Audit regulators have published the latest report cards for three more major audit firms—PricewaterhouseCoopers, Grant Thornton, and BDO Seidman—calling out continued problems with valuations, loan loss allowances, revenue recognition, and impairments.

For PwC, the PCAOB studied parts of 76 different audits and found fault with nine, or 11 percent of the audits it examined. In one instance, the PCAOB said the inspection process led one of the firm’s clients to change its accounting and disclosure practices, though PwC said in its response attached to the report that none of the post-inspection follow-up work led to changes in audit conclusions or restatements of the financial statements.

The PCAOB said PwC failed to properly test the fair value of investment securities or derivatives in four separate audits, leading to insufficient audit evidence to support the audit opinion. Testing problems centered largely around failures to test assumptions and pricing information that was used to value various securities and derivatives, according to the PCAOB’s report.

Inspectors also flogged PwC for failing to check up on audit work performed overseas, an issue the PCAOB raised more recently in a broader practice alert to the entire audit profession. “Issuer G” in PwC’s inspection report had numerous foreign locations accounting for more than 20 percent of the company’s revenue, yet PwC didn’t visit any of those foreign locations or send any if its affiliates in those locations to check up on the reported revenue. Inspectors said the firm put too much faith into the entity-level controls, analytical procedures for a few of the locations, and questions posed to management.

Grant Thornton faced PCAOB scrutiny on 39 audits, with five of those, or 12.8 percent, getting criticism. BDO Seidman’s inspection report noted the PCAOB had issues with eight of the 33 audits studied, for a failure rate of 24 percent.

Inspectors noted that one of BDO’s errors, and more than one of Grant Thornton’s, looked like they could have been material to the client’s financial statements. Both firms said in their response letters that their audit conclusions did not change as a result of the scrutiny and any follow-up audit corrections.

For all three firms, the PCAOB pointed out that auditors had difficulty in meeting the documentation standards of Auditing Standard No. 3, Audit Documentation. The PCAOB often notes in inspection reports that auditors may claim to have performed certain audit procedures, but they’re not in compliance if the work papers do not show adequate documentation of those procedures or other audit evidence to support the audit conclusion.

In one fell swoop, the Public Company Accounting Oversight Board adopted a slate of new auditing standards that tell auditors how to assess risk, doubling the number of standards in the board’s rulebook.

The board adopted Auditing Standards No. 8 through No. 15, giving auditors a detailed roadmap for assessing and responding to the risks of material misstatements in financial statements. The standards address audit procedures to be performed throughout the audit, from planning through evaluation of audit results.

The board first proposed the standards in 2008, then revised and reproposed them based on feedback in December 2009. The final package, if approved by the Securities and Exchange Commission, is expected to become effective for audits of fiscal periods beginning on or after Dec. 15, 2010.

The eight standards will improve audit quality, said Acting PCAOB Chairman Daniel Goelzer, who described them as “a significant step forward in promoting sophisticated audit risk assessment and minimizing the risk that the audit will fail to detect material misstatements. … Of course, most firms’ audit processes already incorporate risk-based methodologies, and the changes to audit manuals and staff training needed to implement these standards should not be overwhelming.”

The standards include:

AS No. 8: Audit Risk describes the components of audit risk and the auditor’s duty to reduce audit risk to an appropriately low level to get reasonable assurance that the financial statements will be free of material misstatement.

AS No. 9: Audit Planning outlines the requirements for planning the audit and developing an appropriate audit strategy.

AS No. 10: Supervision of the Audit Engagement tells the audit engagement partner and other members of the engagement team who supervise audit work how to supervise the audit. The PCAOB also separately published a notice putting audit supervisors on notice that it plans to hold them more accountable for keeping tabs on audit staff and may consider a new rule requiring closer documentation of supervisory responsibilities.

AS No. 11: Consideration of Materiality in Planning and Performing an Audit explains the auditor’s duty for considering materiality as the audit is planned and performed.

AS No. 12: Identifying and Assessing Risks of Material Misstatement establishes requirements for auditors to follow to assure they’ve covered all the bases in identifying and assessing risk, including information gathering procedures and analysis of identified risks.

AS No. 13: The Auditor’s Responses to the Risks of Material Misstatements tells auditors what to do if they identify a risk of concern, outlining the general conduct of the audit that should follow and the specific audit procedures that should be performed regarding significant accounts and disclosures.

