Report on Inspection of KPMG LLP (Headquartered in New York, New York) Public Company Accounting Oversight Board

Transcription

1 1666 K Street, N.W. Washingtn, DC Telephne: (202) Facsimile: (202) Reprt n 2012 Inspectin f KPMG LLP (Headquartered in New Yrk, New Yrk) Issued by the Public Cmpany Accunting Oversight Bard THIS IS A PUBLIC VERSION OF A PCAOB INSPECTION REPORT PORTIONS OF THE COMPLETE REPORT ARE OMITTED FROM THIS DOCUMENT IN ORDER TO COMPLY WITH SECTIONS 104(g)(2) AND 105(b)(5)(A) OF THE SARBANES-OXLEY ACT OF 2002 PCAOB RELEASE NO

2 PCAOB Release N INSPECTION OF KPMG LLP Preface In 2012, the Public Cmpany Accunting Oversight Bard ("PCAOB" r "the Bard") cnducted an inspectin f the registered public accunting firm KPMG LLP ("the Firm") pursuant t the Sarbanes-Oxley Act f 2002 ("the Act"). 1/ The inspectin prcess is designed, and inspectins are perfrmed, t prvide a basis fr assessing the degree f cmpliance by a firm with applicable requirements related t auditing issuers. The inspectin prcess included reviews f aspects f selected issuer audits cmpleted by the Firm. The reviews were intended t identify whether deficiencies existed in thse aspects f the audits, and whether such deficiencies indicated defects in the Firm's system f quality cntrl ver audits. In additin, the inspectin included reviews f plicies and prcedures related t certain quality cntrl prcesses f the Firm that culd be expected t affect audit quality. The issuer audits and aspects f thse audits inspected were selected based n a number f risk-related and ther factrs. Due t the selectin prcess, the deficiencies included in this reprt are nt necessarily representative f the Firm's issuer audit practice. The Bard is issuing this reprt in accrdance with the requirements f the Act. 2/ The Bard is releasing t the public Part I f the reprt and prtins f Appendix C. Appendix C includes the Firm's cmments, if any, n a draft f the reprt. Any defects in, r criticisms f, the Firm's quality cntrl system are discussed in the nnpublic prtin f this reprt and will remain nnpublic unless the Firm fails t address them t the Bard's satisfactin within 12 mnths f the date f this reprt. 1/ The Act requires the Bard t cnduct an annual inspectin f each registered public accunting firm that regularly prvides audit reprts fr mre than 100 issuers. 2/ In its Statement Cncerning the Issuance f Inspectin Reprts, PCAOB Release N (August 26, 2004), the Bard described its apprach t making inspectin-related infrmatin publicly available cnsistent with legal restrictins.

3 PCAOB Release N Inspectin f KPMG LLP Page 2 PART I INSPECTION PROCEDURES AND CERTAIN OBSERVATIONS Members f the Bard's staff ("the inspectin team") cnducted primary prcedures fr the inspectin frm Octber 2011 thrugh February The inspectin team perfrmed field wrk at the Firm's Natinal Office and at 28 f its apprximately 83 U.S. practice ffices. A. Review f Audit Engagements The 2012 inspectin f the Firm included reviews f aspects f 48 audits perfrmed by the Firm and reviews f the Firm's audit wrk n tw ther issuer audit engagements in which the Firm played a rle but was nt the principal auditr. The inspectin team identified matters that it cnsidered t be deficiencies in the perfrmance f the wrk it reviewed. One f the deficiencies relates t auditing aspects f an issuer's financial statements that the issuer annunced an intentin t restate after the primary inspectin prcedures. The inspectin team cnsidered certain f the deficiencies that it bserved t be audit failures. Specifically, certain f the identified deficiencies were f such significance that it appeared that the Firm, at the time it issued its audit reprt, had failed t btain sufficient apprpriate audit evidence t supprt its audit pinin n the financial statements and/r n the effectiveness f internal cntrl ver financial reprting ("ICFR"). In additin, in tw audits in which the Firm played a rle but was nt the principal auditr, the inspectin team identified deficiencies that were f such significance that it appeared that the Firm had nt btained sufficient apprpriate audit evidence t fulfill the bjectives f its rle in the audit. The audit deficiencies that reached these levels f significance are described belw. 3/ 3/ The discussin in this reprt f any deficiency bserved in a particular audit reflects infrmatin reprted t the Bard by the inspectin team and des nt reflect any determinatin by the Bard as t whether the Firm has engaged in any cnduct fr which it culd be sanctined thrugh the Bard's disciplinary prcess. In additin, any references in this reprt t vilatins r ptential vilatins f law, rules, r prfessinal standards are nt a result f an adversarial adjudicative prcess and d nt cnstitute cnclusive findings fr purpses f impsing legal liability.

