On October 23, the PCAOB released the public parts of its Report on 2013 Inspection of KPMG LLP. The Board simultaneously released previously-non-public portions of KPMG’s 2010 and 2011 inspection reports, based on the Board’s determination that KPMG had not addressed the criticisms of the firm’s quality controls in those portions of the reports to the Board’s satisfaction.
The 2013 inspection of KPMG (which took place between December 2012 and February 2014) involved field work at the firm’s national office and at 25 of its approximately 82 U.S. practice offices. The inspection included reviews of 48 public company audits (and two additional engagements in which KPMG US played a substantial role, but was not the principal auditor). In 23 of the 50 engagements reviewed, (46 percent), the inspection team identified deficiencies that, in its view, were of such significance that the firm, at the time it issued its audit report, had not obtained sufficient appropriate audit evidence to support its opinion. The 46 percent deficiency rate is an increase compared to the 34 percent rate in KPMG’s 2012 inspection report; for the four largest firms as a group, the 2013 deficiency percentage was 39 percent. As the Board notes, audit work is selected for inspection based on factors that “heighten the possibility that auditing deficiencies are present, rather than through a process intended to identify a representative sample.” In addition, audit deficiencies included in the public portion of a report do not necessarily indicate that the audited financial statements were misstated or that there were undisclosed material weaknesses in the company’s internal control over financial reporting.
Of the 23 KPMG engagements in which the Board identified audit deficiencies, three of the engagements involved deficiencies related only to the audit of the financial statements and four involved deficiencies related only to the audit of internal control over financial reporting (ICFR). In the remaining 16 engagements in which the PCAOB identified deficiencies, the Board’s inspectors found deficiencies in both the ICFR audit and the financial statement audit.Excluding broadly applicable aspects of standards that relate to auditing generally, the auditing standards cited most frequently as the basis for deficiencies are listed below.
In a response appended to the 2013 inspection report, KPMG Chairman and Chief Executive Officer John B. Veihmeyer, and Vice Chair, Audit, James P. Liddy, said: “KPMG has established a culture built on an absolute commitment to performing consistently high-quality audits. We share the PCAOB’s objectives of continually improving audit quality, building confidence in the auditing profession and meeting our responsibilities to investors and other participants in the capital markets system.”
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As noted above, at the same time as it released the 2013 KPMG inspection report, the PCAOB also released previously non-public portions of KPMG’s 2010 and 2011 reports. Quality control concerns arising from an inspection are initially included in a non-public section of the inspection report. If the PCAOB is not satisfied with the firm’s corrective measures during the one-year “remediation period” following issuance of the report, it releases to the public those parts of the original inspection report that describe the un-remediated quality control deficiencies.
The portions of the 2010 and 2011 KPMG reports that the Board made public both deal with the same quality control issue – the need to search for disconfirming evidence. In the 2010 report, that deficiency is described in this manner: The inspection team identified deficiencies “where the Firm appears to have overemphasized evidence that supported the issuer's conclusion, without evaluating contrary evidence that seemed to be readily available to the engagement team personnel at the time of the audit.”
In the 2011 report, the Board noted that the firm had initiated training in late 2009 that “specifically highlighted the inappropriateness of engagement teams truncating their information search as soon as they
PCAOB Auditing Standard Number of Engagements in Which
Standard Was a Deficiency
AS No. 5, An Audit of Internal Control Over Financial Reporting
That is Integrated with An Audit of the Financial Statements 20
AU Section 342, Auditing Accounting Estimates 13
AS No. 13, The Auditor’s Response
to the Risks of Material Misstatement 8
AS No. 15, Audit Evidence 6
AU 328, Auditing Fair Value Measurements and Disclosures 6
AU Section 350, Audit Sampling 6
AU Section 329, Substantive Analytical Procedures 4
4 Update │ October-November 2014
find evidence that supports the issuer's conclusion, especially when there is more information that could support an alternative conclusion.” In addition, in 2011, KPMG released guidance to its audit staff that included a suggested template to, among other things, document engagement teams' evaluation of contrary audit evidence relating to judgments and estimates. The 2011 report concludes that “additional actions may be needed” and that the firm should “evaluate the root causes of the deficiencies described above, assess the effectiveness of the existing remedial actions, and consider whether those remedial actions are sufficient to address the deficiencies.”
In a statement appended to the Board’s order releasing these parts of its 2010 and 2011 reports, Messrs. Veihmeyer and Liddy state that they “accept the Board’s determination and take seriously [their] responsibility to address these matters” and “have taken remedial actions with respect to our professionals’ evaluation of contrary evidence.”
This is the first time that the PCAOB has concluded that KPMG’s remediation efforts were unsatisfactory and released a non-pubic portion of a KPMG inspection report. The Board has now taken this type of action at least once with respect to all four of the largest firms.
Comment: As with all inspection reports, audit committees of companies that are audited by KPMG should discuss the results of the firm’s most recent PCAOB inspection with their engagement partner. If the company’s audit is mentioned in either the public or nonpublic portion of the inspection report, the audit committee should understand the reasons for the reference to the audit and how it will affect the engagement in the future. If the company’s audit is not cited in the report, the audit committee should explore with the auditor how deficiencies identified in
other audits might have affected the company’s audit and how changes in the firm’s procedures might affect future audits. Audit committees should also have an understanding of how the firm intends to remediate quality control deficiencies described in the nonpublic portion of the report. An agenda for an audit committee discussion of the firm’s PCAOB inspection report is available from the undersigned.
As to the non-public portions of the 2010 and 2011 reports, the PCAOB orders state that the decision to release this material “is not a broad judgment about the effectiveness of a firm's system of quality control compared to those of other firms, and * * * does not signify anything about the merits of any additional efforts a firm may have made to address the criticisms after the 12-month period.” Further, the newly-released information reflects the Board’s views of quality control deficiencies that were identified in inspections conducted five and four years ago, respectively. More recent inspections and remediation determinations may be more relevant in assessing these firms’ current performance. Nonetheless, as part of their annual discussion with their engagement partner of the firm’s PCAOB inspection results, audit committees of companies that are audited by KPMG may want to inquire about the PCAOB’s release of these previously nonpublic reports. In particular, the audit committee might ask what the firm has done subsequently to address the disconfirming evidence issue and how future audits might be affected.