In an unprecedented rebuke to a major accounting firm, the group that oversees the industry released a report criticizing Deloitte Touche, saying that it lacked an adequate system of quality control in its audits.
In a report released Monday, the Public Company Accounting Oversight Board chastised a Deloitte culture that it said placed too much faith in officials of the companies being audited.
“In too many instances,” the report stated, inspectors from the board “observed that the engagements team’s support for significant areas of the audit consisted of management’s views or the results of inquiries of management.”
In some cases, Deloitte auditors did not bother to even consider whether accounting decisions made by companies were consistent with accounting rules. Instead, auditors accepted management assertions that the accounting was proper, the board’s report said.
The report was written in 2008 and covered audits conducted in 2007. It was kept private under rules that say such criticisms must remain confidential for a year, and then may be released only if the firm has failed to make sufficient progress in correcting the problems.
Until now, the accounting oversight board, which was created by the Sarbanes-Oxley law in 2002 in the wake of failures at Enron and WorldCom, had never released such a report on a major firm.
In an interview, Joe Echevarria, the chief executive of Deloitte who took over this year, said the firm had addressed many of the issues raised. “In all of the areas that are mentioned, we have made significant investment. I have complete confidence in our professionals and the quality of our audits,” he said. But he added, “There were, and always will be, areas in which we can improve.”
Deloitte, however, is one of the Big Four firms that audit the vast majority of major companies in the United States.
The board also criticized Deloitte for the way it worked with foreign affiliates, who use the name Deloitte in other countries but are separate partnerships. It said American partners who chose to retain foreign affiliates to help on audits of multinational companies often had no way to assess whether that firm’s personnel were adequately familiar with American accounting and auditing rules.
Board officials have been increasingly critical recently of the failure of the major firms to improve. “Our inspectors have conducted annual inspections of the largest U.S. audit firms for eight years,” James R. Doty, the board’s chairman, said in a speech this month. “They have reviewed more than 2,800 engagements of such firms and discovered and analyzed hundreds of cases involving what they determined to be audit failures.” He said the firms had made efforts to improve, but that each year more failures were found.
“I am left,” he said, “with the inescapable question whether the root of the problem is auditor skepticism, coming to ground in the bedrock of independence. The loss of independence destroys skepticism.”
On Monday, the accounting oversight board issued a statement saying audits should protect investors.
“The board therefore takes very seriously the importance of firms making sufficient progress on quality control issues identified in an inspection report in the 12 months following the report,” the statement said.
The statement added that the board “devotes considerable time and resources to critically evaluating whether the firm did in fact make sufficient progress” in fixing the problems, and goes public only “when a firm has failed to do so.” Officials at the board declined to discuss the Deloitte report.
The 2008 report cited problems in 27 of the 61 Deloitte audits it reviewed, including three where the issuing company was forced to restate its financial statements. It did not name any of the clients.
In each of the cases where the accounting had to be changed, the board said Deloitte auditors had failed to consult with the firm’s top experts to determine appropriate accounting policies. It said there was “cause for concern” that the firm’s policies did not result in appropriate consultations.
In a 2008 reply to the board, also released Monday, the firm disputed many of the conclusions and said Deloitte partners’ “reasonable judgments should not be second-guessed.”
The report pointed to “a firm culture that allows, or tolerates, audit approaches that do not consistently emphasize the need for an appropriate level of critical analysis and collection of objective evidence, and that rely largely on management representations.”
The Deloitte response protested that “such a broad statement by the board mischaracterizes” Deloitte’s practices.
That response indicated that Deloitte believed there was nothing wrong with its quality control procedures. That the board decided to release the report is an indication that those procedures did not change enough to satisfy the board, at least within the following year.
Each year, the board inspects all major accounting firms, and it releases part of the report that deals with specific audit problems. But it keeps confidential the other part that covers the firm’s quality control problems, if there are any, and goes into greater detail on the audit problems found. That is the part of the 2008 report that was released Monday.
The most recent report on Deloitte, released in 2010, cited problems with 15 audits, including some where it said the audit firm had failed to do work needed to assess whether management assertions were correct. The quality control portion of that report was kept confidential.
In addition to conducting inspections, the board has the power to take disciplinary action against firms and individual partners, with penalties up to barring a person or firm from participating in future audits. But the Sarbanes-Oxley law requires that such enforcement proceedings be kept confidential until they are finally resolved, which can take years, so there is no way to know if the board has taken action against Deloitte or any of its partners.
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