4 PCAOB Release N Inspectin f KPMG LLP Page 3 Fr ne f the audits described belw, fllwing the inspectin team's primary inspectin prcedures, the Firm revised its pinin n the effectiveness f the issuer's ICFR t express an adverse pinin. A.1. Issuer A In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its audit pinins n the financial statements and n the effectiveness f ICFR The Firm identified numerus cntrl deficiencies, including deficiencies related t identified misstatements that exceeded the Firm's established level f materiality. The Firm failed t sufficiently evaluate whether certain f these cntrl deficiencies represented material weaknesses individually, as it failed t evaluate the likelihd and magnitude f the ptential misstatements that culd result frm the deficiencies. In additin, the Firm failed t evaluate whether sme f these cntrl deficiencies, when cnsidered in cmbinatin, cllectively resulted in a material weakness. The Firm identified a fraud risk related t revenue recgnitin, including a risk with respect t the issuer's largest custmer, which represented a significant prtin f bth ttal accunts receivable and ttal revenue. The Firm failed t perfrm sufficient prcedures t test revenue and related accunts receivable, including prcedures that were directly respnsive t the assessed risk f fraud related t revenue frm the issuer's largest custmer. The Firm's primary prcedure t test revenue was t develp an independent expectatin f ttal revenue fr the year based n cash receipts fr the year and changes in the balances fr accunts receivable, relevant reserves, and deferred revenue frm the beginning t the end f the year. The Firm failed t develp an apprpriate expectatin since, as nted belw, the Firm failed t sufficiently test accunts receivable that it used in develping the expectatin. While the Firm did perfrm ther testing f a sample f individual revenue transactins, the sample size fr this testing was

5 PCAOB Release N Inspectin f KPMG LLP Page 4 t small, because the Firm placed unwarranted reliance n its primary prcedure. As part f its testing f accunts receivable, the Firm sent cnfirmatin requests fr a sample f invices that related t sales t this custmer's U.S. entity; each invice cntained billings pursuant t many purchase rders. The custmer cnfirmatin requests als included questins as t whether there were any cntract mdificatins and/r side agreements. Nne f these cnfirmatin requests was returned. The Firm's alternative prcedures, which fcused n the recrded accunts receivable amunts, were insufficient. In perfrming its alternative prcedures, the Firm cmpared certain f the selected invices t a reprt that the issuer had prepared fr that particular invice that listed the sales included in the invice by purchase rder. The Firm's testing f the accuracy and cmpleteness f the data in these reprts was insufficient, because it tested the data in nly ne f these reprts, and it had nt tested cntrls ver the cmpilatin f the data in the reprts. Fr each f the selected invices, the Firm tested nly the first three f the many purchase rders included in the invice. The Firm btained shipping dcuments related t these purchase rders; hwever, these shipping dcuments did nt include quantities r the value f items shipped, and the Firm did nt perfrm ther prcedures t determine the accuracy f the amunts in the invices. A.2. Issuer B In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its audit pinins n the financial statements and n the effectiveness f ICFR

6 PCAOB Release N Inspectin f KPMG LLP Page 5 During the year, the issuer sld certain peratins and abandned the remaining peratins f ne f its reprting segments that perated in an emerging market. Althugh the issuer had reprted certain negative infrmatin abut this reprting segment, it had als made psitive statements abut the segment's prspects and made significant capital expenditures related t the segment during the year. The segment had significant net assets as f the date f dispsal. The purchaser was an entity that had n ther assets r peratins, and the cnsideratin the issuer received was a small percentage wnership interest in the purchaser. The Firm's prcedures t test this transactin were insufficient. Specifically, the Firm's prcedures were limited t reviewing the purchase agreement, perfrming analytical prcedures regarding the peratins f the segment fr the prtin f the year that the business was wned by the issuer, testing the mathematical accuracy f the calculatin f lss frm discntinued peratins, and evaluating the disclsure and classificatin f the discntinued peratins. The Firm failed t determine and assess the business ratinale fr the structure f the transactin. Further, the Firm failed t evaluate whether the issuer shuld have disclsed the fact that the purchaser had n ther peratins. The Firm failed t sufficiently evaluate the severity f identified cntrl deficiencies when cncluding that these deficiencies, individually and in cmbinatin, were nt material weaknesses. Specifically, the Firm's cnclusins were based upn its evaluatin that tw cmpensating cntrls mitigated the deficiencies. The Firm, hwever, failed t test whether ne f these cntrls perated at a level f precisin that wuld prevent r detect a misstatement that culd be material, and its evaluatin f the cntrls did nt take int accunt that (a) the ther cntrl had failed t detect misstatements that were in excess f the Firm's established level f materiality, and (b) these cmpensating cntrls culd be subject t management verride because f the cntrl deficiencies the Firm had identified. Finally, in evaluating the severity f ne f the cntrl deficiencies, the Firm cnsidered nly the magnitude f the misstatements that it knew had nt been detected thrugh the peratin f the cntrl, rather than the ptential misstatements that culd result frm the deficiency.

7 PCAOB Release N Inspectin f KPMG LLP Page 6 The Firm failed t perfrm sufficient substantive prcedures t test revenue. Specifically, despite identifying a deficiency in the issuer's cntrl ver manual jurnal entries, which the issuer used t recrd certain revenue, and identifying a risk f fraud related t inapprpriate revenue recgnitin, the Firm selected nly a small number f jurnal entries fr testing, nne f which related t the issuer's mst significant type f revenue. In additin, the Firm's sample f revenue transactins was insufficient, as the Firm determined its sample size based n the requirements fr cntrl testing rather than thse fr substantive testing, which required a larger sample. The Firm als tested revenue by testing the issuer's analysis f revenue, which invlved frming an expectatin based n the amunt f cash received related t revenue during the perid, taking int accunt the change in the recrded accunts receivable. The Firm's testing f the issuer's calculatin f the revenuerelated cash receipts was insufficient, as it failed t test the cmpleteness f the deductins frm the cash receipts fr nn-revenue-related items. In additin, the Firm failed t evaluate the significant difference between the expected revenue and the revenue recrded by the issuer. With respect t the valuatin f assets acquired in business cmbinatins, fr which the Firm had identified a significant risk, the Firm failed t perfrm sufficient tests f cntrls and substantive prcedures. Specifically The Firm identified and tested ne cntrl ver the accunting fr business cmbinatins, but the Firm's testing f that cntrl was limited t inquiring f management and nting that certain changes were made as a result f the review that cnstituted a part f the cntrl, withut determining whether the cntrl perated at a level f precisin that wuld prevent r detect a material misstatement. In additin, the Firm failed t identify and test any cntrls ver the issuer's accumulatin f the data underlying the assumptins that were used t value certain acquired intangible assets. The Firm failed t sufficiently test the attritin rates the issuer used t value custmer-relatinship intangible assets, as its testing was limited t inquiring f management and perfrming a sensitivity analysis fr a subset f the acquisitins. This sensitivity analysis, in