AS No. 14: Evaluating Audit Results tells auditors how to evaluate their audit results and determine whether they have adequate audit evidence, addressing the evaluation of misstatements identified during the audit, presentation and disclosure in financial statements, and the potential for management bias.

AS No. 15: Audit Evidence explains what constitutes sufficient appropriate audit evidence, an area often described as deficient in PCAOB inspection reports.

With no warning or fanfare, the Securities and Exchange Commission has established a formal process for audit firms to appeal the results of an inspection conducted by the Public Company Accounting Oversight Board.

The SEC adopted an amendment to its “informal and other procedures” to add a rule that would facilitate SEC reviews of PCAOB inspection reports when audit firms request them. Sarbanes-Oxley provides for such a review, and now the SEC rule gives the SEC’s chief accountant, Jim Kroeker, authority to review inspection reports and a procedure to follow to execute the review.

The 28-page rule outlines a series of procedures for firms to request a formal SEC review if they disagree with something the PCAOB plans to publish in an inspection report. Most notably, the rule gives the chief accountant the authority to silence a criticism that the PCAOB plans to publish if the chief accountant believes the criticism is not warranted.

The SEC did not respond to a request from Compliance Week to discuss the new rule. PCAOB spokesman Colleen Brennan said firms have always been permitted under Sarbanes-Oxley to seek an SEC review of a PCAOB inspection report, but now the process will delay the publishing of inspection reports.

“The PCAOB’s practice has always been to issue a public report as soon as the board has approved a final report and transmitted it to the firm,” she said. “To comply with the new rule, the board will need to delay a public report for at least 30 days after transmitting the report to the firm and may have to delay portions of the public report even longer if the firm seeks SEC review.”

Under the existing process, the SEC process has not “restricted the transparency of board inspection reports pending the opportunity to seek review,” Brennan said.

Lewis Ferguson, a partner with law firm Gibson, Dunn & Crutcher formerly on staff at the PCAOB, said the rule likely is a response to the volume of appeals that firms have requested in recent years. “In some ways, the rule may benefit (firms that are appealing) because it places the decision-making authority in the hands of an accounting expert and into a single decision maker,” he said.

The rule includes a brief indication that the SEC does not intend to grant reviews without good reason. “In considering whether to grant a review request, among the factors that the Commission may consider are whether the review request makes a reasonable showing that the review is appropriate or otherwise presents a concern,” the rule says. “We do not intend to routinely grant review requests absent some indication of concern.”

Ferguson said that may indicate the SEC is trying to expedite the appeal process rather than stall the publishing of inspection findings. Though he’s never had a hand in an appeal personally, he said he’s aware that the process is “quite chaotic, with very unpredictable time periods.”

The rule takes effect Sept. 7.

The Public Company Accounting Oversight Board is planning to crack down on audit firm supervision and to ask Congress to lift the veil of confidentiality that Sarbanes-Oxley granted to audit enforcement proceedings.

The board published a warning to audit firms that it plans to start taking action against firms that fail to supervise their auditors properly, even considering new rules that would require audit firms to more clearly document how they assign supervisory responsibilities that already exist under other audit requirements. Sarbanes-Oxley gave the PCAOB authority to impose sanctions on firms or their executives when they fail to properly supervise someone who ultimately commits a violation of audit rules, but the PCAOB has never pursued an enforcement act based on that authority, said acting Chairman Dan Goelzer.

“Firms obviously cannot act, or fail to act, independent of their personnel,” said Goelzer in a public meeting to announce the new initiative. “The actions of the firm are those of its partners and staff. When something goes wrong in an audit, the problem can frequently be traced to some type of supervisory breakdown.”

The released published by the board is meant to serve as a warning to audit firms that the board plans to get more aggressive with firms that don’t properly supervise their personnel, said Goelzer. It is not meant to suggest, however, that the board is planning to beef up the existing requirements for firms to supervise their auditors, he said, except for the possible documentation requirement. “The board is prepared to address supervisory failures when they occur, on a case-by-case basis, through its enforcement program,” he said.

On a side note related to the enforcement program, the board and its enforcement director, Claudius Modesti, used the open meeting platform to vent their frustration over the privacy that surrounds the PCAOB enforcement process. The board directed the staff to develop a proposal to Congress to make the audit enforcement process a matter of public record.

