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A review of the auditing work of Canada’s accounting firms has uncovered serious deficiencies in how some auditors ensure quality control and document their work, as well as a host of other systemic problems. The findings, contained in the annual review by the Canadian Public Accountability Board (CPAB) have resulted in the largest number of disciplinary actions taken by Canada’s accounting watchdog since it began its annual accounting reviews in 2004. And for the first time, CPAB has taken disciplinary action against one of Canada’s six largest national accounting firms.
The names of the accounting firms disciplined by CPAB are not disclosed, but the findings are available in CPAB’s public report, which was released earlier this year. “We are pleased with the progress in some areas,” said CPAB chairman Gordon Thiessen in the report. “However, the issues … have been raised by CPAB in earlier public reports and the recommended changes are not being implemented as successfully as we would like.”
Canada’s six largest accounting firms include BDO Dunwoody, Deloitte & Touche, Ernst & Young, Grant Thornton, KPMG and PricewaterhouseCoopers. Together the six firms audit more than 4,500 public companies or other Canadian reporting issuers representing about 70% of the total publicly reported market. In addition to the penalties imposed on the national firm, another 10 small- to medium-sized firms were also disciplined. In total, 16 performance “requirements” were imposed on Canada’s accounting firms, up from just nine in each of the past two years. CPAB went so far as to bar seven firms from accepting any new publicly traded companies or reporting issuers as clients and is forcing three accounting firms to have their audits reviewed by a separate accounting firm before they are issued to shareholders and regulators.
The CPAB review revealed major problems with audits at accounting firms of all sizes. Eleven of the 130 audits conducted by Canada’s largest accounting firms had “serious deficiencies.” Problems were so severe with five of the files that clients were forced to correct, restate or re-file their financial statements. Problems were even worse at small and medium accounting firms where more than 17% of the files reviewed required clients to correct their financials.
Of particular concern to CPAB investigators was the lack of documentation in the auditing files. About 25% of the files reviewed contained sub-standard documentation. “If work is not documented then there is no evidence it was done,” the report states.
Another major issue was the lack of quality control standards at many smaller accounting firms. In previous reviews, CPAB had recommended many of the firms improve their quality control standards, but the problems continue to persist. A number of the problems uncovered by CPAB inspectors should have been caught by an adequate quality control system, CPAB says. This lack of quality control is so pervasive that the CPAB report speculates about whether the smaller firms have the ability or resources to develop and implement those recommendations.
CPAB also uncovered a host of problems with how the firms have dealt with stock-based compensation. That’s surprising given the recent scandals involving backdated stock options in both Canada and the U.S. Both Waterloo, Ont.-based Research in Motion (TSX: RIM) and Toronto-based FirstService Corp. (TSX: FSV) have admitted to breaking accounting rules by changing the dates on which stock options were granted to executives, thus increasing the value of the options. The auditors of neither company caught those violations.
The CPAB review found that many medium-sized accounting firms had no audit program or had insufficient procedures to ensure stock-based compensation was properly awarded or accounted for. In some instances, improper dates were used for determining the value of the options and there was little evidence auditors had confirmed the dates the board of directors actually approved the options. At one medium-sized firm, problems were found with stock-based compensation at all seven files CPAB reviewed.
Canada’s decision not to reveal the names of the accounting firms it takes action against is different from the approach in the U.S. where CPAB’s counterpart — the Public Company Accounting Oversight Board — publicly names the accounting firms it disciplines. CPAB has said in the past that keeping the names of the offending accounting firms secret increases the odds the firms will be more co-operative in the review process and take a less defensive stance when it comes to implementing their findings.
That quiet and consultative approach doesn’t seem to be working for some firms. If these systemic problems continue to persist, perhaps it’s time for CPAB to reconsider its approach and try naming and shaming those problematic accounting firms.
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