8 PCAOB Release N Inspectin f KPMG LLP Page 7 which the Firm used the lwer attritin rate that the issuer had used t value similar assets in ther acquisitins, shwed a calculated amunt that was significantly larger than the recrded value f the assets, but the Firm perfrmed n additinal prcedures t evaluate the results f this analysis The Firm's evaluatin f the reasnableness f the issuer's assumed grwth rate fr revenue frm existing custmers, which was used in valuing the custmer-relatinship intangible assets fr ne f these acquisitins, was insufficient. Specifically, the Firm's prcedures were limited t cmparing that rate t the rate f inflatin, withut taking int accunt higher actual and prjected ttal revenue grwth rates. The Firm failed t sufficiently test the value f certain acquired prperty, plant, and equipment, as it relied n infrmatin prvided by the issuer withut testing this infrmatin. A.3. Issuer C Fr a new audit client, the Firm determined the scpe f its prcedures fr the audits f the financial statements and the effectiveness f ICFR based n a materiality level that was t high under the circumstances and, as a result, it failed t btain sufficient apprpriate audit evidence t supprt its audit pinins. The issuer had a histry f revenue and earnings frm an nging, mature business (including during the year under audit) and had emphasized revenue and earnings in its cmmunicatins with investrs. The Firm, hwever, determined a materiality level based n a percentage f the issuer's ttal assets, withut establishing that it had an apprpriate basis fr ding s. This materiality level was apprximately three times the materiality level the Firm wuld have calculated had it used its guidance fr the typical apprach t determining a materiality level based n incme befre taxes fr the year. A.4. Issuer D In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its audit pinins n the financial statements and n the effectiveness f ICFR

9 PCAOB Release N Inspectin f KPMG LLP Page 8 The Firm assessed the risk f material misstatement f the allwance fr lan lsses ("ALL") as high and als identified a fraud risk related t the ALL. The Firm selected and tested six review cntrls ver the issuer's lan grading and ALL evaluatin prcess. The Firm's testing f these cntrls was insufficient. Specifically In its testing f fur f the review cntrls, the Firm failed t evaluate the criteria the cntrl wner used t identify exceptins, and failed t test whether exceptins had been apprpriately identified and investigated. The Firm als failed t test ne f these fur cntrls, which invlved management's review f the ALL mdel methdlgy, in the third and furth quarters f the year, despite the fact that the issuer significantly revised its methdlgy in the third quarter. Further, the Firm failed t test cntrls ver the accuracy and cmpleteness f certain reprts used in the perfrmance f anther f these fur cntrls. The Firm failed t evaluate the effects f exceptins related t lan grading that it identified when perfrming lan reviews, n its cnclusin regarding the perating effectiveness f the fifth cntrl, which was designed t identify errrs in lan grading. The Firm's prcedures t test the sixth cntrl were limited t cmparing its independent cnclusins t thse reached by the cntrl wner, withut evaluating the prcedures perfrmed by the cntrl wner. Histrically, the issuer had determined its general reserve by selecting, fr each lan type, the largest f the reserves calculated by three separate mdels (the "Traditinal Methd"). Beginning in the third quarter f the year, the issuer calculated an estimate f the general reserve using a new methd based n credit risk (the "Credit Risk Methd"), and it used the results frm bth methds, alng with an amunt representing a qualitative adjustment, t determine the general reserve. The Firm cncluded that it wuld nt rely n the Credit Risk Methd, and did nt substantively test it. The Firm's apprach fr testing the general reserve prtin f the ALL was t evaluate the issuer's prcess fr estimating the general reserve using the Traditinal Methd and t develp an

10 PCAOB Release N Inspectin f KPMG LLP Page 9 independent expectatin f the general reserve. The Firm's testing was insufficient. Specifically The Firm develped its independent expectatin f the general reserve fr each lan type by applying the rati f charge-ffs during the year as cmpared t the prir year's ending lan balances t the current year's lan balances. The Firm, hwever, failed t supprt its use f ne year f charge-ff data, and its exclusin f any qualitative r envirnmental factrs. The Firm failed t evaluate the apprpriateness f the issuer's qualitative adjustments. In reviewing the Traditinal Methd, the Firm failed t evaluate the issuer's decisin t use the largest calculated reserve fr each lan type, despite significant differences in the amunts prduced by the three different mdels underlying the Traditinal Methd. The Firm identified tw design deficiencies in the mdel that prduced the largest calculated reserve fr mst f the issuer's lan types, and thus was used t determine substantially all f the reserve under the Traditinal Methd. This mdel applied lss rates t varius categries f lan grades. The design deficiencies that the Firm identified related t the fact that the lss rates were unchanged frm perid t perid and the gruping f lan grades was t aggregated. In respnse t these deficiencies, the Firm calculated varius ratis related t lans, charge-ffs, and the ALL, and cmpared the results t thse fr peer institutins; hwever, this analysis was nt precise enugh t address the specific design deficiencies. In additin, the Firm failed t test the reasnableness f the lss rates that the issuer applied in this mdel. The Firm's prcedures t test the specific reserve prtin f the ALL were insufficient. The Firm failed t evaluate the reasnableness f significant assumptins used in appraising the fair value f the cllateral fr nearly all f the lans that it had selected fr testing, and failed t evaluate the reasnableness f discunts that the issuer had applied t the appraised values.

