The auditing profession’s top U.S. overseer usually does a flawless job of safeguarding the most embarrassing secrets of accounting firms and their corporate clients. Fortunately, every now and then, the watchdog slips up.

Take the case of Kyoto Audit Corp., a Japanese affiliate of the Big Four auditor PricewaterhouseCoopers. On Feb. 14, the U.S. Public Company Accounting Oversight Board released its first-ever inspection report on the Kyoto-based firm.

The report said the board’s staff reviewed the firm’s audits for two companies and found serious problems with both. The deficiencies were so severe, it appeared 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 report said. In other words, the companies’ books could have been horribly wrong, and the auditors wouldn’t have known it.

Who were these two companies? The report didn’t say, in keeping with the board’s longtime policy of refusing to name the companies where its inspectors find botched audits. In this rare instance, though, it wasn’t hard to figure out their identities.

That’s because Kyoto Audit has only two audit clients with U.S.-registered securities. One is Kyocera Corp., a maker of mobile phones and electronic equipment, which has a stock-market value of $17.2 billion. The other is Nidec Corp., the world’s biggest maker of motors for hard-disk drives, which has a $13.6 billion market value. So there, the cat’s out of the bag. Undoubtedly, the companies and the auditor would have preferred you not know.

After last year’s accounting-fraud scandal at Olympus Corp., the medical-equipment company whose books had been blessed by the Japanese arms of Ernst & Young and KPMG, few things would be more important to an investor in a Japanese manufacturer than the knowledge that its auditor did a lousy job. If investors can’t trust the audit, they might not be able to trust the numbers.

This is the fourth column I’ve written revealing the names of publicly held companies whose external audits were criticized in the board’s inspection reports. Hopefully someday the board will change its policy, considering its stated mission is “to protect the interests of investors.”

Historically, the board has said it’s prohibited from naming audit firms’ clients by the Sarbanes-Oxley Act, which created the regulator in 2002. As I’ve pointed out in previous columns, the plain language of the law undercuts this assertion.

The act says the public portions of inspection reports “shall be made available in appropriate detail,” subject to “the protection of such confidential and proprietary information as the board may determine to be appropriate.” Put another way, it’s the board’s call whether to disclose companies’ names, although the Securities and Exchange Commission, which oversees the board, could overrule it. The obvious beneficiaries of the secrecy policy are the accounting firms and their audit clients.

The board’s inspectors conducted their review at Kyoto Audit in December 2010 and January 2011. The deficiencies they found included “the failure, in both audits, to perform adequate substantive analytical audit procedures to test revenue.” Revenue, of course, is the most important line on the income statement.

The report also cited Kyoto Audit’s failures to perform sufficient procedures “to test the allowance for doubtful accounts” and “to test inventory valuation.” The report didn’t provide further details. In plain English, this means the firm hadn’t done enough to check whether sales figures were accurate, customers could pay their bills, or unsold products were worth what the books said. Kyocera and Nidec are both based in Kyoto.

Kyoto Audit’s managing partner, Yukihiro Matsunaga, declined to discuss the firm’s work for the companies. In an Oct. 24 letter to the board, Kyoto Audit said it performed additional audit procedures in response to the inspectors’ findings. “The completion of those procedures did not result in changes to our audit reports or to the issuers’ financial statements,” the firm said. Lucky them.

A spokeswoman for the accounting board, Colleen Brennan, declined to comment. So did a Nidec spokesman, Masahiro Nagayasu.

A Kyocera spokesman, Judah Reynolds, said the company is “confident in the quality” of Kyoto Audit’s work and that the information in Kyocera’s financial reports “is of high quality and complies with all relevant requirements.” He declined to comment on the inspection report.

Founded in 2007, Kyoto Audit has a colorful history. In 2006, Pricewaterhouse’s Japanese affiliate, Chuo Aoyama, was ordered by Japan’s Financial Services Agency to suspend operations for two months after the regulator found the audit firm had helped Kanebo Ltd., a Japanese cosmetics company, falsify its financial reports. Three Chuo Aoyama auditors pleaded guilty to criminal charges.

Chuo Aoyama later changed its name to Misuzu. After more accounting scandals surfaced at its clients, the firm shut down in 2007. The audit teams at Misuzu that had been covering Kyocera and Nidec (NJ) moved to the newly formed Kyoto Audit. The two companies switched audit firms that year along with them.

Today, Pricewaterhouse classifies Kyoto Audit as a “cooperating firm.” It’s not a full-fledged member of the Big Four auditor’s global network. However, it has the right to use Pricewaterhouse’s audit methodology, and has access to the “expertise of the PwC network,” according to Kyoto Audit’s filings with the accounting board. A Pricewaterhouse spokesman, Mike Davies, declined to comment on the inspection report.

Affiliations aside, what matters most to investors about this or any other accounting firm is whether it has blown the audit of a company in which they hold a stake. There’s only one way the accounting board will ever shed its image as a protector of the industry it’s supposed to be regulating: Start naming names. The public needs to know. 

By Jonathan Weil

Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own. ― Ed.

(Bloomberg)