The Sarbanes-Oxely Act provides that enforcement actions against audit firms or specific auditors should remain private until settled or fully litigated, even if that includes appeals to the full PCAOB or the Securities and Exchange Commission. Since the PCAOB began operations in 2003, it has settled and announced only a few dozen enforcement actions, and only one of those was against a Big 4 or other major firm.

The process represents a “sharp contrast” to SEC administrative proceedings, said Goelzer. “If the SEC were to bring the same case, alleging the same violations against the same auditor, the SEC’s charges would be disclosed at the time the commission instituted its proceedings,” he said. “I believe the Board should ask Congress to make that change so that the public will have the same access to our enforcement proceedings as to those of the SEC.”

Modesti said the enforcement division has a “significant inventory” of ongoing investigations and has pursued litigation involving a broad range of audits, yet he’s not allowed to disclose any of it. Firms and auditors who are party to proceedings take advantage of the privacy, said Modesti, in some cases raising defenses that “do not have substantial merit.”

The result is to prevent investors and others from knowing what wrongdoing has been alleged, he said. “Nonpublic disciplinary proceedings are a major stumbling block for the board’s enforcement program to most effectively protect investors and improve audit quality,” he said.

The Public Company Accounting Oversight Board isn’t yet making much headway in catching up on overdue international inspections, but the Dodd-Frank financial reform bill at least clears an obstacle the board has repeatedly blamed for its inability to meet its inspection mandate.

The PCAOB published an updated status report on its international inspection program saying it made no progress from Jan. 1 to June 30 of this year in checking in on firms whose inspections the board deferred in 2009. The board lists more than 70 firms, many of them affiliates of the Big 4 and other major international firms, that have not yet been inspected, even though they have been doing audit work for companies listed on U.S. exchanges for four years or more.

The list is shorter than the last time the PCAOB published it by three firms, but only because those firms withdrew from PCAOB registration. Most of the uninspected firms are located in China or countries of the European Union, where firms and government leaders have resisted the PCAOB inspection process by citing conflicts with their laws at home.

The PCAOB has said many countries are resistant because the PCAOB has been barred under the Sarbanes-Oxley Act from sharing information arising from inspections with regulators in those countries. The board lobbied Congress to give the board the authority to share inspection findings, which Congress granted in July as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The PCAOB has said the newfound authority will facilitate the sharing of information with foreign auditor oversight authorities, and it hopes that will open the logjam in those countries that have been refusing inspections.

The U.S. auditing regulator says it continues to work to eliminate obstacles to international inspections, but in the meantime it is publishing the list of uninspected audit firms to put investors on notice. “As long as those obstacles persist, investors in U.S. markets who rely on those firms’ audit reports are deprived of the potential benefit of PCAOB inspections of those auditors,” the board wrote in its update.

The Public Company Accounting Oversight Board is seeking comment on a proposed new standard for auditors to pursue third-party confirmations of various details in corporate financial statements.

In the audit process, confirmation refers to direct communication between the auditor and a third party, such as a vendor or a customer, to verify assertions contained in a company’s financial statements. Auditors rely on confirmations to verify the existence, completeness, or value of items appearing in corporate accounts.

The proposed standard would both expand and modernize the requirements of AU Section 330, The Confirmation Process, a 15-year-old audit rule that governs how auditors should go about pursuing third-party confirmations and what they may accept as audit evidence. Martin Baumann, PCAOB’s chief auditor and director of professional standards, said the proposal reflects the importance of audit evidence obtained from third parties and strengthens and extends the requirements for using confirmations.

PCAOB member Steven Harris said the proposed standard expands the use of the confirmation process by requiring auditors to confirm receivables that arise from credit sales, loans, or other transactions; cash and other relationships with financial institutions; and other accounts or balances that pose a significant risk to the financial statements. Currently, auditors are required only to verify receivables if they arise from the sale of goods or services in the normal course of business.

The standard also would relax the requirements for confirmations written on paper, reflecting advances in electronic communication. The proposal would allow auditors to use electronic media to send confirmation requests and receive confirmation responses, and it would make provisions under certain circumstances for auditors to use direct access to a third party’s records to obtain the audit evidence they need.

