• PwC And Huron Consulting: Goodwill Too Good To Be True

    By • Aug 10th, 2009 • Category: Latest, Pure Content

    Crain’s Chicago Business: The Chicago-based consulting firm stunned the financial community…

    The Chicago Tribune: Investors dumped shares of Chicago-based Huron Consulting Group Inc. on Monday, concerned by the firm’s disclosure of accounting errors that forced the departure of Chief Executive Gary Holdren. Huron’s stock plunged $30.66, or 69 percent…

    The Wall Street Journal: Shares of Huron Consulting Group Inc. (HURN) plummeted to an all-time low Monday after the company late Friday made a myriad of negative announcements including that its chairman and chief executive has stepped down and the company will be restating the last three years of financial results.

    Bloomberg: Blowing Up Your Company Gets Raised to Art Form: Jonathan Weil: It almost wouldn’t be fair to say we should have known that Chicago-based Huron Consulting Group Inc. was destined to implode. It is tempting to say it, though…Today, Huron is better known as the forensic-accounting shop that couldn’t keep its own books straight, and blew up its business model in the process.

    The headlines give one the impression that a sudden cataclysmic event triggered an unfortunate deluge of unanticipated but not necessarily undeserved negative consequences. The schadenfreude is palpable. In Chicago, anti-Andersen commentary is flying fast and furious alongside Andersen apologists trying to get their words in between.

    The Huron Consulting Audit Committee of the Board of Directors “finds out” (From whom?  A whistleblower?  Internal audit? An angry exec who hadn’t received one of the “kickbacks”) about some payments to executives as a result of acquisitions that had not been accounted for properly and the result is a long list of “complex matters that demand extraordinary combinations of financial, technical, and industry expertise”:

    • An announcement of restatements of several years of financial statements with a significant impact to net income,
    • The resignation of the CEO, CFO and Chief Accounting Officer,
    • An unprecedented one day drop in stock price,
    • The filing of several class action lawsuits,
    • The disclosure of an SEC inquiry on another serious accounting issue, revenue recognition,
    • Concerns voiced by analyst regarding the ability of the company to continue as a “going concern.”
    However, the warnings signs and red flags were there. Not only had there been independent analysts who sounded alarms, but their auditors, PwC are in there all the time, including providing due diligence for acquisitions and “consulting regarding financial accounting and reporting standards.”  In fact, PwC earned more from audit-related and tax fees than from the audit itself.  I thought that Sarbanes-Oxley was supposed to prevent the Arthur Andersen syndrome from happening again?  Well, maybe not if it’s Arthur Andersen -types giving the orders and paying the bill.
    From the latest proxy:

    The restatement “bombshell” Huron’s management dropped on Monday was a shocker indeed…Granted, the audit committee was right to spill the gruel (better late than never), but why now and where the hell was the board? More importantly, were there any clues in the financial statements leading up to this fiasco which might have flashed warning flags to investors?…much of the current hubbub involves the treatment of “misreported” costs related to acquisitions. With that in mind, let’s start with Goodwill.

    Goodwill is an intangible asset and subject to annual impairment testing. Determining the value of goodwill is hazy at best, when you consider it’s inclusive to patents, brand names, etc. above and beyond book value. Thus, consider goodwill as the cost of an investment in excess of book value…In Huron’s case, goodwill as a % of total assets (March 2008 through March 2009) averaged 50%. This is red-flag #1. Goodwill as a % of shareholder equity during the similar period averaged 137%, also a huge red flag.

    The Chicago Tribune:

    Huron announced late Friday that it was restating earnings for 2006, 2007, 2008 and the first quarter of 2009 because of incorrect accounting related to the acquisition of four businesses between 2005 and 2007…The company said certain Huron employees received some of the payments made to the selling shareholders of the acquired businesses.

    “The employee payments were not ‘kickbacks’ to Huron management.” Rather, the people who received payments were “client-serving and administrative employees” of the acquired companies or workers hired by those companies after the acquisitions, Huron said.

