The Public Company Accounting Oversight Board identified deficiencies in half the audits it examined during its newly released inspection report on McGradrey LLP.

Members of the PCAOB’s inspection team inspected the firm from August through December 2011 at the firm’s national office in Chicago and 13 of its approximately 72 assurance practice offices in the U.S.

The inspection included reviews of aspects of 16 audits performed by the firm. The PCAOB noted that its inspection team selected the audits and aspects to review, and the firm was not allowed an opportunity to limit or influence the selections.

The PCAOB said its inspection team identified matters that it considered to be deficiencies in the performance of the work it reviewed, included failures by the firm to identify, or to address appropriately, financial statement misstatements, including failures to comply with disclosure requirements, as well as failures to perform, or sufficiently perform, certain necessary audit procedures. In one instance, the PCAOB noted, follow-up related to the deficiency led to a change in the issuer’s accounting practices.

The PCAOB said its inspection team considered certain of the deficiencies that it observed to be audit failures. “Specifically, certain of the identified deficiencies were of such significance that it appeared that the Firm, at the time it issued its audit report, had failed to obtain sufficient appropriate audit evidence to support its audit opinion on the financial statements and/or on the effectiveness of internal control over financial reporting.”

The PCAOB cautioned, as usual in such reports, against extrapolating from the results presented in the public portion of the report to broader conclusions about the frequency of deficiencies throughout the firm’s practice. “Audit work is selected for inspection largely on the basis of an analysis of factors that, in the inspection team's view, heighten the possibility that auditing deficiencies are present, rather than through a process intended to identify a representative sample,” said the report.

In some cases, the report pointed out, the inspection team’s conclusion that the firm failed to perform a procedure was based on the absence of documentation and the absence of persuasive other evidence, even if the firm claimed to have performed the procedure.

The report goes on to describe deficiencies in the firm’s audits of eight issuers, out of the 16 audits reviewed.

With one unidentified issuer client, the PCAOB noted that with respect to the majority of revenue, McGladrey’s auditors tested the occurrence of transactions and the completeness of revenue using analytical procedures. However, due to deficiencies in these procedures, they provided little to no substantive assurance. For example, the firm failed to investigate certain differences from its expectations that exceeded its established threshold beyond asking management about the matter. McGladrey’s auditors used system-generated reports in performing their analytical procedures, but failed to test the accuracy and completeness of those reports, the report noted.

The firm also failed to perform sufficient procedures to test the existence and valuation of accounts receivable, according to the PCAOB, and failed to perform sufficient procedures to test the existence and valuation of inventory.

With another client, McGladrey failed to sufficiently test the issuer’s allowance for credit losses, failing to evaluate the reasonableness of certain factors related to expected losses that the issuer used to calculate the allowance. The PCAOB inspectors also found the firm failed to sufficiently test the issuer’s revenue. While the auditors used analytical procedures to test the majority of revenue, they provided little to no substantive assurance, due to deficiencies in these procedures.

For certain procedures, the firm developed its expectations using data from the issuer’s systems that represented a significant component of the amount being tested, but this data had not been tested.

In response, McGladrey noted that it had taken steps to address the deficiencies identified by the PCAOB inspection team, “including, in certain instances, performing additional procedures in accordance with AU 390, Consideration of Omitted Procedures after the Report Date, and, in other instances, adding currently dated documentation to our workpapers to more completely and accurately describe the procedures performed, evidence obtained and conclusions reached.”

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