These actions are just the latest in a steady stream of disciplinary actions by the audit overseer, which has stepped up enforcement activity since Erica Williams became chair in January 2022.
Let’s take a closer look at two of those actions. PwC’s Greek branch was fined $3m on Tuesday for ignoring red flags in its audit of Aegean Marine Petroleum Network, and KPMG’s business in Japan was given a $500,000 penalty on Wednesday for failing to meet US standards in audits of New York-listed clients.
PwC Greece and inconsistent audit evidence
The settled disciplinary order sanctioned Greece-based PricewaterhouseCoopers Auditing Company SA (PwC Greece) and its partner Nicos George Komodromos for violations of PCAOB rules and standards in connection with the audit of the 2016 financial statements of Aegean Marine Petroleum Network Inc.
The PCAOB found that Komodromos and the PwC Greece engagement team failed to respond with appropriate professional care and professional skepticism to inconsistent audit evidence they uncovered about four of Aegean’s customers, from which 13% of Aegean’s reported revenue arose in 2016.
Both Komodromos and PwC Greece understood that an executive at Aegean with significant control over the company had a previous criminal conviction for fuel smuggling involving “virtual invoicing” and been accused of a variety of other criminal activity.
Despite the known risk of fraud and material misstatements, plus concerns about the transactions, Komodromos and the engagement team disregarded and did not resolve inconsistencies from certain contradictory audit evidence about the unusual transactions with the four customers.
For example, the firm engagement team encountered substantial difficulties obtaining street addresses for the four customers from Aegean to use in the firm’s accounts receivable confirmations to those customers.
“Quality control has been and will remain a PCAOB priority across our standard-setting, inspection, and enforcement efforts.”Erica Y Williams, PCAOB Chair
When the PwC network firm visited the first three addresses, it found that one address did not exist and two were residential apartment buildings with no businesses located there. Although the affiliate found no evidence that the customers were located at the addresses, Komodromos instructed the team to cancel the remaining site visit and relied on other inadequate audit evidence to issue an audit report containing unqualified opinion.
In 2018, Aegean publicly disclosed that its audit committee and board of directors had concluded that the transactions with the four customers lacked economic substance, as the relevant customers were shell companies with no material assets or operations and were owned or controlled by former employees or affiliates of the company.
“This order underscores the critical need for auditors to exercise due professional care and professional skepticism, especially when confronting inconsistent audit evidence and heightened risks,” said Robert E Rice, Director of the PCAOB’s Division of Enforcement and Investigations.
In addition to the fine, PwC Greece agreed to the following:
- The firm’s associated persons involved in PCAOB audits will complete additional hours of professional training related to certain PCAOB standards; and
- For the next two years, the firm will obtain pre-issuance reviews by a third party for each issuer audit in which the firm prepares or issues an audit report or plays a substantial role in the preparation or issuance of an audit.
KPMG Japan and inadequate testing of journal entries
The settled disciplinary action sanctioning KPMG AZSA LLC (KPMG Japan) revolved around PCAOB quality control standards.
Specifically, the PCAOB found that, from 2019 through 2021, KPMG Japan’s policies and procedures were insufficient to provide it with reasonable assurance that firm personnel performing audits pursuant to PCAOB standards would conduct sufficient testing of journal entries to comply with applicable auditing standards.
(Journal entries are used to record transactions, classifications, adjustments and corrections in the general ledger, and they include both standard transaction and adjustment details, plus details about unusual transactions or non-recurring adjustments.)
“This order underscores the critical need for auditors to exercise due professional care and professional skepticism, especially when confronting inconsistent audit evidence and heightened risks.”Robert E Rice, Director, PCAOB Division of Enforcement and Investigations
The PCAOB also found that KPMG Japan failed to adequately monitor its system of quality control, as evidenced by the fact that the firm’s internal review program evaluated an audit with deficient journal entry testing but did not adequately escalate or otherwise address that issue, which contributed to similarly deficient journal entry testing continuing in the subsequent year.
In addition to a censure and the fine, KPMG Japan must do the following:
- review and evaluate its policies and procedures concerning journal entry testing;
- submit a report to the PCAOB’s director of enforcement and investigations that summarizes that review;
- and implement any changes identified as warranted because of the review.
“Effective quality control systems protect investors, while ineffective systems put investors at risk,” said PCAOB Chair Erica Y Williams. “That’s why quality control has been and will remain a PCAOB priority across our standard-setting, inspection, and enforcement efforts.”
Chair Williams and an invigorated PCAOB
In late 2022, the PCAOB issued its revised 2022–2026 strategic plan, which consists of four goals: modernizing auditing standards, enhancing inspections, strengthening enforcement, and improving the PCAOB’s organizational effectiveness. Williams noted in the plan’s “Message From the Chair” that since the Board became fully staffed in January 2022, it has been “advancing one of the most ambitious standard-setting agendas in PCAOB history”.
In September, the agency issued a proposal that would update a nearly 20-year-old rule to allow the agency to hold associated persons accountable when they negligently, directly, and substantially contribute to firms’ violations.
In July, the agency issued a staff report that showed a year-over-year increase in the number of audits with deficiencies at audit firms that the PCAOB inspected in 2022. “These findings are absolutely unacceptable, and audit firms must make changes to turn things around and live up to their responsibility to investors,” Williams said in a statement at the time.
And in June, the PCAOB issued a proposal to amend its auditing standards related to the auditor’s responsibility for considering a company’s noncompliance with laws and regulations, including fraud.