11 PCAOB Release N Inspectin f KPMG LLP Page 10 The Firm's prcedures t test the lan grades f a sample f lans were insufficient. The Firm's specialist identified a number f lan grading differences in the sample, nearly all f which related t a prtfli f cmmercial lans. Althugh the Firm extraplated the errr rate fr this prtfli t the rest f the ppulatin f the prtfli, it did nt have a basis t d s since it did nt test a representative sample f lans. In additin, the Firm failed t cnsider the nature f the lan grading differences and the specific characteristics f this prtfli t evaluate whether further prcedures t test the prtfli were necessary. The Firm's prcedures t test the effectiveness f cntrls ver the issuer's investment securities were insufficient. Specifically, the Firm identified and tested three review cntrls related t valuatin. The Firm failed t assess the level f precisin at which each f the cntrls perated. In additin, the Firm failed t test whether the issuer's cntrls addressed the need fr the issuer t have a sufficient understanding f hw the external pricing vendrs had priced certain f the issuer's investment securities withut readily determinable fair values t enable the issuer t determine (a) whether the prices were reasnable and determined in accrdance with generally accepted accunting principles ("GAAP"), and (b) whether the securities were apprpriately classified within the fair value hierarchy. The Firm failed t perfrm sufficient substantive tests f the issuer's investment securities. Specifically The Firm's testing f the fair value f certain municipal securities within the issuer's investment securities prtfli was insufficient. The Firm's internal valuatin specialists develped independent expectatins f the fair values f these securities; these expectatins, hwever, depended n a significant assumptin that was nt supprted by audit evidence ther than the results f inquiry f management. The Firm tested the value f the issuer's investment securities as f the end f the third quarter. The Firm develped expectatins f the year-end values and tested purchases f securities after the interim

12 PCAOB Release N Inspectin f KPMG LLP Page 11 testing date in rder t extend its cnclusins t the year end. These prcedures, hwever, were nt sufficient, because (a) the Firm's expectatins f the year-end values were frmed using benchmarks related t the varius grups f securities that the issuer wned, withut cnsideratin f whether the specific securities within thse grups crrespnded t thse cntributing t the benchmarks, and (b) the Firm's testing f purchases since the interim testing date cnsisted f verifying the prices at the date f purchase, withut any prcedures t test the prices at year end. A.5. The Firm failed t perfrm sufficient substantive prcedures t test the issuer's valuatin f real estate it wned, fr which the Firm had identified a risk f fraud. Specifically, the Firm evaluated the reasnableness f the assumptins used in the valuatin f nly a small prtin -- less than ten percent -- f the real estate prperties that it had selected fr substantive testing. Issuer E In this audit, the Firm failed t btain sufficient apprpriate audit evidence t supprt its audit pinin n the effectiveness f ICFR. The issuer mdified its ALL prcesses during the year, and determined that the fact that the required revisins t its cntrls had nt been fully implemented as f year end represented a significant deficiency. The issuer als identified ther cntrl deficiencies related t its ALL prcesses. In additin, the issuer and the Firm identified multiple deficiencies in infrmatin-technlgy general cntrls ("ITGCs") that affected user access t varius applicatins supprting the ALL. The issuer determined, and the Firm agreed, that these deficiencies in cntrls ver the ALL and related ITGCs did nt cnstitute a material weakness. The Firm, hwever, failed t sufficiently evaluate the severity f these cntrl deficiencies when making that determinatin. Specifically The Firm identified actual and ptential misstatements in the issuer's ALL that, when aggregated, exceeded the Firm's revised materiality level. The Firm failed t cnsider the full range f the ptential misstatements in cncluding that the ALL cntrl deficiencies were nt a material weakness.

13 PCAOB Release N Inspectin f KPMG LLP Page 12 A.6. The Firm identified fur cmpensating cntrls that it believed mitigated the ALL deficiencies. The Firm, hwever, failed t btain evidence that these cmpensating cntrls perated at a level f precisin such that the cntrls wuld have the necessary mitigating effect. The Firm failed t evaluate the deficiencies identified in cntrls ver the ALL in cmbinatin with the multiple user-access deficiencies related t applicatins supprting the ALL. Issuer F In cnnectin with a freign affiliated firm's audit f an issuer, the Firm audited certain financial statement infrmatin f a subsidiary f the issuer and tested the subsidiary's cntrls. The peratins f this subsidiary cnsisted f a legacy business and a business acquired during the year. The Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t fulfill the bjectives f its rle in the audit The Firm failed t test the design and perating effectiveness f cntrls ver the accunting fr business cmbinatins. The Firm failed t identify and test any cntrls ver the existence f available-fr-sale ("AFS") securities f the acquired business. The issuer classifies lans as impaired primarily based n each lan's risk rating. The Firm selected fr testing certain cntrls ver specific reserves fr impaired lans, including cntrls ver lan risk ratings, but its prcedures t test these cntrls were insufficient. Specifically, the issuer used manually prepared infrmatin in the peratin f these cntrls; the Firm, hwever, failed t test any cntrls ver the accuracy and cmpleteness f this infrmatin. In additin, the sample sizes that the Firm used t test the perating effectiveness f the issuer's cntrls ver lan risk ratings were t small. Specifically, the samples were based n a lw risk assciated with the cntrls, despite the assessed high inherent risk related t the ALL, deficiencies that had been identified in the lan risk rating prcess, and an identified fraud risk.

