The Public Company Accounting Oversight Board released a report on the issues it has identified from inspections of U.S. firms that audit 100 or fewer public companies.

The report, based on the board’s observations between 2004 and 2006, does not identify any specific companies. Instead, it describes some general trends that the PCAOB found in inspections of 497 so-called "triennial" firms, which are inspected at least once every three years, as opposed to the more frequent inspections that firms with more audit clients are subjected to. Among the areas where problems were noted were revenue recognition and related-party transactions.

The report noted that firms had failed to sufficiently test the validity and classification of expenditures made by a controlling shareholder of a company in related-party transactions, for example.

Other problems arose with equity transactions. The PCAOB inspection teams found instances where firms failed to test, or insufficiently tested, the accounting for equity transactions, including the reasonableness of the fair values assigned to the transactions.

Other controversial areas included firm independence policies and procedures, indemnification, prohibited non-audit services, and the use of specialists such as engineers and geologists to conduct an audit of a company. Some firms failed to evaluate the relationship of the specialist with the company that could have a bearing on the specialist’s objectivity. At other times, firms failed to understand the specialist’s methods and assumptions.

“The issue relating to specialists is encountered a lot,” said George Diacont, director of the PCAOB division of registration and inspections. “It’s not just an issue related to objectivity. It’s what the auditor does to verify the credentials of the specialist, conducting a review and making a determination of the approach that the specialist used to reach its conclusion.” The report noted, however, that many firms had improved their audit processes after engaging in dialogue with the PCAOB inspectors.

The report also reported that of the 439 reports that the board has issued on triennial firms, close to 28 percent identified no audit performance deficiencies or concerns about potential defects in quality-control systems; approximately 15 percent identified concerns about quality-control systems but no audit performance deficiencies; and the remainder identified concerns about both audit performance and quality control.

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