The leading accounting firms that conduct audits on the financial statements of publicly traded companies suffer from a significant and growing number of deficiencies, according to a new report by an industry oversight organization.

In its annual review of eight firms registered with the Public Company Accounting Oversight Board (PCAOB), the board found that 15% of audits conducted in 2010 lacked adequate evidence to support their ultimate conclusion. Of those cases, 85% of the audits also failed to produce sufficient evidence to verify the financial statement purported by the company under review.

"The audit firms need to be diligent in their identification of the controls and then the actual testing of them," PCAOB member Jay Hanson told reporters on a conference call.

The PCAOB report is the first full review to evaluate the efforts of auditing firms under the group's Auditing Standard No. 5, which stipulates that the examiners must conclude with a reasonable assurance that companies are reporting financial results free of "material weaknesses."

The 2010 examinations comprise the most recent review the PCAOB has completed, but in its preliminary findings for the 2011 inspections, the group has found that 22% of audits were not supported by adequate evidence.

"These numbers are just too high because they represent cases where the opinions are not supported," said PCAOB member Jeanette Franzel.

In addition to the 46 examinations identified in the 2010 report as lacking sufficient supporting information, another 50 cases of the 309 the PCAOB reviewed were found to suffer from minor deficiencies relating to quality control issues that did not rise to the level of a failure to support the auditing firms' opinions, but that nonetheless "require remediation."

Importantly, the board noted that the absence of sufficient evidence from the auditors does not imply that the firms under examination materially misstated their financial results, but rather supports the more limited contention that the reviews were not rigorous enough to confidently affirm the quarterly or annual reports.

"The report contains good news and bad news," Franzel said. "In general the deficiencies we found ... were in the team's execution as opposed to the firm's methodology."

The PCAOB report identified weaknesses in the auditors' testing of controls in place to curb the risks of material misstatement, insufficient monitoring of ongoing operations such as comparative modeling of budgets and results to forecasts, and inadequate testing of the system-generated reports produced by the companies under review.

The review determined that of the 46 audit engagements found to be lacking sufficient supporting evidence, 70% suffered from at least two distinct deficiencies.

The board suggested that the shortcomings in the audits could be attributed variously to reductions in staffing, insufficient training and poor implementation of the top-down auditing methodology outlined in PCAOB's auditing standard.

The eight auditing firms the PCAOB reviewed for its 2010 report were BDO Seidman, Crowe Horwath, Deloitte & Touche, Ernst & Young, Grant Thornton, KPMG, McGladrey and PricewaterhouseCoopers.

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