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Will the PCAOB Survive?

by Peter H. Burgher

By Peter H. Burgher Email: pete@marelco.com

Congress, in its haste to "do something" about perceived corporate errors created the Public Company Accounting Oversight Board ("PCAOB") when the Sarbanes-Oxley Act was passed. The question of whether this was the way to improve things is a reasonable question.

The answer will depend not on the validity of Congress' intent but on how the PCAOB plans to implement its mission. That information is found in the PCAOB's stated plan of reviewing selected audits after the fact. "Wait a minute!" you say, "Isn't that exactly what the peer review process of the AICPA did (and failed at)?" What good is it to look over the work of the Big 3 and some lesser firms after the report is issued and the client's statements read by the public?

Better yet, the PCAOB should guide auditors toward practices that will ensure their examinations of financial statements produce reasonably sound results. Here are some of the areas in which guidance is needed:

Investigate intangibles - with intangible assets rising from 5% of all assets in 1978 to over 75% in 2004, this area is fraught with risk and clearly material. The incredible elimination of systematic intangible amortization in FAS 142 exacerbates the exposure. While it is the new "law of the land" per the FASB, the idea that intangibles are not wasting assets overstates earnings and assets. Tough scrutiny is clearly the call that is needed.

Require real statistical sampling - auditors have gotten away from knowledge of the true contents within their large clients' data universes (witness Health South). Statistical sampling can provide reasonable insight into the contents of large sets of data. If auditors don't use mathematically valid sampling systems their working papers should be able to demonstrate how knowledge of what's in the data was obtained.

Eliminate high risk clients - clients that use questionable business practices or which have inherently high risks (ala Sunbeam) take more time and often end up costing far more than the fees they generate. Long ago the AICPA promulgated criteria for evaluating client risk, trouble is some auditors overlook these and other sensible suggestions. Client risk attributes should be evaluated before, during and after each audit.

Implement industrial quality QC - failure to adhere to firm level quality control procedures (as in Enron) can lead to serious consequences. Procedures for monitoring staff assignments, supervisory activities, training and issues identification and management can be evaluated also before, during and after each engagement. Industry can monitor and control complex manufacturing activities (like auto and aircraft building) and soft-output activities (like computer programming) so why can't auditors plan, monitor and control just as well?

Proactive efforts by the PCAOB may not be well understood by the investing public but they can be far more effective than reactive efforts. After the fact reviews will be no more effective than they were in prior years. There is simply too large a universe for selective scrutiny to be beneficial. Finding things wrong and point out blame may make good headlines but avoidance of headlines should be what it's all about.