14 PCAOB Release N Inspectin f KPMG LLP Page 13 The Firm failed t perfrm sufficient substantive prcedures t test the assets acquired and liabilities assumed in the business cmbinatin. Specifically The Firm's sample size fr testing the risk ratings assigned t the acquired lans, which was a significant input int the valuatin f these lans, was insufficient. Specifically, the Firm determined its sample size based n a risk f material misstatement f lw, but failed t cnsider multiple factrs that it had identified that indicated a higher risk, such as an identified fraud risk, weaknesses identified by the issuer's risk grup with respect t certain assumptins used in the mdel t value the lans, and identified cntrl deficiencies. The Firm's apprach t testing assumed depsit liabilities was t perfrm prcedures subsequent t the acquisitin date and rll back its cnclusins frm the date f testing t the acquisitin date. The Firm's rll-back prcedures, hwever, were insufficient, since the prcedures were limited t a cmparisn f the balances at thse dates. The Firm selected a sample f investment securities acquired in the business cmbinatin t test existence; hwever, the ppulatin the Firm tested excluded a significant prtin f the acquired investment securities. A.7. Issuer G In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its audit pinins n the financial statements and n the effectiveness f ICFR The Firm's testing f certain cntrls ver revenue, fr which the Firm had identified a fraud risk, and ver accunts receivable was insufficient. Specifically The Firm selected a cntrl ver invices that perated nly n transactins abve certain quantitative threshlds. While sme prtin f the transactins that were nt subject t this cntrl were

15 PCAOB Release N Inspectin f KPMG LLP Page 14 addressed by ther cntrls, such as thse related t the timing f revenue recgnitin, the Firm failed t cnsider the ppulatin f transactins that was nt subject t this cntrl when determining that the cntrls it identified and tested sufficiently addressed the assessed risk f misstatement. Fr tw review cntrls that the Firm selected fr testing, the Firm failed t test whether the persns wh perfrmed the cntrl apprpriately identified and investigated variances that met the cntrls' established criteria fr investigatin. In additin, fr tw f the three cntrls described abve, and ne ther cntrl, the Firm failed t identify and test any cntrls ver the accuracy and/r cmpleteness f the data and reprts used in the peratin f the cntrls. The Firm failed t perfrm sufficient prcedures t test revenue. In particular, the Firm failed t perfrm substantive prcedures that were specifically respnsive t the assessed risks f fraud related t revenue. Als, the Firm designed its substantive prcedures based n a level f reliance n cntrls that was excessive due t the deficiencies in the Firm's testing f cntrls described abve. The Firm's primary prcedure t test revenue was t develp an independent expectatin f ttal revenue fr the year. One f the factrs used t develp the independent expectatin was the year-end accunts receivable balance. The Firm failed t sufficiently test this factr, as its sample size used t select accunts receivable fr cnfirmatin was t small given the deficiencies in testing cntrls described abve. Certain f the issuer's accunts receivable that it had acquired in business cmbinatins were subject t extended payment terms that exceeded ne year, and the issuer had determined the value f sme f these accunts receivable by discunting the expected cash flws. The issuer recrded all f these accunts receivable as current assets, and the Firm failed t perfrm sufficient prcedures t evaluate whether this presentatin was apprpriate in light f the payment terms and expected cash flws. Specifically, the Firm's prcedures t test the presentatin f these

16 PCAOB Release N Inspectin f KPMG LLP Page 15 accunts receivable were limited t btaining an issuer-prepared memrandum that fcused n (1) management's expectatins, at the time the credit was initially granted, that these amunts wuld be cllected within a year, and (2) the average days that sales were utstanding fr the acquired businesses, which was less than a year. The issuer cmpleted several significant business cmbinatins during the year. The Firm identified tw review cntrls that were designed, in part, t address the valuatin f the issuer's custmer-relatinship intangible assets acquired in business cmbinatins. The Firm's testing f these cntrls was insufficient, as the Firm limited its prcedures t bserving evidence that the reviews had ccurred, withut evaluating whether the cntrls perated at a level f precisin that wuld prevent r detect material misstatements. The Firm's substantive testing f the valuatin f the acquired custmerrelatinship intangible assets, and f the amrtizatin f these assets, was insufficient. Specifically Fr ne f the acquisitins, the Firm's testing f certain assumptins underlying the expected margin prjectins the issuer used t value these assets was limited t cmparing the assumptins t histrical results, and nting that management's apprach was cnservative; Fr all f the acquisitins, there was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the Firm had evaluated whether the assumptins underlying the estimatin f the custmer attritin rates used in the valuatins were reasnable; and The Firm failed t evaluate the apprpriateness f the issuer's amrtizatin f these assets n a straight-line basis and ver a perid f time that differed frm the perid f cash flws used t value them.

