Julia Irvine 2 Jan 2018 12:39pm

US audit watchdog piles on the misery for GT

US regulator the Public Company Accounting Oversight Board (PCAOB) has slammed the quality of audits carried out by Grant Thornton’s US member firm

Its damning 2016 inspection report comes fast on the heels of last month’s revelation that it had fined the Chicago-based firm £1.12m for breaches of quality control standards and audit failures, and that it had fined and banned former Grant Thornton (GT) partner David Burns from practising for a year over failings related to the Bancorp audit.

Despite being given clean audit reports, in April 2015, the bank was forced to admit  that its financial statements for 2012 and 2013 could no longer be relied on because certain expected losses relating to commercial loans were taken in incorrect periods.

The auditors had failed to properly follow up red flags which indicated that certain loans were impaired and the audit watchdog described the matter as “a case study for what not to do”.

In the 2016 inspection report, the board disclosed that in eight of the 34 audits inspected, there were such significant failings in the audit process that GT should not have issued an audit opinion.

“In these audits,” it said, “the auditor issued an opinion without satisfying its fundamental obligation to obtain reasonable assurance about whether the financial statements were free of material misstatement and/or the issuer maintained effective ICFR [internal control over financial reporting]…

Although the deficiencies did not necessarily indicate that the financial statements were misstated, the audit watchdog made clear that, regardless of the outcome, the auditor’s failure to obtain the required reasonable assurance was a “serious matter”.

“It is a failure to accomplish the essential purpose of an audit, and it means that, based on the audit work performed, the audit opinion should not have been issued.”

The PCAOB inspectors highlighted three particular audit deficiencies that they had frequently come across. The first, which they found in four of the eight audits, was the failure to identify and test any controls that addressed the risks related to a particular account or assertion.

The second involved the failure to sufficiently test the design and/or operating effectiveness of controls that the firm selected for testing (three audits), and the third the failure to sufficiently evaluate significant assumptions or test data that the issuer used in developing an estimate (three audits).

In one audit, for example, GT failed to appropriately address a departure from generally accepted accounting principles (GAAP) that it had detected and which the PCAOB inspectors found to be material. It related to the company’s accounting for a redeemable instrument and was “multiple times the firm’s established level of materiality”.

According to the report, the company had accounted for the increase in value of the instrument as a reduction of additional paid in capital, rather than as a reduction of retained earnings, as required by GAAP. “In concluding that the misstatement was not material, the firm failed to consider the effect of the misstatement on the aforementioned accounts,” it added.

The inspectors also found frequent failures relating to property, plant and equipment, including oil and gas properties (three audits), and revenue (two audits).

In one case, the oil and gas exploration and production company had performed an impairment analysis of its proved properties using cash flow forecasts based on significant assumptions about commodity prices, lease operating expenses and future development costs.

GT not only failed to sufficiently evaluate the reasonableness of these assumptions but it repeated the failing when it came to unproved properties. Here the company had based its impairment analysis on the “significant assumption” about its future exploration of certain of its unproved properties.

“The recorded value of the unproved properties that the issuer believed it would explore was, in the aggregate, multiple times the firm’s established level of materiality,” the report said.

“The firm’s procedure to test this assumption was limited to inquiry of management, without obtaining evidence regarding management’s ability to explore these properties.

“In addition, the firm failed to test the accuracy of certain data that the issuer used in its impairment analysis for unproved properties.”

In a letter to the PCAOB in response to the inspectors’ findings, GT CEO Michael McGuire and national managing partner of audit services Jeffrey Burgess said that they had carefully considered the matters identified in the report and taken steps to remedy the issues.

They added that they looked forward to continuing the dialogue with the board as they pursued a “shared goal of improving audit quality across the profession and protecting the investing public”.