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PCAOB Issues 2004 Deloitte Inspection Report

Dribbling them out one at a time, the PCAOB issued its 2004 inspection report for Deloitte & Touche on Thursday (KPMG’s report was issued last week, as noted in this blog). The inspection covered 125 Deloitte audits from May to November 2004 and the report points out deficiencies in eight of those audits – and 4 Deloitte clients restated their financials as an indirect result of the inspection.

Can the PCAOB Require a Company to Restate Financials?

Both of the Big 4 inspection reports released by the PCAOB recently highlighted the fact that a number of auditor clients restated their financials in the wake of the PCAOB Staff’s inspection. One member posted a question a few weeks ago wondering if the PCAOB had the power to force a company to restate.

Here is that question (Q&A #1163):

Company’s auditor has informed Company that the PCAOB insists that Company must restate its balance sheet. This is in connection with the PCAOB’s inspection of the auditor and the PCAOB’s review of representative audits of the auditor. Earlier this year Company completed an exhaustive six-month long review by the SEC in connection with a registration statement, and the issue raised by the PCAOB was not raised by the SEC. The registration statement was finally declared effective. Company continues to believe that its treatment of the issue is correct. Is the PCAOB’s authority over Company merely indirect in that Company will need auditor’s opinion next year, which the auditor can’t/won’t give in light of the PCAOB’s decision? And is there a mechanism by which Company may talk to the PCAOB directly or appeal the PCAOB’s decision in this matter? Thank you.

Here is my answer:

The PCAOB does not tell an audit firm that a company must restate its financial statements. (If the auditor tells the client that the PCAOB “insists” that the financial statements must be restated, I suspect that this is a CYA on the part of the auditor.) Rather, the PCAOB tells the auditor what it has found in the course of its inspection. It is then up to the auditor and its client to determine what steps to take based on materiality, etc.

In the course of inspecting the conduct of a specific audit engagement, the PCAOB may conclude, based upon the work papers, that there is a violation of GAAP. (Remember, a primary purpose of the PCAOB’s inspection is to determine if the audit has been conducted appropriately. One of the side effects may be that the PCAOB finds a violation of GAAP.)

Whether or not the auditor agrees with the PCAOB, it has an obligation to discuss the issue with the client – one of the AUs requires them to do so. Once the client is aware of the matter, it can go to the SEC if it still believes that the accounting treatment was correct. The SEC is the final arbiter regarding issuer questions, not the PCAOB. In other words, there is no appeal process with the PCAOB for the issuer.

In your scenario, it sounds as though the auditor agrees with the PCAOB. If the auditor doesn’t agree with the PCAOB, it shouldn’t be advising the client to restate. As for the full review by the SEC Staff, that review is not the same as a PCAOB inspection because the SEC Staff typically doesn’t look at the auditor’s work papers and doesn’t delve into the same level of detail as the PCAOB does when it does its inspection.

All of this goes back to what I have been urging companies to do: the PCAOB issues comments to the auditor following a field review and long before a draft inspection report is issued. The company can require its auditor, in the engagement letter or a side agreement, to inform it if its financial statements have been selected for review by the PCAOB. Once the company has been advised by the auditor that its financial statements are being reviewed by the PCAOB, they can also ask to receive from the auditor any comments that are issued by the PCAOB regarding the company. If I were on the audit committee, I would make sure to ask for this kind of information.