    Huron said the selling shareholders had received payments at the time of the acquisition and, in some cases, when their companies hit certain financial targets. Huron had recorded these payments as goodwill on its balance sheets. But under generally accepted accounting principles, when such payments are made to company employees who are not selling shareholders, they must be recorded as a “non-cash compensation expense.”

    PwC may have been the wrong “experts” to ask about classification of expenses related of paying off employees after an acquisition. Maybe there is no right way to record a wrong transaction. But if there were, there are others equally qualified as PwC they could have asked. Unfortunately, companies like FRA (also ex-Andersen) and FTI (ex-PwC) are competitors of Huron’s and share the same pedigree as Huron and PwC.

    PwC is their enabler.

    PwC is inspected by the PCAOB every year.  The 2006 report issued in October of 2007 cites a deficient audit (out of six cited) where,

    “the Firm failed to sufficiently test certain assumptions that management used in its goodwill impairment test…there was no evidence in the audit documentation, and no persuasive other evidence, that the Firm had evaluated the appropriateness of the projections, other than by making inquiries of management.”

    Again in the 2007 report, issued in June of 2008, six deficiencies were cited. One faulted PwC for failing to test the underlying data and the calculation of an award allocation related to a goodwill impairment analysis.

    The Firm also failed to assess whether the methodology was applied consistently from year to year and whether the incorporation of the award allocation into the [goodwill impairment] analysis was appropriate.”

    In another deficiency cited in the 2007 report, PwC

    “…failed to test certain of management’s key assumptions supporting an assertion that payments following the modification of contingent consideration after a significant acquisition represented additional purchase price rather than employment compensation to the sellers or other current-period expense. They also failed to identify and address that the modification rendered the issuer’s disclosure of the agreement inaccurate.”

    Sound familiar?

    In the report for 2008, all of the deficiencies cited were as a result of inadequate evidence to support opinions related to goodwill impairment.

    “…In some cases, the deficiencies identified were of such significance that it appeared to the inspection team that the Firm, at the time it issued its audit report, had not obtained sufficient competent evidential matter to support its opinion on the issuer’s financial statements. The deficiencies that reached this degree of significance are described below, on an audit-by-audit basis, with the exception of similar deficiencies that were observed in multiple audits and are therefore grouped together…In four audits, due to deficiencies in its testing of goodwill for possible impairment, the Firm failed to obtain sufficient competent evidential matter to support its audit opinion.”

    In December of 2008, the PCAOB issued their Report on the PCAOB’s 2004, 2005, 2006, and 2007 Inspections of Domestic Annually Inspected Firms (KPMG US, PwC US, Deloitte US, EY US and KPMG Canada.)  Goodwill impairment issues makes it to the “Top Ten” list of repeated deficiencies.

    “GAAP requires that certain assets and liabilities, such as certain investments in debt and equity securities, derivatives, and assets acquired and liabilities assumed in a business combination, be recorded in financial statements at their fair value. Certain assets need to be evaluated annually (or, depending on the nature of the asset, when events or changes in circumstances warrant) to determine whether their fair value is less than their recorded amount, and their recorded value needs to be reduced.

    Inspection teams observed instances of inadequate testing by firms of fair value estimates in connection with firms’ evaluation of the possible impairment of goodwill and other long-lived assets. The inspectors observed instances where firms had not tested the reasonableness of management’s significant assumptions and the underlying data that the issuers had used in valuation models. As a result, the auditors did not have sufficient evidence to conclude on the issuers’ estimates of fair value…Inspection teams also observed instances where firms had not challenged management’s conclusions that assets did not need to be tested for impairment, despite evidence of impairment indicators.”

    I asked the PCAOB if any of the deficiencies cited in PwC’s inspection reports were related to their client, Huron Consulting.

    PCAOB Spokesperson Colleen Brennan:

    “We can’t identify issuers…The nonpublic portion of any report is not available to the public.  For additional information, please see the Board’s Statement Concerning the Issuance of Audit Reports, PCAOB Release No. 104-2004-001, and Process for Board Determinations Regarding Firms’ Efforts to Address Quality Control Criticisms in Inspection Reports, PCAOB Release No. 104-2006-077, both available at www.pcaobus.org/Inspections.”

