PCAOB finds valuation weaknesses in KPMG audits

Valuation issues have highlighted as an area of deficiency in an inspection
of KPMG US by the audit oversight board.

In the course of inspections of 24 out of 90 KPMG practice offices inspectors
of the Public Company Accounting Oversight Board found that the firm displayed
weaknesses in valuations as it failed to evaluate its clients’ processes for
developing estimates for loan losses, and did not perform sufficient tests of
clients’ valuation of securities which were considered ‘hard to price’.
Additionally, the firm did not highlight instances in which its clients had
strayed from accounting rules.

The PCAOB gave details of ten audits that it inspected, without naming the
clients of the firm.

In one case, a client of KPMG estimated its allowance for loan losses using
recent historical data. The inspectors found that KPMG failed to evaluate
whether the issuer’s process for developing the estimate captured fully the
effects of then-current trends and factors including recent changes in the
composition and quality of the loan portfolio, concentrations, increases in loan
delinquencies and losses, the results of the issuer’s survey of its borrowers,
and deteriorating economic conditions.

In addition, the firm failed to adequately test the accuracy and completeness
of the data that the company had used in its estimate of the allowance because
it did not test certain of the necessary controls over the transfer of these
data between the company’s information technology systems, nor did it test the
loan delinquency data.

In another case, the firm failed to sufficiently test the valuation of a
client’ securities that it considered ‘hard-to-price.’ The firm selected ten of
these securities to test by developing an independent estimate of the fair
value, for comparison to the issuer’s recorded value.

But for two of the ten securities, KPMG was unable to develop an estimate.
The firm’s valuation specialists then inquired of traders – employed by its
client – who had provided the recorded value regarding how the traders had
determined that value. KPMG however failed to test the information provided by
the traders.

In a separate case, KPMG failed to test the accuracy of the loan delinquency
data and borrower credit score ranges that the issuer had used to estimate its
allowance for loan losses. The firm further failed to consider the credit risk
associated with the nature of the issuer’s loans and the issuer’s underwriting
policies and to evaluate the reasonableness of the unallocated portion of the
allowance, which had not changed in five years.

KPMG responded to the PCAOB, saying that just as auditors use their judgment
to determine the auditing procedures to be performed, the PCAOB inspection staff
members’ observations are based upon their assessment of audit risk and
financial statement materiality.

‘We may have differing views as to the nature and extent of necessary
auditing procedures, resulting conclusions, and/or required documentation in
specific circumstances. However, we recognize that judgments are involved in
both the performance of an audit and the subsequent inspection process, and we
view the PCAOB’s comments as helpful and give each careful and thoughtful
consideration,’ the firm said.

Further reading:

the report from the PCAOB

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