The Public Company Accounting Oversight Board (PCAOB) is an organization that was established by the Sarbanes-Oxley Act of 2002 in order to oversee and control the audits of public companies (Anandarajan and Kleinman 114). The organization exists to ensure that investors have access to independent and accurate audits, which helps to protect their and public interests. The PCAOB’s vision is to “promote public trust in both the financial reporting process and auditing profession” (PCAOB “Mission and Vision”). Globalization has increased the need to detect and highlight corporate wrongdoings in an effective and timely manner. Therefore, it is hard to overestimate the importance of the audit industry for the modern economy.
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This paper aims to review audits of four public companies conducted by the PCAOB: Ernst & Young LLP, Grant Thornton LLP, RSM US LLP, and KPMG LLP. The paper will analyze the audit reports in order to better understand the deficiencies detected during audit engagements in terms of their types and categories.
Ernst & Young LLP
Ernst & Young LLP is a public accounting company whose degree of compliance was assessed by the PCAOB in 2015, according to the Sarbanes-Oxley Act of 2002 (PCAOB “Ernst & Young” 1). An inspection team reviewed portions of 55 audits conducted by the company and detected a number of deficiencies associated with testing internal controls over financial reporting (ICFR) (PCAOB “Ernst & Young” 4). Out of 16 audits that appear in the report, 14 audits had substantive testing deficiencies associated with judgment on financial statements (PCAOB “Ernst & Young” 4). Furthermore, out of these 14 audits, 3 audits contained deficiencies in substantive testing that resulted from the overreliance on excessive controls (PCAOB “Ernst & Young” 4).
As is evident from the report, Ernst & Young LLP failed to properly test whether its internal controls meet their objective. It is a common deficiency that prevents either management or employees or both to discover and eliminate misstatements in a timely manner. The report also reveals that the operating effectiveness of the company’s controls lacked in 8 audits (PCAOB “Ernst & Young” 5). It means that the auditor did not obtain evidence that controls functioned properly over a sufficient period of time.
It can be argued that deficiencies reveled during the audit engagement show that the company’s control environment is inadequate. The information obtained with the help of the audit conducted by the PCAOB can be used to engage in remedial actions. Employee surveys can provide the management of the organization with valuable insights into the effectiveness of Ernst & Young LLP’s control environment. It has to be borne in mind that management efforts or “tone at the top” (IPPF 9) are essential in establishing a proper control environment.
The audit of Ernst & Young LLP revealed that the following accounts and auditing areas were associated with some types of deficiencies: business combinations, inventory accounts, impairment of goodwill and intangible assets, long-lived assets, period-end financial reporting process, revenue, and allowances among others (PCAOB “Ernst & Young” 33). The deficiencies detected by the inspection team were related to the application of the following standards: AS 5, AS 9, AS 13, AS 14, AS 15, AU 328, AU 329, AU 331, AU 341, AU 342, and AU 350 (PCAOB “Ernst & Young” 32). The company’s response shows that it is intent on taking remedial actions aimed at eliminating its audit deficiencies and enhancing the effectiveness of its control environment.
Grant Thornton LLP
The inspection of Grant Thornton LLP concentrated on 34 audits performed by the company (PCAOB “Grant Thornton” 2). Grant Thornton LLP’s judgments about materiality were not questioned by the inspection team. However, the results of the inspection show that 9 audits contained deficiencies associated with testing controls for the ICFR opinion (PCAOB “Grant Thornton” 4). Also, all audits were associated with deficiencies in substantive testing for the opinion on issuer’s financial statements. Moreover, 4 audits contained deficiencies that resulted from the overreliance on controls that were not properly tested (PCAOB “Grant Thornton” 4).
As for the types of audit procedures that were deficient, the most common ones include failure to properly evaluate the issuer’s data, failure to perform proper testing, and failure to properly test controls, their design, and effectiveness. For example, the company did not obtain sufficient evidence when issuing its opinion on a significant category of the issuer’s revenue. Namely, Grant Thornton LLP evaluated and compared gross margins without assessing their components. The analytical procedures conducted by the company were not sufficient for drawing reasonable audit conclusions.
Even though Grant Thornton LLP evaluated gross margin percentages of the issuer in order to ensure that they conform to a predictable pattern derived from prior-year margins, it did not exercise a sufficient level of professional skepticism. It is hard to overestimate the importance of professional skepticism in auditing, which should be applied “as a means of enhancing the auditor’s ability to identify risks of material misstatement and to respond to the risk identified” (ACCA).
The inspection of Grant Thornton LLP revealed deficiencies associated with the following accounts and auditing areas: impairment of goodwill and intangible assets, income taxes, insurance reserves, inventory and related reserves, investment securities, property, plant, and equipment, revenue, accounts receivable, and allowances among others (PCAOB “Grant Thornton” 22). The deficiencies discovered by the inspector fall in the following categories of auditing standards: AS 5, AS 13, AS 14, AS 15, AU 328, AU 329, AU 331, and AU 336 (PCAOB “Grant Thornton” 21). It has to be noted that Grant Thornton LLP’s response to the report shows that the company acknowledges the importance of independent inspections conducted by the PCAOB and wants to improve the quality of its audits.
