The Public Company Accounting Oversight Board released the details of their 2015 inspection of KPMG on December 6, 2016.
The PCAOB found issues with 20 out of the 49 audits that they inspected.
Is that an improvement? You could say so because their fail rate in 2014 was over 50%. The problem is their 2015 rate is still close to a 40% fail rate. That is the worst rate for 2015 PCAOB inspection reports of the big 4 accounting firms.
That is a pretty steep rate when compared to Deloitte, EY and PwC whose inspection reports were released earlier this year.
Deloitte failed 13 audits out of 55. That represents a fail rate of about 24% which was an increase from 2014. Deloitte’s fail rate 21 % in 2014.
PwC was deficient in 12 of their 55 audits inspected by the PCAOB. That represents a fail rate of 22%. That is an improvement from PwC’s PCAOB Inspection Report fail rate of 29% from 2014.
Ey was deficient in 16 of their 55 audits inspected by the PCAOB. That represents a fail rate of 29%. That is an improvement from Ernst and Young’s PCAOB Inspection Report fail rate of 36% from 2014.
It seems like PwC and EY were the only Big 4 firm that had decreases in the fail rate of their PCAOB inspection report. I’m not counting KPMG because they have a tremendous fail rate.
Trend in Fail Rate from 2014 to 2015
Big 4 Audit Fail Rate
This is very odd since audit deficiencies for public companies decreased for the first time in five years in 2015.
The PCAOB found that 39% of all audits inspected were deficient in 2015. This is a decrease from 2014 of 43%. I don’t know about you but that seems insane to me. That means as a public company you have almost a 50/50 chance of failing your audit. That also means you are paying public accounting firms millions of dollars, but you might actually be getting nothing in return.
What was the problem with KPMG audits?
The PCAOB stated that in some of KPMG’s audits they did not obtain enough evidence to support the opinion that the financial statements were presented fairly.
The PCAOB caveated that statement though. They said that the financial statements of each respective company were not necessarily misstated just because KPMG did not obtain enough evidence.
Statistics from the PCAOB report
The PCAOB classifies KPMG’s failures into several categories.
Firstly they categorize whether KPMG failed due to deficiencies in testing the financial statements, controls or both financial statements and controls.
Of the 20 audits with deficiencies:
- 11 failed to adequately test controls and the financial statements.
- 3 failed only the financial statement audit.
- 6 failed only on the control audit.
The nature of the deficiencies was also further broken down into the type of failure.
- 14 audits failed to adequately test the design and/or operating effectiveness of controls that were selected.
- 8 audits failed to test controls over the accuracy and completeness of issuer-produced data or reports.
- 7 audits failed to perform substantive procedures to obtain sufficient evidence as a result of relying too heavily on controls. These failed because there deficiencies in controls testing that were detected.
That concept of having this many deficiencies is somewhat confusing to me. Imagine if 39% of all Starbucks cups were empty in 2015. Do you think Starbucks revenues would increase year over year?
The main difference is that Starbucks does not have a monopoly on coffee or liquid beverages.
The Big 4 Accounting Firms have a monopoly/oligopoly on financial statement audits though. That is how they can afford to fail audits at the rate they do.
Since I’m already perched on my soapbox, let’s delve a little deeper too. What is the purpose of the PCAOB? How do they consistently fail companies at a rate of 40% yet don’t take any severe initiatives.
They need to offer incentives for public accounting firms to get their audits right. In my mind that means they need to provide templates to accounting firms. They need to penalize them if they don’t use those templates as well.
I don’t want to hear how every company is different either. Every large company in the United States uses the same advisors. Large public companies all end up with roughly the same structure depending on the industry, so I don’t understand how the PCAOB can’t mandate use of certain workpapers and templates. Both the PCAOB and the Big 4 Accounting Firms need to take a long look in the mirror.
The Big 4 Accounting Firms either need to improve their audit work or lobby for the PCAOB to change its practices.
The PCAOB needs to change what they are doing. Even though there have been press releases saying that they are changing, I’m sure they will be underwhelming and confusing at the same time.
The PCAOB can’t just march out every year giving fail rates of 40% to all public accounting firms. It just sends the wrong message to society and the investment world.