Acting Chairman Daniel Goelzer said the proposed standard “would more explicitly incorporate consideration of the risk of error or fraud into the selection, design, and planning of confirmation procedures.” That would make it consistent with other standards that are also developing, such as new standards around risk, he said. “In its emphasis on fraud and other misstatement risk, this proposal dovetails with the approach in the proposed risk assessment standards.”

The PCAOB first unveiled its thinking about audit confirmation in a concept release published in April 2009. That release drew 24 comments, which the PCAOB says it took into consideration in developing the current proposal. The board is accepting comments on the proposal through Sept. 13.

The Public Company Accounting Oversight Board is warning auditors they need to do more than slap a U.S. opinion on an overseas audit report if they want to remain in the good graces of audit regulators.

The PCAOB published a staff audit practice alert based on something disturbing noticed lately while inspecting U.S. firms registered to audit publicly held companies in the United States. Inspectors are finding cases where U.S. audit firms are providing opinions for overseas companies, especially companies operating in China, even though the majority of the audit work was done by firms or individuals outside the United States. The PCAOB said in most cases, the China-based companies are trading in the United States by executing reverse mergers with U.S. shell companies.

Wayne Carnall, a chief accountant at the Securities and Exchange Commission, raised a red flag on the issue at an April meeting of the PCAOB’s Standing Advisory Group. He said the staff sees hundreds of cases where small companies with virtually all of their operations in China are filing financial statements with U.S. audit opinions where the majority of the audit work was done by someone other than the audit firm providing the opinion.

“You look at the size of the firm and the staff involved, and you question whether any one of those people on staff can speak Mandarin or Cantonese,” he said. “It becomes an issue of who is the principal auditor? Who is doing the underlying audit work? This is not a rare situation.”

The practice alert reminds registered firms of what they are expected to do when using the work of other firms or individuals to perform audit procedures. It also reminds them that anyone they engage from outside their own firm to help with audit work is governed by the same PCAOB standards as staff internal to the audit firm. The alert says the PCAOB will have questions about audit reports where there’s no evidence anyone from the U.S. firm traveled to China or helped plan, perform, supervise, or review the audit.

Gaylen Hansen, a partner with Colorado regional firm Ehrhardt Keefe Steiner & Hottman and a member of the PCAOB’s SAG, said he doesn’t see any connection between the alert focused on reporting emerging from China and the PCAOB’s difficulty in inspecting China-based audit firms that are registered with the PCAOB.

“There are a whole bunch of countries listed on the PCAOB’s Website where that have the same problem (inspecting U.S. registered firms located overseas),” said Hansen. “Maybe business is booming in China, so there’s a lot of capital formation and reverse mergers over there … I think it’s a substance over form question. There’s not a whole lot of substance to these reports.”

The Public Company Accounting Oversight Board published its second Big 4 audit report of 2010, criticizing Ernst & Young’s work on only five audit reports.

The PCAOB spent a year from late 2008 to late 2009 studying 58 audits at E&Y’s headquarters and 30 of 80 U.S. field offices. The PCAOB chose the audits to be inspected following its risk-based approach, looking for audits most likely to have problems. The audit firms have no say in which reports will be inspected, according to PCAOB’s process.

Inspectors flagged only four audits for mistakes related to the classic audit flash points of fair value measurements, loan losses and revenue recognition. It also called out a fifth audit for problems with accounting for inventory.

With problems discovered in only 8 percent of E&Y’s 58 inspected audits, that beats Deloitte & Touche’s inspection outcome published in May. The PCAOB pored over 73 Deloitte audit reports and flogged the firm for its work on 16 of those audits, for a failure rate of more than 20 percent of the inspected audits.

For “Issuer A,” the PCAOB said the firm failed to adequately test fair-value measurements for certain financial liabilities and failed to test the models and various inputs used to determine those values. More specifically, the audit firm should have identified flaws in the models and should have evaluated more carefully whether the data was reasonable and consistent with market information. Auditors also should have tested loan loss reserves related to certain loans held for investment, the report said.

For another issuer, E&Y relied heavily on internal controls and a Web application when assessing revenue, the PCAOB said. And for a third issuer, auditors failed to adequately test allowance for loan losses, relying on systems without testing for their reliability.

