Professional Services Monitor: Today

The PCAOB today voted to adopted a rule, Auditing Standard No. 7, that “provides a framework for the engagement quality reviewer to objectively evaluate the significant judgments made and related conclusions reached by the engagement team in forming an overall conclusion about the engagement.” In other words, according to CFO.com, the rule prohibits lower-level employees for conducting final reviews of financial statements.

Under the new Auditing Standard No. 7, such reviews — which the PCAOB officially calls “engagement quality reviews” but are often referred to as concurring reviews — are expected to be done by a partner or other high-level auditor who hasn’t worked on the audit under review.

To further put the onus on reviewers to take the evaluations seriously, the PCAOB also today issued for comment a concept release to gauge whether concurring reviewers should be required to put their signatures on audit reports.

The PCAOB has struggled to explain how these reviews should be conducted. After the original proposal was made in February 2008, finance executives worried it would lead to “re-audits” rather than just a final backstop to an audit team’s work before signoff on a client’s financial reports.

If approved by the SEC, the rule would take effect for fiscal years beginning on or after December 15, 2009.

Separately, but in the same press release, the PCAOB is seeking public comment “on a Concept Release to consider the effects of a potential requirement for the engagement partner to sign the audit report.”  That is, instead of the audit opinion simply reading, “PricewaterhouseCoopers LLP, New York, NY,” Partner & CPA Jane Smith would also need add her name to the opinion.  Partners personally signing opinions is not uncommon in other countries and jurisdictions.  We encounter this often in Scandinavian countries, for example this annual report from the Finnish company, Outokumpu.

A study conducted by two accounting professors at North Carolina State University on the SEC’s pilot XBRL program found significant flaws in the data.  The study examined filings submitted by 22 companies during the SEC’s voluntary program, and raises concerns about data quality ahead of the mandatory XBRL filing deadline for the largest 500 companies, beginning with quarter-ending June 15, 2009.

But, while the XBRL concept is promising, the study from NC State found that reports from companies that participated in the voluntary pilot program contained multiple errors. “They were poorly tagged,” [Dr. Eileen] Taylor says, “and there were fundamental errors of accounting. One report, for example, contained too many zeros – turning millions into billions.” In their abstract, the researchers note that “These errors are serious because since XBRL data is computer-readable, users will not visually recognize the errors, especially when using XBRL analysis software.” In other words, users won’t be able to spot that something is wrong.

The study, “A Comparison of XBRL Filings to Corporate 10-Ks – Evidence from the Voluntary Filing Program,” examined XBRL filings by 22 companies that participated in the SEC’s voluntary pilot program in 2006. The study was co-authored by Taylor, Drs. Al Y. S. Chen and Jon Bartley, who are both professors of accounting at NC State. The study will be presented at the American Accounting Association Annual Meeting being held in New York City, Aug. 2-5.

Proxy advisor Glass Lewis & Co. is disclosing some findings from a recent study on auditor changes. In 2005, Glass Lewis reports that 72% of the 1430 auditor change filings provide no reason for the change.

“In many respects, today’s disclosures of auditor changes often are no more transparent than the disclosures Enron Corp. made of the special-purpose entities it so famously used to cook its books,” Glass Lewis’s editor of financial research Jonathan Weil said in a note to clients.

Interestingly, the study says that companies changing away from a Big Four firm were less likely to disclose a reason than the overall group.
Glass Lewis concludes that the SEC ought to require more disclosure.

Links: Proxy firm:Companies should say why auditors leave

In a brief article dated 5/23/2006, BusinessWeek reports that President Bush has given John Negroponte, White House intelligence czar, authority to exempt companies from certain SEC reporting requirements for national security reasons. Ostensibly, the only news here is that the President has delegated this power for the first time; the office of the President has had this power since the Carter Administration. However, it seems safe to say that few people are aware this power exists at all. According to BusinessWeek, this authority comes from Section 13(b)(3)(A) of the Securities Exchange Act of 1934:

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The Times Online has a different take on yesterday’s report issued by the UK Financial Reporting Council.

A LONG-AWAITED report into the dominance of the Big Four accounting firms was welcomed by auditors yesterday after it declined to make any policy recommendations.
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However the report… did not find any evidence of anti-competitive behaviour by the Big Four firms and did not make any recommendations on how mid-tier accountancies could win their share of the lucrative audits.

An article in yesterday’s The Scotsman implied a different conclusion to the report.

The UK’s Financial Reporting Council has released a report studying the dominance of the Big Four in the UK market, according to The Scotsman. One of its conclusions, according to the article, is that the dominance of the Big Four hurts competition. In the UK, the Big Four audit 97% of the FTSE 350; for comparison, the Big Four audited 986 of Fortune 1000 in 2005. Furthermore, this study shows that 88% of the FTSE companies would not consider a non-Big Four firm.

Many large listed companies in the UK said they had an effective choice of just two or three audit firms and some, notably banks and insurance firms, said they had no choice at all, the report showed.
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“The near 100 percent combined market share of the Big Four in auditing large companies is not regarded as healthy for competition or choice,” the report said.

The article also quotes Steve Maslin, head of Assurance Services for Grant Thornton, as saying, “The skills that are needed to audit an AIM (Alternative Investment Market for smaller firms in the UK) company are no different than those required for a large FTSE 350 company.” The skills are similar but the scale can be much different. Towards this, Peter Ryan, head of professional affairs for PWC in London, said, “PWC has invested a huge amount of money over a long period of time to get the breadth and depth of expertise both in the UK and around the world.” Second-tier firms have very solid capabilities, but only the capacity to serve a given number of clients with worldwide needs.
The report does touch on a more pressing problem with Big Four concentration, the risk of a firm failing. The loss of a firm would create “serious problems for some companies and a loss of investor confidence,” which we saw very painfully in the Andersen collapse.
This report bears an issue date of April 12, 2006, so there’s certain to be more reaction later in the week.

The Full Report “Competition and choice in the UK audit market” can be downloaded from the FRC website.