PCAOB Chief: Some 404 Audits ‘Excessive’

McDonough foresees a "severe conversation" with accountants who engage in too much testing of their clients' internal-controls reports.
Tim ReasonApril 13, 2005

If you think your outside auditors are going too far when they examine your company’s Section 404 compliance, William McDonough may give you reason to smile.

Speaking Wednesday at a roundtable discussion held by the Securities and Exchange Commission, the chairman of the Public Company Accounting Oversight Board commented on the PCAOB’s inspections of audit firms and their work on Section 404 of the Sarbanes-Oxley Act. That section guides companies’ assessments of their internal controls and auditors’ reports on those assessments.

Noting that the PCAOB inspection process is carefully designed to be evenhanded, he said: “It is at least as likely that we will find that the work they did was excessive as it was inadequate. Now, will we throw someone in jail for excessive audit? Not likely. However, will we have a very severe conversation with the management of that audit firm? You bet.”

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According to a recent study by Compliance Week, 7.7 percent of annual reports have received adverse opinions from auditors due to their evaluations of the companies’ 404 reports.

Other speakers on McDonough’s panel had harsh words for auditors and spent a lot of time on the question of how to “tell” an auditor to use judgment. “Auditor judgment,” indeed, is quickly starting to have the same ring as “principles-based accounting” — nice in theory but difficult to put into practice. For more coverage, see the CFO blog.

The PCAOB chairman received some criticism himself. “Chairman McDonough said he endorses the use of judgment,” noted Jay Haberland, vice president of business controls for United Technologies Corp. “However, the way it has been interpreted by each of the four [audit] firms doesn’t allow for the use of judgment.”

The proof, said Haberland, is in the PCAOB inspection process, which many companies apparently hope will ease the fears of the audit firms.

The panel produced a rare expression of the audit firms’ own frustration with the way companies are portraying them. “We do take it personally,” said Ernst & Young’s Jim Turley. “The Big Four, even the Big Eight firms have tried our best to implement a complex rule. We, like everyone here, look forward to the process and to the inspections and get this to a way that maximizes the process.”