For a fourth issuer, the PCAOB said E&Y didn’t adequately test an assertion that certain long-lived assets were not impaired, despite current and historical operating and cash flow losses. Finally, for a fifth issuer, inspectors said the firm bungled the audit of inventory by failing to test the costing of work-in-process and finished goods inventory and by failing to test certain controls.

In its response to the inspection, Ernst & Young says it took action, “where appropriate, in accordance with E&Y’s policies and PCAOB standards,” though it did describe those actions or say whether they led to any changes to the audit outcomes.

Because the inspection reports do not identify issuers, it’s impossible to determine whether the PCAOB ever studied any of E&Y’s audit work for Lehman Brothers, where bankruptcy proceedings exposed accounting maneuvers permitted by E&Y to shuttle some $50 billion in assets off the balance sheet at key financial reporting intervals.

As the June 30 deadline nears for audit firms to file their first annual reports with the Public Company Accounting Oversight Board, the staff has issued some last-minute tips on how to complete the new form.

Audit firms that are registered with the PCAOB as of March 31, 2010, to audit companies listed on U.S. exchanges have until June 30 to file their first “Form 2” with the PCAOB. The form requires registered audit firms to disclose information about the audit reports they issued, fees billed to audit clients for various services, and disciplinary histories for any new hires.

With the filing deadline fast approaching, the PCAOB staff published a 12-page Q&A that covers 34 specific issues. It provides an overview of the Form 2 requirements and gives some guidance on completing and amending the form. It also explains how audit firms can request confident treatment or withhold certain information if they believe it should be considered proprietary or in conflict with other law, and it explains the mechanics of how to complete the filing using the PCAOB’s web-based system.

The guidance focuses heavily on the content of the report, especially how audit firms should fulfill the fee information demands. The form requires audit firms to break down the fees they have billed to their audit clients into four separate categories – audit services, other accounting services, tax services and non-audit services.

The guidance says if an audit firm is unable to precisely break the total fees paid into those four distinct categories, it can estimate and round the estimate to the nearest 5 percent. If an audit firm relies on estimates, however, it is required to explain why it estimated the breakdown and how it reached those percentages.

The staff Q&A also explains that audit firms may request certain information be kept confidential but they must provide a detailed explanation for why it should be considered proprietary or why it should be protected by law from public disclosure. The PCAOB says it plans to publish the Form 2 filings as they are received so it warns audit firms to check its filing carefully for anything that should be concealed before the filing is posted.

Working whatever angles it can to get information on overseas audit firms doing business in U.S. capital markets, the Public Company Accounting Oversight Board has published some new requirements it may impose on firms seeking new registrations.

The PCAOB added two additional questions and answers to its cumulative Q&A guidance on how non-U.S. firms can audit U.S.-listed companies. The Q&As give a heads up on what the PCAOB may require of new overseas firms seeking to do business in the United States as a way of working around the PCAOB’s growing problems inspecting non-U.S. firms in certain countries.

Sarbanes-Oxley requires all firms that audit public companies listed on U.S. exchanges to be registered with the PCAOB and to submit to periodic inspections. Firms are supposed to be inspected at least once every three years, and the largest firms are to be inspected annually, but the PCAOB has been unable to inspect overseas firms in the European Union, China, Hong Kong, and Switzerland.

Audit firms and officials in those countries have claimed the Sarbanes-Oxley requirement in the United States conflicts with their own national laws. While the PCAOB continues to try to navigate those obstacles, it’s also begun publishing names of firms and public companies whose work has not been inspected by the PCAOB as a result of the conflict.

The PCAOB began publishing the list to give U.S. investors a warning. “As long as those obstacles persist … investors in U.S. markets who rely on those firms’ audit reports are deprived of the potential benefits of PCAOB inspections of those auditors,” the board wrote in publishing the information.

Now the FAQ guidance gives new firms considering registration with the PCAOB another sort of fair warning if they are located in a country denying inspection access. If such a firm intends to register with the PCAOB, it may be asked for some detailed information about any public company audit work it has done, or expects to do, or any currently registered firm it may be working with.

“The additional information will facilitate the Board’s understanding of the scope and nature of the applicant’s activities related to SEC-reporting companies,” the PCAOB wrote in a statement regarding the guidance. The guidance says firms can saves themselves some delay and some hassle if they voluntarily provide the new information described in the FAQ when they initially apply for registration, rather than waiting for the board to request it formally.