Canada's audit firm regulator is warning it cannot review the quality of audit work at some foreign operations of Canadian-based companies, which is a major gap in transparency that poses "another challenge to audit quality" in Canada.
The Canadian Public Accountability Board (CPAB), which inspects the work of accounting firms that audit the books of publicly traded companies, issued its annual inspection report Monday, saying overall audit quality improved last year with 36 per cent fewer "deficiencies" found at 14 major audit firms in 2013. A deficiency is defined as a failure to do enough work to verify a material financial statement number or a disclosure.
It is the second year in a row CPAB has found significant improvements in audit quality, which the regulator attributes to new action plans it required Canada's four largest accounting firms to implement. The action plans were ordered after CPAB found disappointing inspection results in 2011 and expressed concerns that audit quality was not accelerating significantly despite almost a decade of inspection work by CPAB.
The action plan requirement was expanded last year to cover a further 10 large audit firms and major regional firms in Canada. CPAB annually reviews the work of the 14 largest audit firms in Canada, which are responsible for auditing the vast majority of public companies, and less often reviews smaller firms.
CPAB chief executive officer Brian Hunt said the next step will be for audit firms to make new practices permanent by embedding them into their organizations, rather than just doing them to appease CPAB during one year's inspection.
"In 2012, we saw a lot of short-term fixes. In 2013, we started to see more of the embedding of actual organizational changes into the firm's culture," he said in an interview Monday.
But despite a more positive tone about audit quality in Canada, Mr. Hunt warned Monday CPAB is still often unable to access – and therefore review – some audit work done outside of Canada in foreign countries where laws or regulations do not allow a foreign regulator to review records of audit firms.
CPAB said in 2013 that it was denied access to audit working papers in China, Mexico and Tunisia during audits of Canadian companies' financial statements. Mr. Hunt said those were countries that happened to have Canadian operations under review, but there are many other countries also do not allow audit inspections.
Some countries – including Australia, Japan and many in Europe – have agreements allowing audit regulators to inspect working papers in those countries. Mr. Hunt said Canadian regulators are currently in talks to negotiate a similar agreement with China.
"We need access to those working papers, and sometimes you get into privacy issues in certain jurisdictions and we just can't get access," Mr. Hunt said.
CPAB warns investors and corporate officials should be concerned that those audits are not getting the level of oversight they would have in Canada.
Mr. Hunt said investors, managers, audit committee members and other professional advisers "need to be fully aware of the additional risks they take on when working in foreign jurisdictions."
A lead auditor based in Canada is responsible for overseeing audit work done at foreign operations of Canadian firms, but normally does not do the work itself but instead uses local auditors to do the work. While the lead auditor can review a local firm's working papers on location in those jurisdictions, CPAB does not always have the same access depending on the country.
The regulator argues it is the responsibility of the lead auditor to ensure there is appropriate evidence available for inspection, but "some have made more progress in this area than others."
CPAB has had a particular focus on foreign audit work since an accounting scandal erupted in 2011 involving Chinese-based forestry firm Sino-Forest Corp., which was listed on the Toronto Stock Exchange. Following a critical analyst report, regulators investigated Sino-Forest and accused the company's executives of fraud for allegedly misrepresenting the company's assets.
The Ontario Securities Commission also accused audit firm Ernst & Young of failing to properly scrutinize Sino-Forest's books and verify ownership of its forestry holdings in China. In 2013, the OSC also levelled similar allegations against Ernst & Young for its work on the audit of an unrelated Chinese shoe company, Zunghui Haixi Corp.
Both cases are still before the commission.