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Joe Howell on the PCAOB, Audits and Compliance - Part II
The basic concept of auditor rotation is simply to keep fresh eyes on things because auditors may become complacent over time. Simply put auditors can get too familiar, too cozy with the clients. Yet the converse can also lead to problems as Howell noted, “almost every time there has been a fraud that has gone undetected or a major failure that has gone undetected for long periods of time, that has resulted from the fact that the auditors didn’t have enough experience to find the kinds of weaknesses that they’re talking about. That often happens when a new auditor is involved. That’s when things seem to go wrong.”
It is a loss of institutional knowledge that can cause problems. An auditor needs to be asking probing, independent questions and being independent in attitude as well as on paper. Howell noted the “other thing that you lose is that sense of deep understanding of the kinds of transactions, the history, and how things flow together. I think that balance is hard to draw, but it really points to the need that the client has to have a clear understanding of their processes themselves and how those processes are going to effect the controlled environment.”
Inspection Focus is another area that the PCAOB is concerned about and while it may not immediately appear applicable to the compliance department it can have a significant impact. This area focuses on judgments clients make, most generally around revenue recognition or more simply “rev rec”. Howell began by noting, the “number of mistakes are very high and often they’re challenging because when you somehow mischaracterize the top line, the rest of the financial statements change their character because of a number of things that have keyed off of what your revenue is. The other thing that’s true is that it also causes the rest of the financial statements to become questionable just because that most important number was not right.”
Typically with accounting estimates, goodwill is perhaps the most challenging when you acquire a company and you have an excessive payment over what the assets that you identified as tangible assets. Howell said, “You end up with this intangible number goodwill, which needs to be tested for impairment. You can’t go judge the fair value of goodwill other than by an accounting estimate at one point in time when you made an acquisition, but the accounting rules now require that you go back and reassess that value from time to time and put an impairment charge against it if you feel that it’s not what you paid for to begin with.”
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