RSM US LLP
The audit of RSM US LLP was conducted in 2015, in accordance with the Sarbanes-Oxley Act of 2002 (PCAOB “RSM US” 1). The inspection concentrated on 15 issuer audits performed by the company (PCAOB “RSM US” 3). The inspection team revealed deficiencies in 3 audit engagements associated with testing controls for the ICFR opinion (PCAOB “RSM US” 5). Also, 4 audit engagements conducted by RSM US LLP contained deficiencies related to the substantive testing for the financial statements (PCAOB “RSM US” 5). The audit team concluded that 3 audits contained deficiencies caused by the overreliance on controls that were not properly tested (PCAOB “RSM US” 5).
The following two types of audit procedures associated with deficiencies were identified in the report: a failure to test the design and operating effectiveness of controls and failure to sufficiently test accounts. For example, when assessing allowance for loan losses (ALL), the company did not evaluate the objectivity of third parties reviewing loans. Furthermore, the company failed to engage in direct testing of both methodology and control activities performed by the third parties.
The deficiencies in RSM US LLP’s control testing suggest that the company has to address a number of underlying issues. There is ample evidence suggesting that “improper application of the top-down approach detailed in the auditing standards, including overreliance on entity-level controls” (PCAOB “Internal Controls” 3) is the root cause of deficiencies in the testing of internal controls. In order to eliminate deficiencies identified by the inspection team, RSM US LLP has to improve its training and guidance. The PCAOB also suggests that “decreases in audit firm staffing through attrition or other reductions, and related workload pressures” (PCAOB “Internal Controls” 3) are detrimental to the quality of control testing. The company will also benefit from improving communication between its information system professionals and an engagement team (PCAOB “Internal Controls” 3).
The inspection of RSM US LLP revealed deficiencies associated with the following accounts and auditing areas: revenue, ALL, and business combination (PCAOB “Grant Thornton” 22).
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The inspection of KPMG LLP was conducted in 2015, in accordance with the Sarbanes-Oxley Act of 2002 (PCAOB “KPMG” 1). The inspection team reviewed and analyzed 49 issuer audits in order to assess the degree of the company’s compliance with auditing standards (PCAOB “KPMG” 1). The majority of audits reviewed by the board were associated with deficiencies. Namely, 17 out of 20 issuer audits contained deficiencies related to testing controls for the ICFR opinion (PCAOB “KPMG” 4). Also, 14 audit engagements conducted by KPMG LLP contained deficiencies related to the substantive testing for the financial statements (PCAOB “KPMG” 4). Out of these 14 audits, 7 audits contained deficiencies caused by the overreliance on controls that were not properly tested (PCAOB “KPMG” 4).
The following types of the most frequently identified audit deficiencies are described in the report: failure to test the design and operating effectiveness of controls and failure to sufficiently test accounts. Just like the previous company, KPMG LLP has to put more emphasis on the improvement of deficiencies associated with control testing.
Sometimes, it can be challenging to understand and document controls within a system. The combination of approaches such as “talking to the client, internal control and internal control evaluation questionnaires, narrative notes and flowcharts” (ICAEW 2) that is necessary for auditees of large scope and size further complicates the issue. Moreover, auditors are often restrained by budgets; therefore, they spend less time on testing internal controls, which results in deficiencies. In order to improve its audit approach, KPMG LLP has to revise the control risk assessment in the areas that have deviations exceeding the tolerable level.
The inspection of RSM US LLP revealed deficiencies associated with the following accounts and auditing areas: business combinations, cash flows, ALL, income taxes, inventory, securitizations, investments, derivatives, and revenue among others (PCAOB “Grant Thornton” 22).
The analysis of the inspections conducted by the PCOAB has shown that Ernst & Young LLP, Grant Thornton LLP, RSM US LLP, and KPMG LLP had deficiencies in their audits. However, even though the audit approaches of the companies lacked in quality, those deficiencies did not exceed the tolerable level. The paper has shown that the companies did not exercise a sufficient level of professional skepticism and needed to work on the improvement of their audit practices.
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IPPF. “Auditing the Control Environment.” IIA. 2017.
PCAOB. “Mission and Vision.” PCAOBUS,
PCAOB. “Report on 2015 Inspection of KPMG LLP (Headquartered in New York, New York).” PCAOBUS.
PCAOB. “Report on 2015 Inspection of RSM US LLP (Headquartered in Chicago, Illinois).” PCAOBUS.
PCAOB. “The PCAOB’s Views on Internal Control Audit Deficiencies.” EY.