17 PCAOB Release N Inspectin f KPMG LLP Page 16 A.8. Issuer H In this audit, the Firm failed t identify a departure frm GAAP related t the classificatin f revenue and cst f sales that it shuld have identified and addressed befre issuing its audit reprt. The Firm failed in the fllwing additinal respects t btain sufficient apprpriate audit evidence t supprt its audit pinins n the financial statements and n the effectiveness f ICFR A.9. The Firm failed t perfrm sufficient substantive prcedures t test certain revenue thrughut the year, as its prcedures were limited t (a) btaining an explanatin frm management fr the increase in this revenue f 45 percent ver the prir year, withut btaining crrbratin f that explanatin; (b) testing a sample f transactins frm nly the last tw mnths f the year; and (c) perfrming an analytical prcedure that was nt precise enugh t identify a ptential material misstatement related t this revenue. The Firm identified fraud risks related t sales cut-ff and revenue recgnitin, and selected a statistical sample f sales invices in rder t test revenue. The Firm's testing was insufficient, as the Firm cmpared less than ten percent f the selected invices t apprpriate supprting dcumentatin; fr the remaining invices, the Firm relied n systemgenerated infrmatin that it had nt tested. There was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the Firm had identified and tested any cntrls ver the existence f inventry held at strage facilities cntrlled by external parties. Issuer I In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its audit pinin n the effectiveness f ICFR The Firm failed t sufficiently test cntrls ver ne significant type f revenue. Specifically, the Firm selected an applicatin cntrl that

18 PCAOB Release N Inspectin f KPMG LLP Page 17 autmatically calculated earned and unearned revenue, but the Firm's testing f this cntrl was insufficient, as the testing addressed nly that certain infrmatin had been entered int the applicatin and nt that the revenue had been apprpriately calculated. The Firm als tested a review cntrl that cnsisted f the cmparisn f recrded results t budgeted and prir-year infrmatin. The Firm's testing f this cntrl was als insufficient, hwever, because (a) the Firm failed t evaluate the threshlds the issuer applied t identify unusual r unexpected trends r relatinships, and the prcess fr investigating any such trends r relatinships; and (b) the Firm failed t identify and test any cntrls ver the accuracy and cmpleteness f infrmatin used in the peratin f this cntrl. The issuer used pricing infrmatin frm its external investment managers t determine the recrded fair value f its AFS securities. Fr securities fr which pricing infrmatin was nt available frm the external investment managers, the issuer used prices prvided by the custdian f its securities, btained nn-binding brker qutes, r used pricing mdels. The Firm identified and tested tw cntrls ver the valuatin f the AFS securities, but failed t sufficiently test either f these cntrls. Specifically The first cntrl invlved management bth reviewing a cmparisn f the fair values prvided by the investment managers t thse prvided by the custdian, and seeking additinal infrmatin frm the investment managers fr securities with price differences ver an established threshld. The Firm's interim testing f this cntrl was insufficient because (a) it tested a sample f nly ne item; and (b) the infrmatin the issuer btained fr that security established nly that the value shuld be lwer than that f a different security fr which the investment manager prvided infrmatin. Further, there was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the Firm had selected any items in rder t test this cntrl at year end. The secnd cntrl included the review f the investment managers' reprts by the issuer's investment cmmittee. This cntrl was the nly cntrl tested ver the valuatin f securities

19 PCAOB Release N Inspectin f KPMG LLP Page 18 fr which the issuer's custdian did nt prvide a price. The Firm's testing f this review was insufficient, because its prcedures were limited t btaining the reprts frm the investment managers that the investment cmmittee reviewed, btaining minutes f certain relevant meetings, and making inquiries f management, withut evaluating whether the cntrl perated at a level f precisin t prevent r detect material misstatements. The Firm failed t test whether the issuer's cntrls addressed the need fr the issuer t have a sufficient understanding f hw the external investment managers had priced the AFS securities withut readily determinable fair values t enable the issuer t determine (a) whether the prices were reasnable and determined in accrdance with GAAP and (b) whether the securities were apprpriately classified within the fair value hierarchy. A.10. Issuer J In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its audit pinins n the financial statements and n the effectiveness f ICFR The Firm failed t sufficiently test cntrls ver revenue. Specifically Fr almst all f the issuer's revenue, the issuer used an autmated calculatin t divide inviced amunts between revenue t be recgnized and deferred revenue. The Firm elected nt t test applicatin cntrls ver this autmatic calculatin, and the Firm did nt identify and test any ther cntrls that addressed the calculatin f this revenue. The Firm's testing f the perating effectiveness f a review cntrl ver the reasnableness f mnthly revenue and accunts receivable balances was limited t inquiring f management, determining whether there was evidence that a review had ccurred, and nting that certain items had been reslved, withut evaluating whether any variances identified in the review that were ver the established threshld were apprpriately investigated.

