News highlights for June 2014

The PCAOB’s use of the term “audit failure” in its inspection reports of audit firms appears to have caused confusion and misunderstanding about the severity of inspection findings among investors, audit committees, and others, PCAOB member Jay Hanson said.

Hanson wants the PCAOB to stop using the term “audit failure” in inspection reports. He made the remarks during a speech in March at the CBI Pharma/Biotech Accounting & Reporting Congress in Philadelphia.

The PCAOB uses the term “audit failure” to identify cases in which the auditing firm failed to obtain sufficient appropriate evidence to support its audit opinion, Hanson said. This does not necessarily mean that the financial statements are misstated, he said. Instead, it means that the auditor did not do enough work to know whether they are misstated, Hanson said.

In other contexts, “audit failure” is understood to mean that the company’s financial statements are misstated and that the auditor did not identify relevant problems during the audit, Hanson said. He cited the example of a U.S. Government Accountability Office study that defined the term “audit failure,” in part, as “audits for which audited financial statements filed with the SEC contained material misstatements whether due to errors or fraud.”

“I don’t believe it is necessary or appropriate for us to deviate from this more commonly understood definition of ‘audit failure’ by using the term to refer to our inspection findings—which are deficiencies in the firm’s work but not necessarily representative of problems in the audit client’s financial statements or internal controls,” Hanson said.

PCAOB spokeswoman Colleen Brennan said in an email that the board is aware of the concerns that some have expressed about the terminology in its reports.

“Whether we use the expression ‘audit failure’ or not, what we put in Part 1 of the inspection reports are situations where our inspectors have found that the audit report was unsupported and not reliable,” she said. “Also, it’s worth noting that we have always made clear in our reports that an audit failure does not necessarily mean the financial statements are materially misstated.”

Cindy Fornelli, the executive director of the Center for Audit Quality (CAQ), said in an email that the CAQ and the public company audit profession recognize the importance of the PCAOB inspection process and view it as a valuable input for continuous improvement in audit quality. But the CAQ believes investors, auditors, and audit committees could benefit from more clarity and context in PCAOB inspection findings.

“We share board member Hanson’s concerns about the use of the term ‘audit failure’ in PCAOB inspection reports, because the term can be misleading,” Fornelli said. “As board member Hanson pointed out in his speech, ‘very few [PCAOB] inspection findings … can be linked to a problem in the company’s financial statements, and restatements arising out of [the] inspection process are rare.’ ”

The CAQ is affiliated with the AICPA.