GE GE Aerospace

By David Benoit 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (January 31, 2019).

Accounting giant KPMG LLP has been blessing the books of General Electric Co. for 110 years, but the audit currently under way holds significant risks for both companies.

KPMG is under fire for a string of audit failures and scandals, highlighted again Friday in a set of scathing reports by the nation's top accounting regulator, which is demanding KPMG increase its skepticism and improve the quality of work, particularly at big, complicated clients like GE.

A tough audit is the last thing GE needs right now. Investors have already been concerned about more unknowns bubbling up. The conglomerate is trying to increase cash, pare debt and return to growth. More bad news could hamper those efforts or provide evidence for investigators from the Securities and Exchange Commission and the Justice Department, which are probing GE's accounting decisions.

GE is set to release its fourth-quarter numbers on Thursday. As with most quarterly earnings, those numbers won't be officially audited. But, in one of the biggest and most lucrative audits of any company, hundreds of KPMG partners and staff are poring over GE's books in preparation for the company's annual audited results, likely released in late February.

KPMG hasn't been named in the GE investigations, but the Public Company Accounting Oversight Board, or PCAOB, released several reports Friday calling into question KPMG's work on similar issues.

The reports said PCAOB found problems in nearly half of the 103 KPMG audits it inspected from 2016 and 2017 and said improvements it ordered in prior years hadn't been made. The regulator also disclosed new details on the impact of leaks from the PCAOB about what audits would be reviewed, which helped KPMG prepare for the annual inspections.

KPMG said in a letter to PCAOB that it has taken significant steps, including management and board changes, to improve its processes.

A spokesman said it couldn't comment on GE specifically but that "We are confident that our audits and reviews were appropriately performed in accordance with applicable professional standards, and we stand behind our work."

The PCAOB reports don't name specific clients of the auditor, and it wasn't clear if the regulator had inspected or found any issues with KPMG's work related to GE, which said it doesn't believe its audit is involved.

But the reports criticize how KPMG policed its clients over the accounting questions that are central to the GE probes: How did GE decide when to book revenue and how to value assets, and why were the assumptions behind those decisions too optimistic?

GE has said it is cooperating with the probes and that it hasn't found evidence of wrongdoing. The company said it would consider new auditors for 2020.

GE has said the government investigators are looking at how it booked revenue from service contracts in its power business, which builds turbines used by electricity generators and sells longtime contracts to service them.

In the PCAOB reports, the most frequent area of trouble was KPMG's work on how clients decided to book revenue, which came up 18 times in 103 audits.

The investigators are also looking at a $22 billion write-down GE took on its 2015 acquisition of French company Alstom's power business.

The PCAOB four times faulted KPMG for the work it did while checking clients' assumptions when assigning value to acquired assets.

In another thread of the auditing probes, GE is facing scrutiny over a $15 billion increase to its reserves for long-term care insurance policies, which cover care like nursing homes and proved more expensive than much of the industry expected. GE has said the need for more reserves was discovered following a sudden spike in claims that differed from historical trends.

In the 2017 report, the PCAOB cited KPMG for failing to adequately test an insurance client's use of historical data to estimate future insurance claims.

For KPMG, the report was the latest blow to its reputation amid many scandals, including the leak from the PCAOB about audit reviews. Three people, including a former KPMG partner, have pleaded guilty to criminal charges; two other former partners still face charges.

The regulator said that leak led to a review of 10 new KPMG audits from 2016. The inspections turned up problems in nine of those audits.

No matter what happens with the SEC and Justice Department investigations or the current audit, KPMG's bottom line is already likely to take a hit.

GE paid KPMG $142.9 million in 2017, the biggest total audit fee for any company regulated by the SEC, according to Audit Analytics. The fee was higher than in recent years due to work done on GE's efforts to break off assets. GE has been one of the 10 most lucrative audits in each of the past five years, Audit Analytics data said.

The GE audit was so important to KPMG that roughly 400 partners worked on it last year, according to GE's financial disclosures. But the importance of GE to KPMG raised questions among investors about auditor independence, and whether the accounting firm would stand up to GE's aggressive accounting maneuvers.

The pressure was clear inside KPMG, where people who worked there said a well-known phrase among executives was, "you don't want to be the partner who lost the GE account."

Thomas Gryta contributed to this article.

Write to David Benoit at david.benoit@wsj.com

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January 31, 2019 02:47 ET (07:47 GMT)

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