Auditor Changes at Daily Journal Corporation Charlie Munger is vice chairman of Berkshire Hathaway Inc. and...

     

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Auditor Changes at Daily Journal Corporation Charlie Munger is vice chairman of Berkshire Hathaway Inc. and is informally known as War- ren Buffett's "right arm." Munger also serves as chairman of Daily Journal Corporation, which publishes 10 newspapers and offers specialized information services and technology-based prod- ucts. While often mentioned in the media because of his association with Buffett and long tenure and leadership at Berkshire Hathaway, Munger was recently in the news for another reason: his penchant to change auditors at Daily Journal. REPORTING DELAYS On December 16, 2013, Daily Journal informed the Securities and Exchange Commission (SEC) that it would not meet the filing deadline for its 2013 Form 10-K. (Daily Journal has a September 30 fiscal year-end.) The reason stated in its Form 12b-25 filing was that Daily Journal's auditor (EY) had not completed its audit of the financial statements or internal control over financial reporting. Subsequently, Daily Journal informed the SEC that it would also miss the filing dead- line for its December 31, 2013 and March 31, 2014 Forms 10-Q. Once again, the reason stipu- lated in the filings was additional time required by EY to complete its audit and assessment of internal control over financial reporting. (While EY had audited Daily Journal's financial state- ments since 2000, 2013 was the first year EY reported on Daily Journal's internal control over financial reporting.) On June 24, 2014, Daily Journal filed its 2013 Form 10-K (almost seven months after the filing deadline), in which EY issued an unqualified opinion on the financial statements but an adverse opinion on Daily Journal's internal control over financial reporting. Two days later, Daily Jour- nal reported that its audit committee approved the dismissal of EY, effective June 24, 2014. An excerpt from Daily Journal's Form 8-K filing is shown here:² The Audit Committee of the Board of Directors of Daily Journal Corporation (the "Company") approved the dismissal of Ernst & Young LLP ("EY") as the Company's independent reg- istered public accounting firm, effective June 24, 2014... The reports of EY on the Company's financial statements for the past two fiscal years con- tained no adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles. During the Company's two most recent fiscal years and the subsequent interim period, there have been no disagreements with EY on any matter of accounting principles or prac- tices, financial statement disclosure, or auditing scope or procedure, which disagreement(s) if not resolved to the satisfaction of EY would have caused EY to make reference to the subject matter of such disagreement(s) in its report on the Company's financial statements. During the Company's two most recent fiscal years and the subsequent interim period, there have been no reportable events of the kinds described in Item 304(a)(1)(v) of Regula- tion S-K under the Securities Exchange Act of 1934, except that EY expressed an adverse opinion in its report on the Company's internal control over financial reporting as of September 30, 2013 (emphasis added)... The Audit Committee of the Company's Board of Directors has discussed this matter with EY and has authorized EY to respond fully to the inquiries of the Company's successor independent registered public accounting firm. The Compan raquacted and has ranniued a lattor from DV c APPOINTMENT OF BDO USA, LLP On July 3, 2014, Daily Journal announced the appointment of BDO USA, LLP as auditor to replace EY. Shortly following BDO's appointment, Daily Journal filed its Forms 10-Q for the first (filed on August 13, 2014), second (filed on August 15, 2014), and third (filed on August 18, 2014) quarters of 2014, bringing Daily Journal current with respect to its SEC filings. SEC COMMENT LETTER Almost on cue, the Division of Finance at the SEC sent a letter of comment to Gerald Salzman (CEO of Daily Journal) that raised concerns with the 2013 Form 10-K. This letter (dated September 25, 2014) referenced Daily Journal's disclosure of intangible assets from an acquisition, the effective- ness of Daily Journal's internal controls, and discrepancies between preliminary financial filings on Form 8-K and subsequent filings on Form 10-Q. With respect to the intangible assets, Salz- man's response to the SEC noted the following: At the time of the New Dawn acquisition, the Company discussed the purchase price allocation with EY. Accordingly, the Company was surprised when EY first raised the [accounting] issue after the original filing deadline. As further discussed below, the Com- pany does not believe that the adjustments were necessary under GAAP, but EY required them as a condition to the delivery of its audit report. The Company did not view this as a disagreement with EY, but rather a matter of the parties making different judgment calls about the requirements