Watchdog Sniffs Accounting Firms

Canada's accounting watchdog questions the practices of those responsible for the financial statements of public companies.

Just when you thought it was safe to rely on the financial statements of public companies, Canada's accounting watchdog is raising troubling questions about the practices of accounting firms charged with ensuring those statements are accurate. The Canadian Public Accountability Board (CPAB) uncovered a litany of weaknesses during recent inspections of auditing firms. Among them: a lack of auditor independence, inadequate training and monitoring, and failure to adhere to accepted accounting policies. “There is room for significant improvement in the quality of audit work being done on the financial statements of reporting issuers in Canada,” the CPAB report states.

As a result of the inspections of 23 accounting firms, four firms have had restrictions placed on their business until they improve their auditing practices. Three firms (none of which are named in the report) have been barred from accepting new auditing work from publicly traded companies, while certain partners in a fourth firm will no longer be permitted to perform audits on publicly traded companies.

It is not just auditors that face repercussions. Some public companies could be forced to restate their financial results after CPAB inspectors uncovered material departures from generally accepted accounting principles (GAAP) in at least 15 different financial statements, the report says.

The examination also uncovered several examples where the financial statements submitted to auditors differed from those the company released to investors. The accounting firms failed to compare the numbers they were given with those the companies either posted on their website or submitted to SEDAR, the Canadian corporate public filings website, or EDGAR, its American equivalent.

The inspections, conducted over the past year, examined the practices of 23 of Canada's small to mid-sized accounting firms. In total, the firms audit more than 5,500 public companies, representing about 80% of the market. “For the majority of firms inspected… the necessary improvements can be described as further enhancements to basically sound audit processes,” the report says. “However, a minority of firms have an urgent need to implement substantial improvements if they are to continue to audit public companies.”

The findings differ sharply from an earlier CPAB report that examined the practices of Canada's four largest accounting firms. While some questions of auditor independence and quality control were identified in the October 2004 report, there were no major auditing issues.

The CPAB was established in July 2002 in the wake of the accounting scandals that destroyed once powerful U.S. firms such as Enron, WorldCom and Arthur Andersen. All accounting firms that wish to audit the books of Canada's publicly traded companies must register with CPAB and submit to its oversight.

In addition to basic accounting problems, the latest CPAB report found that some accounting firms have failed to implement new auditor independence rules and lack sufficient internal controls to monitor the quality of work. As well, some firms continue to accept clients that pose an unacceptable business risk. “Clients were retained despite clear evidence from audit work that the integrity of management was in significant doubt,” the report says.

The findings don't surprise Al Rosen, a forensic accountant and outspoken critic of the Canadian accounting industry. But the CPAB inspections fail to address fundamental weaknesses in Canadian accounting, he says. “Citing auditors for lack of independence or differences in GAAP doesn't answer the basic question: do the audited financial statements fairly and accurately reflect the underlying business?”

Despite the weaknesses identified in the report, investors shouldn't worry, says Gordon Thiessen, CPAB chairman. Overall, the Canadian accounting industry is strong and continues to improve, according to Thiessen, and smaller accounting firms just need more time to implement the relatively new accounting rules and standards. “If we find the same weaknesses in next year's survey, then I would worry.”