    Maybe one of the class action lawsuits naming PwC can push this issue a bit more. They’ll find out if PwC was negligent, complicit, or just plain incorrigibly incompetent about the “errors” at Huron Consulting. Revenue recognition deficiencies are the subject of an additional SEC inquiry at Huron. Interestingly enough,  allocation of chargeable hours, or revenue recognition issues, were the downfall of another PwC consulting firm client, BearingPoint.  For professional services firms like Huron that also sell proprietary software, the issues multiply. Revenue recognition is probably one of the Top 3 deficiencies cited in PwC’s PCAOB inspections in the last few years.

    Image Source: Matt Damon and Ben Affleck accepting their Oscars for Good Will Hunting.

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    23 Responses »

    1. Francine:
      I am in PWC’s corner here. The PCAOB is full of crap. What tests of “reasonableness” does it want done? How? Have any of these PCAOB clowns ever bought a stock which went down? If so, do they know why? Who are these PCAOB clowns anyway? My experience with PCAOB personnel, is I wouldn’t trust them to audit a Jack in the Box. Any goodwill impairment test is speculative. I wouldn’t expect the PCAOB clowns to know that. As bad as the Big 87654 are, this PCAOB criticism strikes me as a “nothingburger” from a bunch of incompetents. I say, kill the PCAOB. I’m still not sure what the problem with Huron’s accounting was from the press accounts I’ve read. It seems that it was correct and the restatement is wrong! I am following the story and will read Huron’s SEC filings.

    2. Francine:
      I went to Huron’s website. I read its recently filed 8-Ks. If they are correct, I conclude the inital accounting was correct and the restatement is wrong. I now wonder what’s REALLY GOING ON HERE? If I were Huron’s management, assuming the facts are as stated, I would fight the SEC to the Supreme Court, if necessary, just like Ray Dirks did over Equity Funding. I wait to see if the “selling shareholders” are indicted for securities fraud. If not, we appear to have a massive coverrup with Huron’s management as the patsy.

    3. Another PwC post? When is the name of this site going to change to “if_it’s_a_story_and_can_be_spun_negatively_for_PWC_it_will_be_here.com”

    4. @007CPA

      Unfortunately for PwC they’ve been in the news for the worst reasons more lately… I do have something coming up later this week on KPMG and independence and also some follow-up on the RSM/H&R Block dispute. If it’s not one firm, it’s another. And you don’t even have to wait that long.
      Francine

    5. This site has turned into nothing but a bash the big four blog. Everything is spun in such a negative fashion that it is almost not worth even coming here to read straight financial/accounting news information, the little bit that remains that is

    6. re: Huron audit fees. It is clear from the proxy disclosures that a majority of the audit-related fees were incurred in support of rendering an audit opinion, and that clearly they are not an independence violation. They are in no way similar to the Enron fact pattern, and to suggest that they areis irresponsible,at least to me. The tax fees are also clearly not an independence issue, and completely unrelated to any of the Huron news.

    7. @ Independent accountant:

      The restatement is correct, and Huron’s original accounting was wrong. The difficulty with this case is that management of a Company (in this case, Huron) cannot account for a separate transaction that they are not aware of. Likewise, an audit firm cannot catch an error relating to a transaction they are not aware of. The accounting for contingent consideration is fairly straight forward (there are a few quirks, but nothing real complex), and Huron’s accounting was correct if you are unaware of the “side agreements”.

      Honestly,you’d like auditors to catch every covered-up, undocumented side agreement at every client, but it’s just impossible to. The selling shareholders would not have been within the scope of Huron audit procedure. Perhaps we’ll discover how forthcoming the employee was- unless he disclosed the agreement, as he should have, I don’t see any way PwC could have known about the side-agreement.

    8. @Clown College

      ” management of a Company (in this case, Huron) cannot account for a separate transaction that they are not aware of. Likewise, an audit firm cannot catch an error relating to a transaction they are not aware of…”

      Those are two big “ifs.” Why do you believe the CFO and CAO, if not the CEO, were not aware of these side deals and payment transactions? How could the auditor not be aware when they are getting paid to advise on both M&A and accounting and financial reporting standards? And did you realize that two of the Audit Committee members are also members of the Compensation Committee? Hard to believe that in a company of that size, not that big, and managed so much in a “command and control fashion” you would have a pattern of behavior related to compensation that senior management was unaware of.