in these specific circumstances regarding a matter the Company believed was not material to investors. Accepting EY's position was a practical decision on the part of the Company, and not the result of deficiencies in the Company's close process or in the areas where the adjustments were made. In the midst of these distractions, Daily Journal notified the SEC that it would not meet the fil- ing deadline for its 2014 Form 10-K (which was ultimately filed 28 days after the December 31, 2014 deadline). BDO issued an unqualified opinion on Daily Journal's financial statements and an adverse opinion on its internal control, citing in part issues noted in the SEC's letter of comment in this latter opinion: The Company does not have sufficient technical expertise in assessing and applying accounting standards to non-routine transactions, reviewing the quarterly and annual tax analysis and provision, and assessing the adequacy of disclosures in the quarterly and annual consolidated financial statements. The Company amended its Form 10-Q for the third quarter of fiscal 2014 to restate amounts to correct a misstatement in the accounting for income taxes in connection with one of its acquisitions. This resulted in material audit adjustments the Company recorded to primarily offset the previously recorded income tax benefit as well as additional disclosures in the consolidated financial statements. ANOTHER AUDITOR CHANGE BDO's opinion on Daily Journal's 2015 financial statements and internal control over financial reporting was issued on December 14, 2015 (ahead of the December 31, 2015 deadline). As in the previous two years, Daily Journal received an unqualified opinion on its financial statements and an adverse opinion on internal control over financial reporting; in this latter report, BDO cited a material audit adjustment that was required in the fourth quarter of fiscal 2015. In February 2016, Daily Journal announced the dismissal of BDO and the appointment of Squar Milner LLP, a regional accounting firm with offices in California that provides audit or tax services to 30 public companies. Ironically, less than one week earlier, Daily Journal sharehold- ers ratified the appointment of BDO as its auditor with a positive vote of 95 percent of all shares voted." Over a three-year period, Daily Journal engaged the following auditors: Auditor Period 2000-2014 EY 2014-2016 BDO 2016-current Squar Milner No. Offices 80 63 5 Revenue $9.9 billion $1.1 billion $47.4 million Inside Public Accounting Revenue Rank 3 7 71 Academic research examining auditor changes has concluded that clients receiving adverse internal control opinions are more likely to dismiss their incumbent auditors and choose a higher- quality replacement (represented by the size and level of firm, with Big Four being highest qual- ity); this decision may reflect a desire of clients to improve their financial reporting quality. A more recent study found that clients engage in "opinion-shopping" by dismissing auditors prior to potentially receiving an adverse opinion on internal control and often do so later in the fiscal year, in response to anticipating a negative report on their internal control. DISCUSSION QUESTIONS 1. From the SEC website or other sources, locate Daily Journal's 2013 Form 10-K and review EY's report on Daily Journal's internal control over financial reporting. What were some of the weaknesses noted in this report? 2. Review the excerpt (presented in the case) of Daily Journal's Form 8-K (filed with the SEC June 26, 2014) related to the dismissal of EY. What type of disclosures are provided in this excerpt? What are some reasons that Daily Journal would provide these disclosures? 3. Review the excerpt (presented in the case) from Gerald Salzman's response to the SEC. Do you believe this response is consistent with the Form 8-K filing related to the dismissal of EY? What implications might this response have with respect to Daily Journal's internal control over financial reporting? 4. From the SEC website or other sources. locate Daily Journal's Form 8-K (filed July 3, 2014) related to the appointment of BDO. What type of disclosures are provided in this filing? What are some reasons that Daily Journal would provide these disclosures? (Note: Daily Journal filed two different Form 8-Ks on July 3, 2014.) 