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

7 Comments

  1. Narkissos Dansu 07/14/2009 at 10:25 am - Reply

    Very relevant and well written article. I will be on the public accounting job market a year from now and this article has provided me with a tool to screen national CPA firms for possible repetitive violation of audit processes (i.e http://pcaob.com/Inspections/Public_Reports/index.aspx). It’s very important that I target CPA firms with stellar records when it comes to their audit practices. Again many thanks for this and I will keep coming back for more of your great articles. Keep up the good work!

  2. Audit CPA 08/08/2009 at 5:54 am - Reply

    Grant Thornton was effectively acquired by the former Arthur Andersen. Yes, they have gotten the band back together, and the music sounds the same. But they have picked up a few new instruments along the way.

    Now, they use electronic workpaper software. This software allows Partners and Managers to “clean up” problems noted during audits after the Seniors and Staff have left the field, without attribution.

    So, that sample reveal a problem that just doesn’t have a good explanation? Simply hit delete and the problem goes away. The client played hide and seek with the audit documentation, and procedures were left incomplete? Just upload a memo, and affix the Senior’s initials to the audit program after they have left the field – problem solved.

  3. CPA Auditor 01/13/2010 at 2:58 pm - Reply

    Without defending either firm, the blog posting above is not factually correct…”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.”

    Per the BDO report, they visited NY, Chicago, Grand Rapids and 8 other locations, for a total of 11 locations. Per the GT report, they visited the national office plus 17 locations, for a total of 18 locations. Based on my experience, each office has at least 3 audits selected. Thus putting the total to roughly 30+ and 50+, respectively. While the rates are still not astounding, they are a far cry from the “failure rates” suggested in the blog. IMHO

  4. Tracy Coenen 01/13/2010 at 3:07 pm - Reply

    Since you’re employed by Grant Thornton, it would appear that you ARE defending at least one firm. The number of audits examined by PCAOB were not noted in the reports, but were reported by CFO.com. I am not sure who provided CFO.com the information on the number of audits selected, but I put more weight in that than your guess of how many audits they would have examined. If you can point me to a source that identifies how many audits were examined, I’d be happy to look at it.

  5. CPA Auditor 01/15/2010 at 2:32 pm - Reply

    Again – per the PCAOB reports that you provided the link to, the PCAOB performed inspcections at 11 and 18 locations. What were they doing at these locations if not reviewing audits? Do you have any idea of what a PCAOB inspection entails? And by the way, Audit CPA may work for GT but I work for BDO, for full disclosure.

  6. Tracy Coenen 01/15/2010 at 2:40 pm - Reply

    CPA Auditor – Again, you’re guessing at the number of audits examined, and I’ve said that I’m quoting CFO.com.

    So you say you work for BDO, but you just happen to be surfing the net from a server owned by Grant Thornton???? I can see your IP, and it’s from Grant Thornton.

  7. BzStdt 01/25/2010 at 10:29 pm - Reply

    Damn CPA Auditor, you just got OWNED.

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