      I don’t buy it. Actually, I buy the theory I’m hearing that some of the defectors from Huron and wannabe defectors (I have heard from some that were shopping practices to others) were disgruntled because they didn’t get their piece or as big of a piece and decided to report the shenannigans to the Board and/or regulators.

      As far as your earlier comemnt about PwC’s fees, I stand by my contention that when an audit firm makes more from other services than it does from the audit, I think there’s a conflict. In particular, I am troubled by the blatant disclosure of audit firms being paid extra to advise on transactions and transaction accounting that they will later be asked to audit and opine on. Unfortunately, the SEC and DOJ are too busy reacting to the other scandals and crisis that the auditors missed to be proactive about independence.
      Francine

    9. FM – as for the fees, PwC has different ways of pricing the services. The audit has what they add to the fee and M&A work has their additional fee. If I recall, M&A and work around this, the lift was substantial. I think it would be hard to say just because the “not-pure audit” fees were more then the audit that something funky was going an PwC was 100% aware. I have been on clients where our audit fee was 10M and non-audit was 12M (Federal work in the same Department), does that mean we were doing funky things?

      If the right questions were asked and documentation provided to support the #’s what more should PwC have done? There has to be a balance to audit, not too little, and do not over audit. When PCAOB reviews, they are looking at the facts in the workpapers and draw their own conculsions. Sometimes they do not agree with the engagement conculsions and write it up as an issue.

    10. Francine, I think we need to tackle the issue that is the elephant in the room. Do we want to incur the cost for a zero defect audit system in the United States. I am not sure a zero defect system is even possible, however, I am sure based on how the SEC and the IRS operate that if the Government did the audits themselves it would be much much worse. If PwC had 6 sub-standard audits according to the PCAOB, the defect rate would be very very small. The cost to the investing public of making all 4 Firms virtually perfect would probably be way beyond the benefit.

      We should be looking a systemic problems and not implying corruption or collusion and impugning audit firm’s integrity every time we have a failure.

    11. Four acquisitions, four identical structures, same issue, hummm.

    12. Terry Fox @ 10 —

      How do you measure the “defect rate”? If PCAOB found 6 “sub-standard audits” the ratio would be 6 over the total number of audits that PCAOB reviewed, not the total number of audits that PwC performed. “Very very small” likely is not an accurate description of that ratio.

      I for one do not advocate a zero-defect audit environment. I do, however, advocate an environment of accountability. Right now, the only real accountability comes from the legal system. This is because SEC and PCAOB are driven by politics and budgets, and not by a mission to enforce statutory, regulatory or even AICPA ethical standards. And the legal system is a dang poor way of enforcing quality standards and accountability; it’s too expensive and wastes time and resources.

      If I saw individual partners held accountable for their blown audits, and firms held accountable for failing to exercise sufficient oversight on their partners, then I would see a ray of hope in this miasmic gloom of obfuscation and spin. And I bet if individual partners and their firms had a clear understanding that they WOULD be held accountable by their peers and by their clients, if they understood that the linkage between professional negligence and professional accountability was a certainty, then they would do a better job of performing audits.

      You say the cost of making all audit firms “virtually perfect” would outweigh the benefits. I say that the current oligopolistic structure distorts any true cost/benefit analysis, so your assertion(s) lack evidentiary support. You defend the status quo on the basis of cost versus benefit, and I say the true costs are hidden and the true benefits are unknown. But I know the status quo should not be accepted. I say that the lack of accountability can be addressed cheaply and will naturally move the firms toward a lower incidence of botched audits.

      Hey! It’s almost like I’m on a soapbox. What am I doing up here?

      — Tenacious T.

    13. @TT

      I actually like it when you’re on your soapbox. Myself along with others could stand to learn some things from you.

