Well, the auditing profession appears to have finally hit the “bottom of the barrel.” The demise of the respected Arthur Andersen firm in the wake of the Enron scandal was a huge disappointment. And now PricewaterhouseCoopers (PwC) has failed us by not living up to the high standards set by its legacy firm. For those of you too young to remember, Price Waterhouse & Co. was the Brooks Brothers of the accounting and auditing profession at one time. As Mark Stevens in The Big Eight noted in 1981 (yes, over 30 years ago), Price worked hard “to retain its image as the gilt-edge CPA firm.” My how times have changed!
So what happened? On March 7, 2013, the Public Company Accounting Oversight Board (PCAOB ) reported that the PwC had failed to address certain audit related quality control criticisms levied at the firm in previous PCAOB inspection reports, not once but twice, first in March 25, 2009 and then again in August 12, 2010. What makes this so interesting is that the issues raised in those previously issued reports would have remained “private” had PwC simply corrected the problems within 12 months of the reports’ issuance. While this is not the first time that one of the Big Four has thumbed their noses at the PCAOB (Deloitte felt the PCAOB’s wrath in October 2011), it is surprising that “a leader in the profession” (and yes, those are PwC’s own words) has done so. You may recall that the Grumpies were not wild about this behavior the first time it happened.
Well, Lynn Turner, a former Chief Accountant of the U.S. Securities and Exchange Commission (SEC), in a recent email (March 7th) to his distribution list, has asked the million dollar question:
What kind of leaders are running the firms, what type of governance do they have, that provides that type of response to the regulator?
Just look at PwC’s response to the PCAOB in its March 7, 2013, Release No. 104-2013-054:
The Part II comments relate to some of the most complex, judgmental and evolving areas of auditing. Our actions relating to those areas, during the 12 months following issuance of the comments and thereafter, have included providing our audit professionals with enhanced audit tools, training and additional technical guidance to promote more consistent audit execution. We believe that these efforts have been important positive contributors to audit quality at our firm. We are proud of our focus on continuous improvement and of the dedication and high quality audit work performed by our partners and other professionals.
Wow! This hints at an admission by PwC that its highly paid auditors were not properly trained to audit publicly traded firms. If this is indeed the case, we surely can’t overlook the ethical implications of a firm contracting to do work for which it was not qualified. This never would have happened at Price Waterhouse & Co. What really bothers this grumpy old accountant is that PwC just doesn’t get it. The old “we’ll try harder” language is just not acceptable.
Just look at a couple of the more glaring audit quality control problems plaguing PwC. First, there is the supervision issue. Apparently, some PwC engagement partners are spending miniscule amounts of time on their engagements (see PCAOB Release No. 104-2009-038A page 23). Remember, these are the same engagements that PwC (in responding to the PCAOB) indicated involved “some of the most complex, judgmental and evolving areas of auditing.” How could PwC allow this to happen?
Particularly troubling is PwC’s “let them eat cake” attitude in addressing PCAOB concerns such as “failure to adequately challenge management assumptions, excessive reliance on management's responses to inquiries, and the failure to respond appropriately to potential issues identified during the audit.” Apparently, PwC engagement teams view cumulative audit knowledge and experience (CAKE, a PwC acronym) as a “source of substantive assurance” in their audit model, which may have undervalued skepticism, supervision, and good old fashioned audit procedures (see PCAOB Release No. 104-2009-038A page 14).
And while I am on the topics, skepticism and supervision are NOT just about technical competency and/or having someone review your work. Skepticism and supervision require competency, experience, judgment, and strength of character, traits typically found only in seasoned, grumpy old auditors…like engagement partners. So, is it really surprising that the PCAOB found problems in these areas given the firm’s reduction in partner engagement time?
Also, let’s be clear on what the PCAOB really means by “quality control system.” This is the audit model itself…the activities and procedures used by an accounting and auditing firm to actually execute an audit. So, when the PCAOB finds problems with how PwC audits estimates, fair value, and revenue recognition; evaluates controls; and uses specialists, it raises serious questions about how the firm’s business processes function. So, what PwC and its three other Big Four cronies really need is a new “audit model.”
Second, the PCAOB must move the auditing profession away from its historical audit pyramid where relatively inexperienced and inadequately trained “grunts” labor long hours to make their audit partners wealthy. That may have worked when business transactions were much simpler, local, and slower paced. But with today’s transaction complexity, speed, and globalization, what we need to have for quality audits is senior manager and partner time…not rookie time. The tired, old, audit pyramid needs to be scrapped and should have gone the way of rolodexes, printed encyclopedias, phone books, film, bank deposit slips, and answering machines…AWAY.
Finally, the auditing profession must stop forcing their elder statesmen (those over 60) into retirement. By forcing these early departures, these firms are throwing away one of (if not THE) most valuable assets that they have….experience.
So, while it brings tears to this grumpy old accountant’s eyes to see the demise of what I remember as such a great firm, PwC and the other large accounting firms are getting exactly what they deserve for promoting bad accounting standards: impossible to audit balance sheets!
This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.