The Hindu Business Line : Big brother watching the Big 4

THE Public Company Accounting Oversight Board (PCAOB) has issued its report on the reviews it performed on audits conducted by the Big Four accounting firms. The scope of the review was exhaustive and included a look at the policies of the Big Four, their internal documentation and compliance with regulatory requirements.

The first area was to assess whether actions and communications by the firm's leadership demonstrate a commitment to audit quality and compliance with the Sarbanes-Oxley Act, the rules of the Board, the rules of the SEC, and professional standards in connection with the firm's performance of audits, issuance of audit reports, and related matters involving issuers.

The deficiencies

One common accounting omission that has come forth from the reviews of all the firms is that they missed out on reflecting balances under revolving lines of credit if it involved both a subjective acceleration clause and a requirement to maintain a lock-box arrangement for customer remittances.

All the clients had reflected this amount under long-term liabilities. In the case of one firm, PCAOB observed that deferred income tax was not segregated into current and non-current amounts and that there was no written communication to the audit committee about independence. The staff of the PCAOB noted that in the case of one company, the existence of leases that had been guaranteed by an issuer and transferred as part of the sale was not disclosed. Moreover, the engagement partner of the audit firm had not documented the basis for his conclusion that a restatement was not necessary.

One firm had categorised the engagement risk as "normal" for a company which was struggling to maintain its going concern tag, whereas the PCAOB team opined that it should have been "greater than normal". The firm was able to convince PCAOB the basis for its conclusion. Another firm placed significant reliance on the work of the Internal Audit Department of a company without having obtained sufficient evidence of the competency and objectivity of the Internal Audit function.

Evaluation and testing of the internal audit function was not done sufficiently. One company did not include loan origination fees and costs in the calculation of gains or losses on mortgage loans sold.

One company was a counter-party to a forward sales commitment of student loans but failed to address whether this could be termed as a "derivative".

There was a disagreement between the firm and the staff of PCAOB on this and a note of dissent in the file of the client was placed. In the case of one company, the PCAOB team noted that the financial statements for two years failed to disclose certain guarantees related to leases that the issuer had transferred in connection with the sale of assets in a prior period.

It's in the documentation

Apart from the above observations, the crack PCAOB team took exception to the documentation of the firms.

A signed management representation letter from a company was not in the audit work papers though the firm stated that it had been received. The classic Indian solution was found — another management representation letter was obtained and filed back-dated. The same firm did not document the basis for reliance on specialists in its work papers. The work papers reflected that the provision for income-tax and more particularly deferred tax was not seen at all by the auditors.

Another firm did not maintain in its work papers documentation relating to board minutes containing information about impairment of long-lived assets.

(The author is a Hyderabad-based chartered accountant.)

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