Risk & Compliance

Who Really Does Your Audit?

A PCAOB rule would let everyone know the answer.
Sarah JohnsonOctober 12, 2011

The audit opinions tucked into public companies’ financial reports usually carry one name, that of an accounting firm. For large companies, it tends to be a Big Four firm headquartered in the United States. Behind the scenes, however, the reviews, tests, and assurances could have been handled by many outside parties, including firms that carry the same moniker of that U.S. firm but are, legally, separate entities.

Under a proposed rule released Tuesday, the Public Company Accounting Oversight Board would require accounting firms to list some of the accountants and outside parties that contribute to their public audit opinions. Third parties that do at least 3% of the audit work (measured by total audit work hours) would be included. The PCAOB estimates the change could add as many as 20 entities to the financial reports of large multinationals.

The additional information would also include the locations of those third parties, which could highlight the fact that, for some companies, the bulk of the audit work is being done overseas, possibly by auditors that are not subject to the same level of PCAOB scrutiny experienced by the largest U.S. accounting firms. According to James Doty, the board’s chairman, “savvy businesspeople” and high-level policymakers are not aware that an audit report signed by a large U.S. firm may in fact be largely based on the work of an affiliated firm. “In theory, when a networked firm signs the opinion, the audit is supposed to be seamless and of consistently high quality,” he said at a Tuesday meeting. “In practice, that may or may not be the case.”

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The PCAOB hopes that by putting additional names on audit reports, investors will know better how much they can trust the opinions. “Disclosure of participating firms would shine a light on these relationships and give investors a better idea of whose work supports the audit report they are relying on,” said Daniel Goelzer, a member of the PCAOB.

Under the proposal, engagement partners would also have to put their name on the audit opinions. Accounting firms pushed back on the concept of adding an individual’s name to the reports two years ago, when the PCAOB first raised the idea. The firms were concerned that it would raise the personal liability of individual auditors and imply that the partner, not the firm, was solely responsible for the work. European companies already include this data in their financial reports, according to the PCAOB. The board has compromised by no longer requiring that engagement partners provide their signature, but rather just their typed name.

Every year the PCAOB publishes inspection reports on accounting firms that have at least 100 clients listed on U.S. exchanges, including Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers. But the member firms of those Big Four entities may receive fewer visits by the audit watchdog – as little as one visit every three years if they are registered with the board as a separate firm. For audits conducted outside the United States, the PCAOB sometimes has to rely on the work of other countries’ regulators and in some cases has struggled to get other governments to cooperate.

PCAOB members also suggested on Tuesday that the new requirement could reveal problematic auditing arrangements. According to Goelzer, the board is increasingly seeing smaller U.S. auditors claiming to audit foreign companies whose operations are mostly based in an emerging market, such as China. “The U.S. firm accomplishes this feat by contracting with an accounting firm in the company’s home country to perform significant parts of the on-the-ground auditing,” said Goelzer.

The PCAOB is collecting comments on the proposed rule through January 9, 2012. Any final rule would also require the approval of the Securities and Exchange Commission.