PCAOB Inspections Pick Up Speed

PCAOB Inspections Pick Up Speed
Working Out the Kinks in Inspection Process and Staffing

By Simon Eskow

Continued from the Home Page

The PCAOB in 2003 launched a limited inspection program of the Big Four, Diacont told more than 200 attendees of the Foundation for Accounting Education’s Sept. 14 conference. The board, which began inspecting firms with a 20-member staff and five consultants, reviewed at least 16 audits at each of the Big Four firms. This year, the PCAOB’s inspectors expanded work to include reviews at BDO Seidman, Crowe Chizek, Grant Thornton and RSM McGladrey, in addition to the Big Four.

The PCAOB’s mandate to assess compliance of registered firms with the Sarbanes-Oxley Act, board rules and other regulations and standards, makes inspections a paramount function of the overseer. Approximately half of the PCAOB’s current staff of 225 is involved directly in the inspection and registration program. Representatives of the PCAOB speaking at the conference drew a picture of an inspection process that has gone from zero to 60 in under a year.

“We started with zippo,” Diacont said.

Paul Bijou, the deputy director of inspection in the New York office, echoed Diacont’s comment in his presentation about the mechanics of the inspection process.

“Fifteen months ago, we had a blank sheet of paper about what to expect with regard to how we carry out the limited inspections,” he said. “We locked ourselves away for days, three of us and one manager of inspections.”

The result of their work was a framework for inspections.

This included looking at seven quality control areas, such as the practices for partner evaluation, compensation, promotion and assignment of responsibility; independence implications of nonaudit services; client acceptance and retention; internal inspection; communication of audit policies and procedures, including training; and supervision by U.S. engagement teams over foreign affiliates.

The inspectors this year also homed in on specific “big ticket items,” such as compliance with the spirit of SAS 99, and documentation.

The limited inspection program, while not as far-ranging as this year’s full inspections, identified failures to comply with GAAP, resulting in 20 audit clients restating their balance sheets, according to the PCAOB. These items and others are helping the PCAOB to focus auditors on aspects of their practice that may “stand as an impediment” to quality audit performance.

The PCAOB published the reports from its limited inspection program in August, to what Diacont described as favorable coverage in the press. Diacont said that the London Financial-Times characterized the inspections as “cheerfully harsh.”

(The reports, which concern the limited inspections of the Big Four, are available under “Inspections” at www.pcaobus.org/Inspections/.)

While there have been dozens of inspections this year, the PCAOB has yet to publish any reports on them. Diacont said that tailoring the inspections to smaller firms has created a delay.

But the PCAOB is also working with a limited staff. Diacont said the PCAOB needs at least 250 more inspectors.

“We have 101 inspectors now, up from 20 last year,” he said. “No offices now are fully staffed. We’re interested in qualified people from smaller firms; there have to be small-firm audit experts.”

This is especially true since 80 percent of the PCAOB registrants have five or fewer issuer-clients. Adding to the staffing issue is the beginning of international inspections at the end of the year. According to Bijou, there already are three inspectors on staff with dual citizenship in several countries.

Inspection Mechanics

Bijou described the inspection process in his presentation, saying that the overall inspection can take up to two weeks. Prior to the inspection, the PCAOB makes initial contact with the firm—first with the lead partners, and then with the quality-control partner.

The PCAOB then issues a formal letter with an “exhaustive” document request. The document request can include the firm’s most recent financial statements; its current business model; its ethics code for partners and staff; quality-control policies; agendas and minutes of management meetings; and other documents related to policies and procedures.

This is followed by a registration update that helps the PCAOB determine staff requirement for the inspection. Mergers, for example, have a direct impact on how many inspectors are needed for a job.

One week prior to the start date of the inspection, the inspectors identify the engagements they want to review.

“From the time of initial contact to inspection there shouldn’t be any modifications to the work papers,” Bijou said. “We’ll take a dim view of this if you do. We want the real story.”

Then the engagement review begins, taking one to five days depending on the complexity of the engagements.

“We digest everything so that when we come in we have a sense of what the client’s about,” Bijou said.

This is also when the quality-control-process evaluation begins, Bijou said.

Following the inspection, the PCAOB submits to the firm matter sheets that summarize the areas where inspectors discovered problems. The firm generally has two weeks to respond to the matter sheet. Then, the inspection staff prepares a report that culminates in a presentation to the PCAOB.

“We are cognizant of the impact we will have on small firms,” Bijou said. “We understand that we can be seen as a disruptive force. So we don’t force ourselves on the firm; we try to be accommodating as possible.”

The all-day conference, cochaired by Mitchell J. Mertz and Rita Piazza, and sponsored by the SEC Practice Committee, chaired by George I. Victor, drew a large cross section of the media. The Wall Street Journal, the Bureau of National Affairs, Accounting Today, SEC Compliance and Reporting, CFO.com, SEC Accounting Report, Journal of Accountancy and Reuters news agency covered the event.