Problems found in Big Four

WASHINGTON — Limited inspections of the Big Four accounting firms uncovered “significant” problems in their audits of companies’ books, the head of the board overseeing the accounting industry said Thursday.

William J. McDonough, chairman of the independent board created to shore up investor confidence, also warned auditors against the sort of short cuts or bending to pressure to please corporate clients that fueled the accounting scandals of 2002.

The Public Company Accounting Oversight Board, established by Congress to replace the accounting industry’s own regulators amid the wave of scandals, has subpoena power and the authority to discipline auditors. Its inspectors did only limited reviews of the Big Four firms’ work in 2003, its first year of operations, but full inspections began this year.

“We expect the prospect of scrutiny to alter the relative risks and rewards to individual (auditors) who might otherwise consider short-cutting audit steps or bending to pressures to please clients,” McDonough said.

In testimony at a House subcommittee hearing, McDonough said the four firms — Ernst & Young, PricewaterhouseCoopers, KPMG and Deloitte & Touche — agreed to the voluntary limited inspections, which used as a sample their auditing work for several “high-risk” client companies with complex finances.

In the inspections, the oversight board “identified significant audit and accounting issues,” McDonough said.

“There’s room for improvement,” he told the lawmakers.

The board raised its concerns about auditing quality control to the firms, “and we will continue to look hard at whether the firms’ conduct mirrors their words,” he said.

McDonough has indicated that while signs of positive change have appeared in “the tone at the top” among senior executives of the big accounting firms, it is less clear whether all the thousands of partners at the firms also are on board and have learned the lessons of the scandals.

Edited versions of the board’s reports on the 2003 inspections will be made public in August, McDonough said Thursday.

Under the unusual law setting up the oversight board, accounting firms are given 12 months to correct problems and violations that turn up in inspections. During that time, the firms’ alleged lapses will not be made public, except in especially egregious cases.

If problems are cleaned up to the board’s satisfaction, no further action would be taken. Otherwise, individual auditors and firms could face civil penalties of as much as $750,000 and $15 million, respectively, as well as temporary suspension or a permanent disqualification from auditing public companies.