      I fully agree with you that today’s audit model needs some revamping, and perhaps an overhaul. And there does need to be accountability among firm leadership. However, I do feel you gotta at least acknowledge where @Terry Fox is coming from. You say he lacks real evidence that costs will outweigh the benefits in trying to foster a perfect audit environment. While he may not have any evidentiary support for his point, maybe this very simplistic (and perhaps extreme) example in the meantime will do – Imagine a college student’s parents telling him as he begins his freshmen year that he is to make straight As throughout his college career. And in doing so, he must not have a single incorrect answer on ANY of his homework, quizzes, or exams – he has to score 100%, 100% of the time. And any deviation from this expectation will result in harsh consequences. How do you think the student will feel before even setting foot in a classroom? Imagine him even trying to meet those expectations. The poor kid will have to sacrifice so much of himself that he will probably crash and burn before finishing his first year because he ends up being counterproductive. How would any student survive trying to meet those expectations? He’d be much better off at least aiming for 3.5 GPA…

      I think you can see where I’m going with this (and like I said, this is probably too basic of an example, but in the absence of the TF’s support, I figured my little example might help). Without considering evidential matter, I think part of it is just common sense. Trying to promote a perfect, no-fail audit environment is simply non-productive – resources become ridiculously wasted, everyone burns out, staff morale plunges, etc, etc. Which is partly why the concept of “reasonable assurance” exists in my view. I know you have way more breadth and depth on this area of discussion than I do (see: my pseudonym for this post), but just respectfully givin out my two cents on this thats all.

    14. @13, you make some good points, and I do see where you’re coming from, but I think the “no-defect audit” is a strawman. I would agree with TT on the environment of accountability, so that in those blown audits we do hold people responsible for their negligence.

      Big picture, we can say that most audits go well (or so we think, right?) And we’re fine from the 30,000 feet view, but when we come down to individual Hurons, we can’t pawn it off on reasonable assurance if the teams aren’t performing the procedures and asking the questions to obtain that reasonable assurance. If we dive deeper and see that the auditors couldn’t have detected the fraud, or shouldn’t have been expected to know something, so be it.

      A little off topic, but GM was blown, too. How so? Well, it should have been a going concern years ago, and issuing one for 2008 is like getting an email from the weather service after the hurricane blows through and cuts off your power. We as auditors need to show some spine, whether or not perfection is attainable.

    15. Clown College:
      I assure you I know what the issues are and what proper accounting for contingent consideration is as well as other SFAS 141 and 141(R) requirements. I await more facts before coming to a conclusion. I’ll say again, from what I have read, the initial accounting looks correct. As one who blasts the Big 87654 regularly, including PWC’s miserable excuses for audits at AIG and Satyam among other, it looks like PWC is in the clear here.

    16. Missing forest Auditors look at large transactions in detail….materiality…..big deals….no stay bonuses…why… anyone who has done ma work knows better…..hide behind rulles or dig…

    17. […] well-known history and mentions of Lehman Brothers, GE, GM, New Century, Satyam, Refco and Huron Consulting.  I also drop names like Michelle Leder and Aaron Task, two people who know much more about where […]

    18. […] responsibility and accountability to outsiders that comes with it. Tell that to the employees of Huron Consulting, a public company in Chicago, under $500 million in revenue. Huron is under SEC investigation, […]

    19. So where does the SEC investigation stand. I can’t even find anything that says they started an investigation. How long does that usually take?

    20. @AreAitch

      The SEC will not publicize an investigation. The company is supposed to disclose it but they often do not. And they often take years, in particular if there are criminal issues involved.

    21. […] where I’ve seen adequate identification and warning of poor audit processes: American Home and Huron Consulting. Slow issuance of the inspection reports, the lack of transparency caused by the secrecy provisions […]

    22. […] make sure that the entrepreneurial former Arthur Andersen partner Bergstein does not make the same mistake the former Arthur Andersen Huron guys made and pay off favorite folks without accounting for it […]

    23. […] in 2008 all of the deficiencies cited in their firm report were about goodwill. Then their client, Huron Consulting, suffered a significant scandal regarding their goodwill […]

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