During January, the Public Company Accounting Oversight Board released the public portions (Part I) of its reports on the 2012 inspections of the fifth and sixth largest U.S. accounting firms, Grant Thornton and BDO USA. Both reports contain unusually high percentages of deficiencies.

Grant Thornton

The 2012 Grant Thornton inspection included reviews of 34 public company audit engagements. The inspection report characterizes 22 of those engagements (65 percent) as “audit failures” – situations in which it appeared to the Board’s inspection staff that Grant “failed to obtain sufficient appropriate audit evidence to support its audit opinion on the financial statements and/or on the effectiveness of internal control over financial reporting.” The report states that, in one of the 22 deficient engagements, the company involved restated its financial statements after the PCAOB inspection.

The 65 percent deficiency rate appears to be the highest percentage of deficiencies the Board has ever identified in an inspection report on a firm it is required to inspect annually (i.e., a firm with more than 100 public company audit clients). In Grant’s 2011 inspection, the Board found significant audit deficiencies in 15 of 35 engagements inspected or 43 percent; in 2010, the comparable percentage was 37 percent.

As in the other 2012 PCAOB large firm inspection reports, the deficiencies described in the Grant report are heavily weighted toward problems involving ICFR auditing. Of the 22 deficient audits discussed, 19 included deficiencies with respect to the ICFR component of the work. In 15 of the 22 deficiencies, the Board stated that Grant lacked sufficient evidence to support its opinion with respect to both the financial statements and ICFR. In three of the 22 engagements discussed in Part I of the report, the Board cited deficiencies related only to the ICFR audit, while in three others the deficiencies related only to the financial statement audit.

The inspection report includes a table summarizing the specific auditing standards to which the Part I deficiencies relate. Excluding Auditing Standard No. 5, which is implicated by all of the ICFR deficiency findings, the auditing standards most frequently cited as the basis for deficiencies in the 2012 Grant report are AS No. 13, The Auditor’s Responses to the Risks of Material Misstatement (10 deficiencies); AU 328, Auditing Fair Value Measurements and Disclosures (9 engagements); and AU 342, Auditing Accounting Estimates (7 engagements). In most of the engagements described in the report, the Board found more than one deficiency and cited more than one auditing standard.

In a letter responding to the 2012 report, Stephen Chipman, Grant’s CEO, and Trent Gazzaway, National Managing Partner of Audit Services, state that the “volume of findings in this report is concerning and of great importance to our dedicated professionals.” They also note that 86% of the 22 engagements in Part I of the report include findings related to ICFR and state that in 2012 the firm “revised our ICFR audit methodology and training” and that those “changes were in effect during our audits of 2012 financial statements and we believe have been effective at improving audit quality in this important area.”

BDO

The 2012 BDO inspection included reviews of 20 public company audit engagements. The inspection report characterizes 11 of those engagements (55 percent) as “audit failures” (as defined above). In BDO’s 2011 inspection, the Board found significant audit deficiencies in 9 of 23 engagements inspected or 39 percent; in 2010, the comparable percentage was 26 percent.

Of the 11 deficient audits discussed, 10 included deficiencies with respect to the financial statement audit. In four of those 10 cases, the Board stated that BDO lacked sufficient evidence to support its opinion with respect to both the financial statements and ICFR. Five of the deficient engagements included deficiencies with respect to the ICFR component of the work; in one of these, the Board cited deficiencies related only to the ICFR audit. In another five cases, the deficiencies related only to the financial statement audit. (It should be noted that some of the engagements inspected may have involved issuers not subject to the ICFR audit requirement; this cannot be determined from the public portion of the report.)

The inspection report includes a table summarizing the specific auditing standards to which the Part I deficiencies relate. Excluding Auditing Standard No. 5, which is implicated by all of the ICFR deficiency findings, the auditing standards most frequently cited as the basis for deficiencies in the 2012 BDO report are AU 342, Auditing Accounting Estimates (5 engagements); AU 328, Auditing Fair Value Measurements and Disclosures (4 engagements); AS No. 15, Audit Evidence (4 engagements); and AS No. 13, The Auditor’s Responses to the Risks of Material Misstatement (3 engagements).

In a brief letter responding to the 2012 report, BDO states that it “remain[s] committed to improving our audit performance and our underlying quality control systems.”

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Comment: As noted in prior Updates, audit committees should annually discuss with the audit firm the results of its most recent PCAOB inspection and how any deficiencies identified impact the company’s audit. An agenda for an audit committee discussion of the auditor’s PCAOB inspection report is available from the undersigned