedicated to summarizing PCAOB observations in this area!

The PCAOB strongly believes that these standards underlie the entire audit process and provide the solid foundation needed for an effective audit. Here’s another example to illustrate what the PCAOB found:

The issuer recognized certain other revenue upon completion of a service or based on the shipping terms for the product. For this revenue, the Firm identified a fraud risk related to cut-off and another fraud risk related to the valuation of the reserve for loss contracts. The Firm's testing was insufficient. The Firm failed to perform sufficient substantive procedures related to the sale of certain types of products that represented a significant portion of the issuer's revenue, as its procedures excluded revenue that was multiple times the Firm's established level of materiality and was approximately 70 percent of this type of revenue.”

This comment focuses on the fact that the audit firm identified a fraud risk related to revenue but did not respond appropriately to this assessed risk. Specifically, the auditor did not include a significant portion of revenue in its scope of testing. Also, it’s important to remember that an auditor typically performs additional testing procedures for areas identified with a high risk of misstatement, such as a fraud risk, above and beyond procedures that would normally suffice for areas of lower audit risk.

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Auditing Accounting Estimates, including Fair Value Measurements

Last but not least, auditing accounting estimates, including auditing fair value measurements takes the stage. Issues noted when applying AU 342 and AU 328 led to a 21% deficiency rate in this area.

The example inspection finding below points out a fundamental issue in this area:

The Firm failed to sufficiently evaluate the reasonableness of certain significant assumptions underlying the cash-flow projections that the issuer used to determine the fair value of the reporting unit and the amount of the goodwill impairment loss. Specifically, the Firm failed to consider the implications of a significant shortfall in the issuer's actual results for the first nine months of the year compared to its forecast on the reliability of the issuer's projections.”

This comment highlights the importance of challenging data or assumptions used to develop auditing estimates, a recurring theme in this area. Here, the audit firm should seek more information to corroborate management’s future operating projections when disconfirming evidence appears, such as a shortfall in current results compared to budget.

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Conclusion

“Here I go again on my own, goin’ down the only road I’ve ever known.” The record keeps repeating: ICOFR, risks of material misstatement, and accounting estimates continue to top the charts of identified audit deficiencies in PCAOB inspection reports. Don’t be flexible like Tawny Kitaen doing yoga on the hoods of Jaguars! Be firm when applying auditing standards and performing PCAOB audits, especially in these three areas.

This blog kicks off a series of PCAOB-related content that we will release over the next several weeks, including additional blogs and our first ever eBook on learning from PCAOB inspection reports to improve audit quality!

Subscribe to our blog now, so you don’t miss our latest releases! Also, take a peek at our Preparing for PCAOB Audits and Inspections course, using the button below, or contact us to get more information on tailored training solutions for your firm!

 
PCAOB Inspection

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