5. Referring to the professional standards (AU-C 210), what is BDO's responsibility with respect to communicating with EY? 6. From the SEC website or other sources, locate Daily Journal's Form 8-K (filed February 17, 2016) that announced the dismissal of BDO and engagement of Squar Milner. Compare the disclosures in this filing to those in questions (2) and (4) related to the dismissal of EY and engagement of BDO, 7. Why might adverse opinions on internal control over financial reporting prompt Daily Journal to change auditors? Are Daily Journal's auditor change activities consistent with the results of the academic studies summarized in this case? Why or why not? Auditor Changes at Daily Journal Corporation Charlie Munger is vice chairman of Berkshire Hathaway Inc. and is informally known as War- ren Buffett's "right arm." Munger also serves as chairman of Daily Journal Corporation, which publishes 10 newspapers and offers specialized information services and technology-based prod- ucts. While often mentioned in the media because of his association with Buffett and long tenure and leadership at Berkshire Hathaway, Munger was recently in the news for another reason: his penchant to change auditors at Daily Journal. REPORTING DELAYS On December 16, 2013, Daily Journal informed the Securities and Exchange Commission (SEC) that it would not meet the filing deadline for its 2013 Form 10-K. (Daily Journal has a September 30 fiscal year-end.) The reason stated in its Form 12b-25 filing was that Daily Journal's auditor (EY) had not completed its audit of the financial statements or internal control over financial reporting. Subsequently, Daily Journal informed the SEC that it would also miss the filing dead- line for its December 31, 2013 and March 31, 2014 Forms 10-Q. Once again, the reason stipu- lated in the filings was additional time required by EY to complete its audit and assessment of internal control over financial reporting. (While EY had audited Daily Journal's financial state- ments since 2000, 2013 was the first year EY reported on Daily Journal's internal control over financial reporting.) On June 24, 2014, Daily Journal filed its 2013 Form 10-K (almost seven months after the filing deadline), in which EY issued an unqualified opinion on the financial statements but an adverse opinion on Daily Journal's internal control over financial reporting. Two days later, Daily Jour- nal reported that its audit committee approved the dismissal of EY, effective June 24, 2014. An excerpt from Daily Journal's Form 8-K filing is shown here:² The Audit Committee of the Board of Directors of Daily Journal Corporation (the "Company") approved the dismissal of Ernst & Young LLP ("EY") as the Company's independent reg- istered public accounting firm, effective June 24, 2014... The reports of EY on the Company's financial statements for the past two fiscal years con- tained no adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles. During the Company's two most recent fiscal years and the subsequent interim period, there have been no disagreements with EY on any matter of accounting principles or prac- tices, financial statement disclosure, or auditing scope or procedure, which disagreement(s) if not resolved to the satisfaction of EY would have caused EY to make reference to the subject matter of such disagreement(s) in its report on the Company's financial statements. During the Company's two most recent fiscal years and the subsequent interim period, there have been no reportable events of the kinds described in Item 304(a)(1)(v) of Regula- tion S-K under the Securities Exchange Act of 1934, except that EY expressed an adverse opinion in its report on the Company's internal control over financial reporting as of September 30, 2013 (emphasis added)... The Audit Committee of the Company's Board of Directors has discussed this matter with EY and has authorized EY to respond fully to the inquiries of the Company's successor independent registered public accounting firm. The Compan raquacted and has ranniued a lattor from DV c APPOINTMENT OF BDO USA, LLP On July 3, 2014, Daily Journal announced the appointment of BDO USA, LLP as auditor to replace EY. Shortly following BDO's appointment, Daily Journal filed its Forms 10-Q for the first (filed on August 13, 2014), second (filed on August 15, 2014), and third (filed on August 18, 2014) quarters of 2014, bringing Daily Journal current with respect to its SEC filings. SEC COMMENT LETTER Almost on cue, the Division of Finance at the SEC sent a letter of comment to Gerald Salzman (CEO of Daily Journal) that raised concerns with the 2013 Form 10-K. This letter (dated September 25, 2014) referenced Daily Journal's disclosure of intangible assets from an acquisition, the effective- ness of Daily Journal's internal controls, and discrepancies between preliminary financial filings on Form 8-K and subsequent filings on Form 10-Q. With respect to the intangible assets, Salz- man's response to the SEC noted the following: At the time of the New Dawn acquisition, the Company discussed the purchase price allocation with EY. Accordingly, the Company was surprised when EY first raised the [accounting] issue after the original filing deadline. As further discussed below, the Com- pany does not believe that the adjustments were necessary under GAAP, but EY required them as a condition to the delivery of its audit report. The Company did not view this as a disagreement with EY, but rather a matter of the parties making different judgment calls about the requirements in these specific circumstances regarding a matter the Company believed was not material to investors. Accepting EY's position was a practical decision on the part of the Company, and not the result of deficiencies in