PCAOB Faults Flaws in KPMG’s Audits

The auditor should have done more work to support its opinions at 10 companies, the board's inspection report says.
Sarah JohnsonAugust 18, 2008

KPMG failed to do the proper evaluations and testing procedures to back up its assessments of 10 clients, according to the most recent inspection report of the Big Four firm done by the Public Company Accounting Oversight Board.

The PCAOB, which inspects the largest of the auditors annually, cited instances where the firm should have performed additional tests to confirm its clients’ valuations and assertions, as well as to notice instances where a client had strayed from GAAP. For the report released late last week, the board inspected 24 of KPMG’s 90 practice offices between April 2007 and January 2008.

In a July 30 letter included in the report, KPMG noted that none of the PCAOB’s findings prompted the firm to change its audit opinions. Still, the auditor admitted that its staff conducted additional procedures and supplemented its documentation after the deficiencies were brought to their attention.

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Using similar language in its response letter as in previous years, KPMG acknowledges the human nature of auditing may lead to differing opinions on the part of the firm’s auditors and the PCAOB’s auditors. “We recognize that judgments were involved in both the performance of an audit and the subsequent inspection process, and we view the PCAOB’s comments as helpful and given each careful and thoughtful consideration,” the firm wrote.

In addition to reviewing accounting firms’ audit work, the PCAOB looks at auditors’ employee and client relationship policies, their inspection program, and their leadership’s so-called “tone at the top.” For the first time in its response letter, KPMG commented specifically on its work culture. “We are committed to creating an environment in which every individual feels a personal responsibility to uphold our core values and to do the right thing, in the right way,” the firm wrote.

However, the PCAOB does not share its findings related to a firm’s quality control system with the public, unless the issues go unresolved after a year. What the board does include is its list of audit deficiencies at each firm, keeping each client’s identity confidential.

For instance, the PCAOB pings KPMG for not testing the accuracy of “Issuer A’s” data used for its loan loss allowance and for missing when “Issuer E” did not fully follow FAS 144, the rule that instructs companies how to account for the impairment of long-lived assets.

What follows are other excerpts from the inspection report:

Issuer B: The firm failed to sufficiently test its client’s valuation of “hard to price” securities.

Two of KPMG’s independent, fair-value estimates of 10 securities did not match the client’s estimates. The firm turned to the issuer’s traders who had come up with the valuations to find out how they had come up with their numbers. But KPMG did not test the information on which the traders had based their assessments.

Issuer D: The firm failed to gather sufficient evidence that revenue involving licensing agreements was not recognized prematurely.

KPMG should have corroborated the issuer’s claims of when it could record revenue for some of its licensing agreements with various start dates, based on contractual terms. KPMG could have done that by checking the terms with the issuer’s lawyers or by confirming the facts with the customer involved.

Issuer H: The firm failed to perform sufficient tests of a managed health-care company’s claims payable.

KPMG did not do the work necessary to ensure that the data used to come up with its independent estimate of the issuer’s liability was accurate and complete.