20 PCAOB Release N Inspectin f KPMG LLP Page 19 The Firm failed t identify and test any cntrls ver the accuracy and cmpleteness f reprts used in the peratin f certain cntrls it selected fr testing. Fr all but ne f the cntrls ver revenue that it selected fr testing, the Firm used inquiry t update the results f its cntrls testing perfrmed at interim dates t the year end. Limiting the prcedures t inquiry was inapprpriate, given that the Firm had determined that ITGCs, including change management cntrls, were ineffective fr a prtin f the update perid and the Firm had identified a fraud risk related t revenue. The Firm failed t perfrm sufficient substantive prcedures t test revenue, as it designed its substantive prcedures based n a level f reliance n cntrls that was excessive due t the deficiencies in the Firm's testing f cntrls that are described abve and the fact that the Firm determined that ITGCs were ineffective fr a majrity f the year. The Firm's testing included recalculating the amunt f earned and unearned revenue fr a sample f items, but the Firm did nt cmpare these amunts t the crrespnding recrded amunts. With respect t the Firm's substantive analytical prcedures, the Firm's expectatin f revenue was lwer than the recrded balance by mre than three times its established level f materiality, but the Firm failed t perfrm any prcedures t evaluate whether this difference culd represent a material misstatement. In additin, the Firm used certain data t develp its expectatin that were derived frm the accunting system, withut perfrming any prcedures t test the accuracy and cmpleteness f the data. The Firm failed t perfrm sufficient prcedures t test the issuer's cntrls ver the valuatin f certain derivative instruments that the issuer held, as the Firm did nt identify and test any cntrls ver the develpment f the assumptins used t estimate the fair value f these derivative instruments. In additin, the Firm failed t identify and test any cntrls ver the disclsure f the derivative instruments as level 2 r 3

21 PCAOB Release N Inspectin f KPMG LLP Page 20 within the hierarchy set frth in Financial Accunting Standards Bard ("FASB") ASC Tpic 820, Fair Value Measurement. A.11. Issuer K In this audit, the Firm failed t sufficiently evaluate the apprpriateness f the issuer's change in its methd fr determining its "current price" f natural gas, which was an imprtant input t the issuer's evaluatin f ne f its il and natural gas prperties fr impairment. Specifically, the Firm did nt evaluate (a) whether the change was cnsistent with the applicable SEC guidelines fr determining the "current price," and (b) whether it was apprpriate fr the issuer t use, when determining the value f the gas reserves, a "current price" that was higher than the average f the prices the issuer had received during the year. A.12. Issuer L In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its audit pinins n the financial statements and n the effectiveness f ICFR The issuer used infrmatin frm an external pricing vendr t determine the recrded fair value f the majrity f its fixed-maturity AFS investment securities. Fr securities fr which pricing infrmatin was nt available frm the external pricing vendr, the issuer btained prices frm its external investment manager. The Firm failed t sufficiently test the issuer's cntrls ver the valuatin f the fixed-maturity AFS investment securities withut readily determinable fair values. Specifically With respect t the prices btained frm the external pricing vendr, the Firm selected fr testing a cntrl that cnsisted f the issuer's review f infrmatin prvided by the issuer's external investment manager. The infrmatin reviewed included the investment manager's cmparisn, fr certain f the issuer's investments, f prices btained frm the issuer's external pricing vendr t prices received frm ther pricing vendrs, and the identificatin f investments fr which variances between prices exceeded established threshlds. There was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the

22 PCAOB Release N Inspectin f KPMG LLP Page 21 Firm had identified and tested cntrls t ensure that the prices used in the investment manager's cmparisn were the same as thse the issuer used t recrd its fair values. In additin, the Firm failed t cnsider the effect f incrrect calculatins by the investment manager f certain variances between prices n its cnclusins regarding the severity f an identified deficiency in this cntrl. The Firm failed t test whether the issuer's cntrls addressed the need fr the issuer t have a sufficient understanding f hw the external pricing vendr had priced the AFS investment securities withut readily determinable fair values t enable the issuer t determine (a) whether the prices were reasnable and determined in accrdance with GAAP and (b) whether the securities were apprpriately classified within the fair value hierarchy. The Firm failed t identify and test any cntrls ver the valuatin f investments fr which its external pricing vendr did nt prvide a price. With respect t the substantive testing f the valuatin f the AFS investment securities, the Firm tested the value f the securities at an interim date and, t extend its cnclusins t the year end, it develped expectatins f year-end values fr the AFS investment securities and tested sme transactins that ccurred after the interim testing. The prcedures perfrmed t extend the Firm's cnclusins were nt sufficient. Specifically The Firm's expectatins were that the value f mst f the investments it had tested at interim dates wuld nt change significantly frm the interim testing date t year end, and that, fr sme investment securities withut readily determinable fair values, the value wuld nt change by mre than five percent f the value n the interim testing date. The Firm failed t btain evidence t supprt these expectatins, but nevertheless used them despite the diverse cmpsitin f the issuer's prtfli, the issuer's disclsure regarding market vlatility in the last half f the year, and the decline in the credit rating f certain f the relevant investments.

23 PCAOB Release N Inspectin f KPMG LLP Page 22 The Firm's testing f the valuatin f certain investments that were reclassified frm level 2 t level 3 between the interim testing date and year end was nt sufficient. Specifically, the Firm's year-end testing was limited t (1) cmparing the value f these securities at the interim testing date t the value at year end and (2) btaining a price fr nly ne security frm a pricing service, withut perfrming any additinal prcedures t evaluate whether the price was reasnable and determined in accrdance with GAAP. The Firm failed t sufficiently test the valuatin f the securities that the issuer acquired between the interim testing dates and year end, as its testing was limited t (a) testing the prices at the date f acquisitin and (b) verifying that the change in price frm the date f acquisitin t year end was in line with its expectatin, withut btaining evidence t supprt its expectatin. A.13. Issuer M In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its audit pinins n the financial statements and n the effectiveness f ICFR The Firm failed t sufficiently test ITGCs relating t the issuer's general ledger applicatin and its systems fr prcessing lans and depsits. As a cnsequence f this failure, the Firm's reliance n certain systemgenerated reprts, autmated applicatin cntrls, and infrmatin technlgy-dependent manual cntrls was excessive. The specific deficiencies in testing ITGCs are as fllws The Firm failed t test the perating effectiveness f the issuer's cntrls related t the granting and remval f user access t the issuer's general ledger applicatin at the time that emplyees were hired, transferred, r terminated. The Firm failed t sufficiently test a cntrl cnsisting f the annual review f user access prfiles, as its testing was limited t ne department and did nt cnsider the fact that the cntrl was based primarily n users' self-reviews.

