One of the Big Four accounting firms in Canada is repeatedly making more mistakes in its audits than the others – and I’d love to tell you which one.
Trouble is, I can’t. Canada’s robust system for inspecting the work of accounting firms stops short of making the results public – and that’s allowing underperforming firms to muddle along, in private, failing to quickly fix their audit quality issues.
The Canadian Public Accountability Board is the entity that inspects the firms. All public accounting firms that audit public companies must register with CPAB; any firm that audits at least 100 public companies gets looked at annually. That club includes the Big Four (Deloitte LLP, Ernst & Young LLP, KPMG LLP and PricewaterhouseCoopers LLP), plus seven smaller firms.
CPAB’s key performance metric is what it calls a “significant finding.” Put simply, it’s where an accounting firm falls short of accepted auditing standards for a material part of a particular company’s financial statements and has to go back and do additional work to support its audit opinion. One example of a deficiency, CPAB said, is “overreliance on management representations without corroboration with third-party evidence.”
CPAB’s annual report summarizes the results, and the 2020 numbers show audit quality isn’t clearly improving – in fact, in some areas, it seems to be getting worse.
First, let’s look at some statistics from the Big Four firms, which CPAB breaks out separately. The good news is “significant findings” dropped to six audits in 2020 from 12 the previous year. (The board looked at 72 audits in each year.)
Two firms improved, two did not. And one unidentified firm, CPAB said, missed the goal of having a significant finding in no more than 10 per cent of its audits. That firm also “did not meet the target in previous years” and now must “perform a number of procedures” to evaluate why this keeps happening.
“Mandatory development and implementation of specific actions that will result in meaningful improvement to audit quality will be undertaken by the firm,” CPAB said, adding “a decision regarding additional regulatory intervention will be made in 2021.”
Alas, we do not know which firm the board is talking about, as CPAB would not identify it, citing the confidentiality provisions of the Canadian Public Accountability Board Act of 2006. The Big Four firms all refused to comment on whether they were the one with the most audit issues, saying they are prohibited from discussing CPAB communications.
That isn’t the only question I had after reading CPAB’s report, however.
The second tier of annually inspected firms had significant findings in 22 of the 35 audits CPAB reviewed, up from 20 of 37 audits in 2019. Four firms had significant findings in more than 50 per cent of files inspected in 2020, up from three the prior year, and two firms had significant findings in more than 25 per cent of the files inspected. “Targeted remedial and enforcement action” is in place for firms with unacceptably high levels of significant findings, CPAB said.
Only one firm of these seven met the target of having significant findings in no more than 10 per cent of audits – in fact, it had none. (Who deserves the 2020 gold star? We do not know.)
Over all, there were 35 audits in 2020 with significant findings. The accounting firms responsible notified the audit committees of the companies’ boards in 24 of them – which means 11 companies that may have received a flawed audit are still in the dark.
CPAB said it could not tell me the identity of these firms. The act that created the board extends confidentiality to “all documents and other information prepared for or received by the Board … and all deliberations of the Board.” CPAB has taken the position that the language on “deliberations” extends the confidentiality obligations to all discussions and writings of CPAB, which includes its inspection report materials.
To be clear, I am happy that CPAB is out there looking at audits, finding problems and telling firms to get better. And I am very happy to have some numbers that give us a sense of the state of audit quality in Canada.
But many investors, fairly or not, think the opinion of an auditor, particularly one from the Big Four, is a seal of approval for financial statements. These CPAB numbers suggest that some firms’ opinions are probably distinctly better than others – but we don’t know which firms to applaud and which ones we should shame.
I think CPAB should expand its view of what it can say – and if the board believes the Act prevents that, lawmakers can help them out by making it clear that flawed audits should not be private matters.
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