Auditing

PCAOB Revokes Two Registrations

The accounting oversight board is keeping tabs on smaller firms, too.
Stephen TaubDecember 2, 2005

The Public Company Accounting Oversight Board recently revoked the registrations of two small accounting firms and barred their sole shareholders from associating with a public accounting firm for violating the PCAOB’s auditing standards.

Clyde Bailey, of San Antonio-based Clyde B. Bailey CPA, agreed to a settlement offer without admitting or denying the board’s findings stemming from its audits of four clients during 2004 and 2005.

The PCAOB asserted that Bailey and his firm “failed to exercise due professional care, failed to exercise professional skepticism, and failed to obtain sufficient competent evidential matter.” The four companies for which he violated PCAOB’s standards are Endevco, formerly Adair International Oil and Gas Inc.; Call Now Inc., formerly Phone One International Inc.; Image Innovations Holdings Inc., formerly Busanda Explorations Inc.; and Health Discovery, formerly Direct Wireless Communications Inc.

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In the case of Endevco, the PCAOB noted that on January 26, 2004, Bailey’s firm issued an unqualified audit report on Endevco’s consolidated financial statements for the year ended December 31, 2003. During that year, Endevco disclosed that it acquired two options to acquire interests in certain oil and gas leasehold interests in Colombia and the Gulf of Mexico. The company stated that it acquired the options in exchange for a $500,000 note and 1.5 million shares of preferred stock valued at $1 per share. Endevco recorded those options as assets valued at $2 million, representing 61 percent of the company’s total reported assets at the end of 2003.

Other than obtaining the option agreements and reviewing the board resolution authorizing the option purchases, Bailey “performed no audit procedures to assess the values assigned by management to the option rights or to the preferred shares that were exchanged for those rights,” the PCAOB alleged. It also accused Bailey’s firm of not performing audit procedures to test whether the option rights would result in a probable future economic benefit to Endevco. “Respondents failed to perform such procedures despite the existence of several factors that cast doubt on Endevco’s ability to exercise the options,” the board added.

It also criticized Bailey for overlooking red flags concerning Endevco’s ability to exercise the options, noting that the accounting firm “relied exclusively on management’s assurances” that it would be able to obtain from unidentified sources the funds needed for the exercise price. In addition, the PCAOB asserted that the accounting firm “failed to perform necessary audit procedures” to evaluate whether Endevco appropriate recognized certain revenue.

The PCAOB also revoked the registration of Los Angeles-based Kenny H. Lee CPA Group Inc., and barred its sole shareholder, Kwang Ho Lee stemming from the audit of two clients in 2004 and violations of PCAOB independence standards by one of those clients in 2003.

The PCAOB cited Lee’s firm in its audit of GSL Holdings Inc., formerly Bethurum Laboratories Inc., and Axesstel Inc., formerly Miracom Industries Inc.

In the case of GSL, the board asserted that Lee “failed to exercise due professional care, failed to exercise professional skepticism, and failed to obtain sufficient competent evidential matter.” For example, the accounting firm “never obtained sufficient competent evidence to reasonably conclude” that GSL had legally acquired two properties in question, according to the PCAOB report. The board also asserted that Lee’s audit procedures “were insufficient to reasonably conclude that GSL had properly valued the properties in its financial statements.”

In May, the PCAOB took its first action against a public accounting firm, revoking the registration of New York-based Goldstein and Morris CPAs P.C. and barring its managing partner, Edward B. Morris, from associating with a registered accounting firm.

The PCAOB found that the firm concealed information from the board and submitted false information in connection with a PCAOB inspection. The board also censured two former partners of the firm, finding that they participated in the misconduct.