24 PCAOB Release N Inspectin f KPMG LLP Page 23 The Firm identified as a cntrl deficiency that certain prgram develpers had inapprpriate access t the issuer's systems used fr prcessing lans and depsits and had the ability t make unauthrized changes t these systems. The Firm tested a manual cntrl that it believed mitigated this risk, but failed t cnsider that this cntrl was nt designed t perate ver all changes that develpers with the inapprpriate access might make t the systems. Further, the Firm failed t test whether ther users had been granted similar inapprpriate access t these systems. The issuer btained pricing infrmatin fr the majrity f its AFS investment securities frm external pricing vendrs, and used this infrmatin t recrd the securities' fair value. The Firm failed t test whether the issuer's cntrls addressed the need fr the issuer t have a sufficient understanding f hw the external pricing vendrs had priced its AFS investment securities withut readily determinable fair values t enable the issuer t determine (a) whether the prices were reasnable and determined in accrdance with GAAP and (b) whether the securities were apprpriately classified within the fair value hierarchy. The Firm tested the value f the issuer's AFS investment securities at an interim date and, t extend its cnclusins t the year end, it develped expectatins f year-end values fr these securities. With respect t certain AFS investment securities, the Firm used market indices t develp its expectatins f the securities' value, but it failed t btain evidence t supprt its assumptin that the securities underlying the indices were cmparable t the issuer's AFS investment securities. In additin, fr ne categry f AFS investment securities, the Firm failed t perfrm prcedures t supprt its cnclusin that a difference between the recrded fair value and its expectatin f fair value, which exceeded the Firm's level f materiality, did nt represent a material misstatement. A.14. Issuer N In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its audit pinins n the financial statements and n the effectiveness f ICFR

25 PCAOB Release N Inspectin f KPMG LLP Page 24 Due t the judgment invlved in the prcess, the Firm identified a significant risk related t the apprpriateness f the csts assciated with cnverting raw materials int finished gds ("cnversin csts") that were capitalized int inventry, but it failed t perfrm sufficient prcedures t test cntrls that addressed this risk. Specifically, the Firm failed t identify and test cntrls that wuld address whether the cnversin csts included in inventry were apprpriate t be capitalized, including whether they had been allcated t the apprpriate prducts, and instead fcused n cntrls that addressed whether the judgments management had made were executed. The Firm failed t perfrm sufficient substantive prcedures t test cnversin csts, as it designed its substantive prcedures, including its sample size fr testing cnversin csts, based n a level f reliance n cntrls that was excessive due t the deficiency in the Firm's testing f cntrls that is discussed abve. A.15. Issuer O In cnnectin with a freign affiliated firm's audit f an issuer, the Firm audited the financial statements f a subsidiary f the issuer and tested the subsidiary's cntrls. The Firm failed t btain sufficient apprpriate audit evidence t fulfill the bjectives f its rle in the audit. Specifically The Firm failed t test cntrls that wuld address (a) whether inventry was recrded at the lwer f cst r net realizable value as required by the applicable accunting literature, and (b) the apprpriateness f the csts assciated with cnverting raw materials int finished gds ("cnversin csts") that were included in the inventry valuatin. The Firm's substantive prcedures t test the apprpriateness f the cnversin csts capitalized int wrk-in-prgress inventry were insufficient. Specifically, the Firm's prcedures related t cnversin csts were limited t recalculating variances between standard and actual csts fr a sample f items, based n infrmatin in the subsidiary's accunting system, and cmparing the recalculated amunts t amunts in the

26 PCAOB Release N Inspectin f KPMG LLP Page 25 subsidiary's accunting system and t a schedule prepared by the subsidiary. The Firm failed t perfrm any substantive prcedures related t the cst f finished gds inventry. A.16. Issuer P In this audit, the Firm failed in the fllwing respects t sufficiently test the existence f inventry The Firm determined that ITGCs ver the issuer's perpetual inventry systems were ineffective. Fr tw significant lcatins, the issuer used cycle-cunt prcedures t determine inventry quantities. The Firm tested cntrls ver the issuer's cycle-cunt prcedures in rder t rely n these cntrls with respect t the existence f this inventry. The Firm's testing f the cycle-cunt prcedures, hwever, was nt sufficient. Specifically The Firm failed t test the accuracy and/r cmpleteness f the system-generated reprts and spreadsheets that were used in, and that the Firm used t evaluate, the cycle-cunt prcedures, including thse that were used t address the accuracy and frequency f the cunts. The Firm's sample fr its interim testing f the cycle-cunt prcedures, which perated n a daily basis, was nly three days. The Firm did nt have a reasnable basis fr limiting its sample t three days, given that it (a) had assessed the "risk f failure" f these cntrls ver certain inventry as "higher," (b) had determined that the relevant ITGCs were ineffective, and (c) relied n the results f its testing f cycle-cunt cntrls t reduce the extent f the Firm's substantive prcedures. There was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the Firm had perfrmed any prcedures t extend its audit cnclusins related t the cyclecunt prcedures frm the dates f its interim testing t the year end.