PCAOB finds audit flaws on fraud risk, SPACs

By Jim Tyson for CFODive.com

• An inspection team under the Public Company Accounting Oversight Board (PCAOB) found flaws in audits of fraud and “going concern” risks, as well as the integrity of transactions by special purpose acquisition companies (SPACs), the PCAOB said.

• Some auditors during fraud detection efforts failed to adequately vet a company’s whistleblower program or show “due professional care” when assessing “contradictory information,” the PCAOB said in a report on a review by its so-called Target Team of audits performed during fiscal year 2021. Some auditors also failed to note that a SPAC’s equity statement contradicted its accounting records.

• During its coming fiscal year 2022 inspections, the Target Team will focus on “risks related to climate change that would affect a company’s financial statements, IPOs/de-SPACs and use of firm-designated shared service centers,” the PCAOB said. The team investigates emerging audit risks under the Registration and Inspections Division.

Since assuming the top post at the Securities and Exchange Commission (SEC) in April 2021, Gary Gensler has shaken up the PCAOB, replacing its leadership and calling for sharper reviews of the accounting firms that audit publicly listed companies. The PCAOB was established after the Enron accounting scandal under the Sarbanes-Oxley Act of 2002.

Gensler and other agency commissioners last month backed tougher PCAOB standards for audits involving more than one audit firm, saying stricter rules will streamline coordination and communication between firms and improve audit quality and investor protection.

Under Gensler, the SEC and PCAOB have intensified scrutiny of SPACs.

The SEC in March proposed tougher disclosure rules for the so-called blank-check companies aimed at ensuring the same protections offered to investors in traditional initial public offerings.

The new rules would tighten requirements on performance projections by SPACs and the companies that they target for purchase. SPACs would also need to provide more information about their composition, conflicts of interest and sources of dilution.

After a record, two-year boom, sharper regulatory scrutiny and volatility in equity markets have dampened the SPAC market so far in 2022.

The rate of SPAC IPO issuance has plunged, with just 74 transactions so far this year at an average size of $168 million compared with 613 transactions last year at an average size of $265 million, according to SPACInsider.

Tougher SEC oversight helped push up the number of financial restatements last year. Restatements by all types of companies surged to 1,470 in 2021 — a 289% increase over the prior year — with 77% filed by SPACs, according to Audit Analytics. Excluding SPACs, the number of restatements last year fell 10% compared with 2020.

Some audit firms that reviewed SPAC and de-SPAC transactions failed to “consider whether presentation and disclosures of the interim financial statements conformed with GAAP,” or Generally Accepted Accounting Principles, the PCAOB said.

Also, some auditors did not identify errors “in the public company’s financial statement for fair value disclosure where public warrants were incorrectly included in the Level 3 fair value roll-forward,” the board said in its report.

The Target Team especially focused on fraud risk, “given the potential increased risk of fraudulent financial reporting due to the current economic environment,” the PCAOB said.

“This risk may manifest, for example, in management’s use of more aggressive assumptions and estimates, improper revenue recognition and/or misleading disclosures,” the board said.

Some auditors when looking for signs of fraud failed to sufficiently document their assessments across several topics, including the criteria for selecting journal entries for testing, and procedures both for approving journal entries and for identifying company employees who can initiate entries in the general ledger, the PCAOB said.