Three times a year the California Board of Accountancy issues a newsletter. It contains a variety of information useful for CPAs. If you are a CPA, you really ought to be reading the newsletter.
That newsletter is also where the board publicizes disciplinary actions against CPAs.
In the last few newsletters I’ve noticed a number of cases where firms are sanctioned for substandard audits. Have also noticed a number of firms sanctioned for not getting a peer review when it was required or fibbing to the board whether they had complied with the peer review standards.
I wanted to understand better what I’ve noticed in passing so decided to dive into the disciplinary reports to get a better picture of the extent of sanctions for audit quality and peer review issues. I looked at the Fall 2014, Winter 2015, Summer 2015, and Fall 2015 newsletters.
That covers 16 months of reporting for disciplinary actions by CBA.
I focused on sanctions for audit issues excluding anything that was a follow-up to PCOAB or SEC sanctions. That rules out quite a few cases.
Also ignored a long list of social misbehavior such as DUIs (several incidents), fabricating Form E (once – fabricating the experience report? – really??), embezzlements, disbarment (once), and other such human foibles. Also excluded a variety of contingency fee violations, breaches of client trust, and sundry tax fiascos.
For context, the Fall 2015 newsletter had 28 disciplinary actions of which 5 were of interest for this little bitty research project. Of those 5 cases, the public notices refer to 2 firms which had substandard audits, 1 had a substandard compilation, and 4 included failures to get a peer review when required of which 2 fibbed to CBA about compliance with the peer review requirement.
Scope and result of my analysis
I looked at 4 disciplinary actions from Fall 2014, 4 from Winter 2015, 4 from Summer 2015, and 4 from Fall 2014. One of the Fall 2014 cases not included in this count is for a Big 4 firm which will be discussed at the end of part 2). Of those 16 cases, 15 appeared to be for individuals or smaller firms with one from a medium-sized firm with multiple partners and multiple offices.
Of the 15 cases I noted:
- 7 were sanctioned for substandard audit engagements. More on that in a moment.
- 3 were sanctioned for substandard compilation engagements. As my editorial observation, seems to me you would have to try to get in trouble with CBA for a compilation engagement. Each of those firms had more serious issues than just the comp.
- 9 cases were for a firm not having a peer review report when one was required. Frequently this was for failing to obtain a peer review within 18 months of the first engagement requiring a peer review.
- 4 cases involved the accountant making false statements on the annual renewal, which requires disclosing whether there was a requirement to obtain a peer review and whether such a review was obtained.
- There is some overlap in my count. For example there are five cases where a firm had a substandard engagement and problem with the peer review. Three firms were sanctioned for not having a peer review and make a false statement on the renewal.
What does a substandard audit look like?
It is sometimes difficult to tell from the narratives what a bad audit looked like, but here is an illustration from the sanctions reported in Winter 2015. I will quote this disciplinary action without specific permission from CBA since the announcement of their action is a public document:
Respondents’ acts included failures to properly plan the audit and to obtain a sufficient understanding of the entity and its environment to assess risks. Respondent failed to establish an audit plan that reflected a description of the nature, timing and extent of planned risk assessment procedures to assess the risks of material misstatement.
Looks to me like the firm did a poor job planning the audit, didn’t perform an assessment of entity level controls, didn’t perform an assessment of activity level controls (internal controls), and didn’t assess whether internal controls had been designed effectively and placed in operation. Likely didn’t assess risks at either the financial statement or assertion level. By the way, for those who don’t know, that is the core of the risk assessment suite of audit standards.
Respondents failed to exercise due professional care with respect to documenting the audit work. Respondents failed to apply auditing procedures to the individual participant accounts…. Respondents failed to obtain a signed management representation letter from the client.
That means the firm missed a major audit test. Also didn’t get a rep letter, which is absolutely required.
Respondents’ audit report failed to conform to professional standards in that Respondents’ unqualified opinion was not supported due to respondents’ failure to conduct the audit in accordance with Generally Accepted Auditing Standards.
Paraphrased, the paragraph means the CBA asserts the firm did not obtain reasonable assurance that the financial statements were fairly presented and therefore did not have support to issue a clean opinion. Editorial: ouch; since the core function of an auditor is to express an opinion on the financial statements, that means the firm didn’t do the one main job they were hired to do.
Respondents failed to produce and/or retain audit documentation regarding the procedures applied, test performed, evidence obtained and relevant conclusions reached sufficient to enable a qualified reviewer with no prior connection with the audit to understand the nature, timing, extent, result of the auditing procedures performed, evidence obtained and conclusions reached.
That last long sentence is the key test to see if the documentation is sufficient. The CBA concluded this firm failed the test.
Here is a further illustration of the breadth of problems created by this practitioner. The public documents also state the CPA
… failed to obtain a peer review report accepted by a CPA-recognized peer-review program within 18 months of completing its audit…. Respondent… falsely stated to the CBA that (the) firm had not engaged in any auditing services that would require a peer review.
There were a number of other CPAs in trouble for one or the other or both of those last two issues: a) not getting a peer review when it was required, or b) making an untrue statement under penalty of perjury that they were in compliance with the peer review requirements.
Full disclosure: I am regulated by the California Board of Accountancy. I perform peer reviews for CPAs under the program administered by the California Society of CPAs.
Next post looks at sanctions imposed by CBA and what disciplinary actions are visible against larger firms.