Auditing firms are in a world of trouble. Their audit procedures haven’t really kept up with the changing business environment, and the expectations of the users of financial statements are practically impossible for auditors to fulfill. Regardless of the many disclaimers auditors provide about their work (that they don’t provide absolute assurance on the numbers, that they usually don’t find fraud, that they’re only looking at a fraction of the transactions behind the financial statement), financial statement users have much higher expectations.
The survival of the large auditing firms is in question right now, in my opinion. The business model of the auditing firms really isn’t working as well as it used to, and their are many liability issues. Auditors are being sued left and right, and these are expensive cases to defend, and difficult to win. (All the disclaimers in the world don’t protect the auditors from accusations of malpractice.)
Last week the the Public Company Accounting Oversight Board released reports on auditors Grant Thornton and BDO Seidman. And they’re not pretty.
In many ways, auditors have a low level of responsibility. So long as they follow their work programs, doing the procedures that are outlined, and documenting the work they did, they can mitigate their exposure to malpractice claims. The problem is that auditing firms are continuously being tagged for not doing all the necessary procedures and failing to follow up on issues uncovered during the audit (i.e. the audit testing reveals a problem, the auditors have to actually do something about it).
What did these audit firms hammered by PCAOB do?
BDO didn’t perform some important audit procedures, or failed to perform them well enough. One example… the auditors noted that revenue increased toward the end of the year for a brand new client, but didn’t actually examine the revenue further to see why that was. (Anyone who investigates financial statement fraud will immediately recognize that as a risk factor. Why is revenue jumping up at the end of the year? Is management trying to pad the numbers?) Something like this must be examined further!!!
Also related to fraud, on one audit the BDO auditors noted a specific fraud risk (channel stuffing), but didn’t do any work to determine whether that was happening at the client.
Grant Thornton found errors in how their clients applied the accounting rules (GAAP), but didn’t actually address them. At some clients they didn’t even find the misapplication of the rules. The other deficiencies included a variety of things, such as a failure to understand the valuation of auction rate securities, a failure to determine whether a company’s accounting for it post-retirement benefits plan was correct, and a failure to audit an acquisition transactions.
Here’s the best part of this all: The PCAOB inspections included the examination of 7 BDO audits and 8 Grant Thornton audits. Of the BDO audits examined, 5 had deficiencies in testing of revenue. Of the Grant Thornton audits examined, 5 had deficiencies in testing of assets, and 2 had deficiencies related to auction rate securities. Those aren’t good failure rates, and they raise the issue of just how prevalent audit failures are at these firms and others.
PCAOB has basically said these audit opinions cannot be relied upon. And the auditing firms say “move along, nothing to see here.”
BDO even criticized the fact that such small sample of audits is used for these PCAOB repors, and doesn’t “…lend itself to a portrayal of the overall high quality of our audit practice.” I take the opposite view. If so many problems were found in such a small sample of your audit work, that should be cause for alarm about all the rest of your work