the Company's close process or in the areas where the adjustments were made. In the midst of these distractions, Daily Journal notified the SEC that it would not meet the fil- ing deadline for its 2014 Form 10-K (which was ultimately filed 28 days after the December 31, 2014 deadline). BDO issued an unqualified opinion on Daily Journal's financial statements and an adverse opinion on its internal control, citing in part issues noted in the SEC's letter of comment in this latter opinion: The Company does not have sufficient technical expertise in assessing and applying accounting standards to non-routine transactions, reviewing the quarterly and annual tax analysis and provision, and assessing the adequacy of disclosures in the quarterly and annual consolidated financial statements. The Company amended its Form 10-Q for the third quarter of fiscal 2014 to restate amounts to correct a misstatement in the accounting for income taxes in connection with one of its acquisitions. This resulted in material audit adjustments the Company recorded to primarily offset the previously recorded income tax benefit as well as additional disclosures in the consolidated financial statements. ANOTHER AUDITOR CHANGE BDO's opinion on Daily Journal's 2015 financial statements and internal control over financial reporting was issued on December 14, 2015 (ahead of the December 31, 2015 deadline). As in the previous two years, Daily Journal received an unqualified opinion on its financial statements and an adverse opinion on internal control over financial reporting; in this latter report, BDO cited a material audit adjustment that was required in the fourth quarter of fiscal 2015. In February 2016, Daily Journal announced the dismissal of BDO and the appointment of Squar Milner LLP, a regional accounting firm with offices in California that provides audit or tax services to 30 public companies. Ironically, less than one week earlier, Daily Journal sharehold- ers ratified the appointment of BDO as its auditor with a positive vote of 95 percent of all shares voted." Over a three-year period, Daily Journal engaged the following auditors: Auditor Period 2000-2014 EY 2014-2016 BDO 2016-current Squar Milner No. Offices 80 63 5 Revenue $9.9 billion $1.1 billion $47.4 million Inside Public Accounting Revenue Rank 3 7 71 Academic research examining auditor changes has concluded that clients receiving adverse internal control opinions are more likely to dismiss their incumbent auditors and choose a higher- quality replacement (represented by the size and level of firm, with Big Four being highest qual- ity); this decision may reflect a desire of clients to improve their financial reporting quality. A more recent study found that clients engage in "opinion-shopping" by dismissing auditors prior to potentially receiving an adverse opinion on internal control and often do so later in the fiscal year, in response to anticipating a negative report on their internal control. DISCUSSION QUESTIONS 1. From the SEC website or other sources, locate Daily Journal's 2013 Form 10-K and review EY's report on Daily Journal's internal control over financial reporting. What were some of the weaknesses noted in this report? 2. Review the excerpt (presented in the case) of Daily Journal's Form 8-K (filed with the SEC June 26, 2014) related to the dismissal of EY. What type of disclosures are provided in this excerpt? What are some reasons that Daily Journal would provide these disclosures? 3. Review the excerpt (presented in the case) from Gerald Salzman's response to the SEC. Do you believe this response is consistent with the Form 8-K filing related to the dismissal of EY? What implications might this response have with respect to Daily Journal's internal control over financial reporting? 4. From the SEC website or other sources. locate Daily Journal's Form 8-K (filed July 3, 2014) related to the appointment of BDO. What type of disclosures are provided in this filing? What are some reasons that Daily Journal would provide these disclosures? (Note: Daily Journal filed two different Form 8-Ks on July 3, 2014.) 5. Referring to the professional standards (AU-C 210), what is BDO's responsibility with respect to communicating with EY? 6. From the SEC website or other sources, locate Daily Journal's Form 8-K (filed February 17, 2016) that announced the dismissal of BDO and engagement of Squar Milner. Compare the disclosures in this filing to those in questions (2) and (4) related to the dismissal of EY and engagement of BDO, 7. Why might adverse opinions on internal control over financial reporting prompt Daily Journal to change auditors? Are Daily Journal's auditor change activities consistent with the results of the academic studies summarized in this case? Why or why not?

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DISCUSSION QUESTIONS From the SEC website or other sources locate Daily Journals 2013 Form 10K and review EYs report on Daily Journals internal control over financial reporting What were some of the w... View the full answer