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2 Sep 2014 08:57am

Nearly half of EY inspected audits found wanting

US audit watchdog inspectors have revealed that, of the audits carried out by EY’s US practice in 2013 which they reviewed, nearly half failed to meet the essential purpose of an audit and should not have had an audit opinion issued

The Public Company Accounting Oversight Board inspectors looked at parts of 56 audits performed by the firm and one piece of work it did on another issuer audit engagement and found that in 28 cases, there were significant deficiencies.

According to their report, the deficiencies were so significant that the inspectors were forced to conclude that EY, “at the time it issued its audit report, had not obtained sufficient appropriate audit evidence to support its opinion that the financial statements were presented fairly, in all material respects, in accordance with applicable financial reporting framework and/or its opinion about whether the issuer had maintained, in all material respects, effective internal control over financial reporting (ICFR)”.

“In other words,” they say, “in these audits, 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.”

While the existence of these deficiencies does not necessarily mean that the financial statements were misstated or that there were undisclosed material weaknesses in the internal controls, the inspectors point out that an auditor’s failure to obtain the reasonable assurance that he or she is required to obtain is a “serious matter”.

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

This is not the first time the US firm has fallen foul of the PCAOB inspectors. In its 2011 report on the firm, the board revealed that it did not think EY audit partners were sceptical enough because they were too close to some of their audit clients. In 2012, the board fined the firm $2m (£1.2m) over audit errorsrelating to the audit of Medicis Pharmaceuticals and in 2013 the firm fought back against PCAOB criticisms about its audit quality control.

However, it is possibly the most scathing of the board’s reports on EY so far. As well as a detailed list of the 28 audits issues identified involved, the inspectors have added 25 pages of footnotes referring to auditing standards that the firm did not follow. Overall, the report runs to 82 pages.

Details of the audit failings at one client alone cover four and a half pages. These range from EY’s assumption that a control monitoring routine transactions in the client’s two business units was designed effectively and implemented uniformly, leading it to reduce the number of locations at which it would test the transaction-level controls, to relying on the work of the client’s compliance group, on the assumption that the internal audit function at the client would perform reviews of the quality of the compliance group’s work.

During the audit of another client, the firm identified a fraud risk related to insurance reserves yet, as the inspectors discovered, its procedures in relation to the valuation of the reserves, as well as certain other insurance reserves and policy claim liabilities, were insufficient.

For example, the client had discovered errors in the insurance reserves during the year and in prior years and identified a related significant control deficiency. “Yet EY failed to sufficiently evaluate this control deficiency, as its evaluation focused only on the actual amount of the errors rather than the potential misstatement.

“In addition, the issuer identified other control exceptions and deficiencies through its review of controls. The firm, however, failed to evaluate the effect of these exceptions and deficiencies, in combination with the significant deficiency, on its conclusion about the effectiveness of ICFR.”

Writing in response to the PCAOB report, EY US managing partner Stephen Howe and vice chair assurance services Frank Mahoney say that they have taken action to address the board’s findings.

They says they welcome the board’s inspection process because it highlights areas where the firm can continue to improve audit quality.

“We respect and benefit from this process as it aids us in fulfilling our responsibilities to investors, other stakeholders, and the capital markets generally,” they say. “We appreciate the opportunity to provide our response to the report and look forward to continuing to work with the PCAOB on matters of interest to our public company auditing practice.”

Julia Irvine

 

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