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Total Number of Subscribers: 464 |
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Date:20th January 2009 |
Compiled by Mr. M. Sathya Kumar |
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For
Auditors' Eyes Only
Why audit
committees should ask for confidential information on the quality-control
systems of their companies' audit firms.
A federal
law that enables auditors to keep clients in the dark about the audit firms'
quality-control deficiencies for as much as a year leaves public companies
open to the risk of financial restatement, audit-committee activists contend. The
statute, Section 104 of the Sarbanes-Oxley Act, says that if the Public
Company Accounting Oversight Board (PCAOB) finds during its inspections of
auditors issues that need improvement—particularly
in the area of quality control—the audit firm has one year from the
date of the report to fix them. If they do so within that time frame, the
matter stays confidential. William
McDonough, chairman of the PCAOB, praised the statute last summer as an “effective tool” that would help the PCAOB keep auditors
honest. “It is a wonderful discipline,” he said at the House Committee on
Financial Services hearing. “It is like telling your kid you have to
pass school this year.” At the same
time, he noted that he had heard public concern about keeping key parts of
the inspection confidential. Under Sarbox, the board is barred for 12 months
from making public parts of the report "that deal with criticisms of or
potential defects in the quality control systems of the firm under
inspection" if the firm mends its ways. PCAOB is, however, required to
provide a copy of each report, "in appropriate detail," to the SEC
and certain state regulatory authorities. To be sure,
some of the findings of PCAOB auditor inspections are made public on the
regulator’s Web site. But Part II, which addresses internal control
deficiencies of the audit firm, isn't revealed to audit clients. Fred
Lipman, president of the non-profit Association of Audit Committee Members,
however, is one of a number of Sarbox critics who believe a client has a
right to know if their external auditor is failing in certain areas. He
reasons that the nonpublic portion of the PCAOB reports could detail controls
deficiencies that could threaten the quality of the client's audit and
potentially lead to a restatement. That’s why he’s urging corporate directors to ask their
companies' auditors for a copy of the full inspection report. "Many
audit committees are naive and do not know that they should be requesting
[the reports]," Lipman says. At the same
time, having the entire report could help companies "defuse
problems" or even head off a Securities and Exchange Commission (SEC)
investigation, Lipman says. At the very least, it could alert audit committee
members to accounting practices that need to be altered, not to mention
signaling that a change in auditors might be a good idea. Auditors,
however, are under no legal obligation to share the confidential part of the
report. Lipman, who is also a partner at Blank Rome LLP, a law firm, says
audit committees should negotiate with auditors for a stipulation in the
firm's engagement letter releasing the full report to clients— even if the firm insists that it's correcting all of
its problems. Lipman
wonders about the information audit committees might be missing out on by not
seeing it for as much as a year. "If you are an audit committee member,
you may want a lot more detail," he says. At least
one Big Four firm is apparently trying to reveal a bit more of the
confidential inspection material, however. In a move KPMG says is "in
the spirit of transparency," the firm is disclosing on its Web site a
summary of the PCAOB's nonpublic observations about its 2003 inspection of the
firm and actions the firm is taking in response to them. The audit firm calls
the full report "detailed and technical." In its
summary, for instance, KPMG notes that the PCAOB observed that although the
importance of audit quality is clearly stressed in gauging audit partners'
compensation, it's not clearly stated that it's "the most important
factor." In response, the firm is clarifying its 2004 pay practices to
document that it is the most important factor, according to the summary. Asked
whether KPMG received requests for the full report from its clients and what
the auditor's response had been to those requests, Tom Fitzgerald, a
spokesman for the firm, declined to comment. Steve
Silber, a PricewaterhouseCoopers representative, said the firm does not intend
to "part from the process" set forth from Congress. “We think the confidential process to improve audit quality is
working,” he added, noting the firm does not comment on communications with
clients.(Representatives from Deloitte & Touche and Ernst & Young did
not return calls requesting comment for this story.) Lipman says
that audit clients are likely to find that getting full inspection reports
may be next to impossible without a change in the law. Auditors, he says,
"don’t want their 'dirty laundry' disclosed to their clients.” From the
client' point of view, however, knowing what's in the full report is crucial
since the nonpublic part could include details requiring the client to make a
future accounting restatement, he contends. "Our
inspectors have conversations with the chair or member of that audit
committee in [their] general course of examining specific audit engagements
to test whether the auditor is communicating as he or she should," she
said. If the
PCAOB finds that an audit firm is not complying with generally accepted
accounting principles, Harlan says, alerting the audit committee to that “could cause a change right then and there, which is
much better for the investing public.” Last year,
the PCAOB inspected the eight largest accounting firms (those that have more
than 100 public company audit clients each), as well as 91 smaller accounting
firms. This year, it will inspect the top eight again and continue to chip
away at the long list of smaller firms. Article
by Craig Schneider, published in the CFO magazine, a reputed magazine
for the CFO's |
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