Gol's Whole Goal of Internal Control

Gol Linhas Aéreas Inteligentes S.A., also known as Gol Intelligent Airlines is a low-cost airline corporation based in Sao Paulo, Brazil. In doing its business, Gol has been encountering problems with its internal control, especially the accounting system of recording advance ticket sales, revenue accruals, and the ‘maintenance deposit’ assets.

Deloitte Touche Tohmatsu Auditores Independentes is a Deloitte branch in Brazil. During the time of this issue, Deloitte has been the auditor of Gol. However, as opposed to the big name it is carrying, it can be argued that Deloitte had not been doing a satisfactory job in its Gol’s audit. They failed to obtain sufficient documents and evidence regarding these issues and later issued an unqualified audit opinion anyway.

As it turned out, Gol found out about the material weakness and issued a financial report restatement. This triggered the attention of the SEC and PCAOB to investigate the issue further as a restatement automatically implies that there was a material misstatement in the financials. The problem was that the financial statement Gol proposed to restate had already been approved and authorized by the Deloitte partner. By this time, the falsely authorized unqualified audit report was on the verge of being exposed. But, rather than cooperating with the PCAOB investigation and admitting wrongdoing, the auditors further complicated the issue by altering the work papers and providing the fabricated documents to the investigators. The documents were later proven to be fictitious and a surprisingly large number of high roles are held accountable for their involvement in this issue.

The Nature Internal Control Weaknesses At Gol

Gol has been struggling in its internal control system and has not been able to figure out the process of recording their revenue accruals and which period they belong to. Gol has also shown material weaknesses over the accounting of advance ticket sales. Auditors’ responsibility is to track these kinds of material weaknesses through inquiries and evidence tracing and vouching. However, in this case, Deloitte failed to obtain sufficient evidence regarding this issue.

Other than that, there were also some issues in their financial statements regarding the accounting of their maintenance deposit assets. The auditors once again failed to obtain sufficient evidence and later improperly acquiescing to the Issuer’s accounting of its maintenance deposit assets.

This led to Deloitte issuing materially misstated financials and false unqualified audit reports on the Issuer’s 2010 financial statements and ICFR. This violated the Exchange Act Section 10(b), Exchange Act Rule 10b-5, and PCAOB standards.

After year end, Gol realized that there was a material weakness in their internal control system and later issued a restatement of $57 million. This restatement implies that there was an audit failure which means that Deloitte issued an unqualified audit opinion on financial that is incorrect. Gol's announcement of its financial restatement started to gain the attention of the SEC and PCAOB, which opened up the investigation.

However, rather than cooperating with the PCAOB, the auditors chose to add another layer of unethical and unprofessional behavior. To cover up their false unqualified audit opinion, they altered the work papers in advance of the 2012 PCAOB inspection. In this matter, the auditors failed to perform professional due care and were dishonest in their filings.

The Role of The Audit Engagement Partner

Jose Domingos do Prado played a large role in the unethical actions taken by Deloitte Brazil in relation to the Gol engagement. He was responsible for authorizing the issuance of Deloitte Brazil’s audit reports on Gol and gave his authorization while knowing that there were violations of accounting standards in the unqualified audit reports. Some of them involve significant issues in the recording of maintenance deposit assets, passenger revenue, and advance ticket sales.

In anticipation of the PCAOB inspection of this audit, Jose told senior managers to alter their papers to hide the falsified statements they had made in issuing their opinion. While he violated many standards, some of his failures include those of failing to obtain sufficient evidence and to investigate possible material misstatements. Along with these violations, he acted unethically and unprofessionally by leading his team to falsify their opinion and work. Rather than setting a good example and tone, Prado did the opposite and directly told his subordinates to make unethical decisions, and lie to the regulatory boards.

Violations of PCAOB rules and standards

This case relates closely to the audit documentation standard (previously standard number three, currently number 12). This standard regulates that a final set of audit documentation is completed by a specified date and that no documentation is altered after this completion date. Prado and his team of senior managers violated this standard during the Gol engagement in that they did alter their documents after they had been completed, in an attempt to cover up their incorrect work. It also relates to the PCAOB Rule 4006. This rule, titled “Duty to Cooperate with Inspectors,” requires firms and their associates to cooperate with inspections conducted by the PCAOB. Prado’s team did not cooperate with inspections as they falsified documents, and provided them to the Board despite their misleading and incorrect information.

Concerning Prado’s efforts during the audit, his errors relate to paragraphs 05, 06, and 08. Paragraph 05 requires that documentation demonstrate compliance, support of conclusions, and reconciliation of accounts with financial statements. Prado knew false information related to these areas were in the work papers but authorized them as being complete anyway. Paragraph 06 requires that documentation show the work was actually performed. In this case, Deloitte Brazil did not take the additional steps needed to investigate potential misstatements but wrote that they did everything necessary. Similarly, paragraph 08 requires the identification of significant findings inconsistent with the auditor’s conclusions. Prado could have identified the possibilities of a potential misstatement as findings against the conclusion.

Also, paragraph 09 gives guidance on what an auditor must do if they recognize, after the completion date, that there is not sufficient documentation or evidence of the auditor's conclusions. This paragraph requires that the auditor must demonstrate and clarify that sufficient procedures were performed, evidence was obtained, and conclusions were appropriate through written evidence (and possibly additional documentation). Though Prado knew that the audit did not have sufficient documentation, rather than altering the work with additional documentation, he altered them to cover his errors.

The Impact On Gol's Stock

The more analysts a company has following its performance, the more reluctant a company is to fix the Financial Statements. When an analyst follows a company, they will publish a press release with their estimated EPS. Some will argue higher than others and some less than the others, giving us the average EPS, which will be the benchmark in the market. The more press release published, the more attention a company gets. And the more attention it gets, the more a company worries about the number. As of November 2019, Gol has six analysts following its performance with a high estimate of $24, a low estimate of $19.95, and an average of $21.98. This consensus induces pressure toward the management to meet or beat this analyst consensus.

From the quantitative benchmark, posting adjusting entries can result in lower expected earnings than what the analysts estimated and thus hurt the financial income of the company. On the other hand, seen from the qualitative benchmark, a negative earnings surprise will hurt the public perception of the company’s management that has failed to achieve the target earnings.

What is the current analyst consensus earnings for Gol today?

As of November 12, 2019, there are six analysts following GOL’s performance with the consensus of $21.98/share (high: $24/share, low: $19.95/share). Based on the analysis, the consensus for Gol’s stock is a strong buy.

What does the term “analyst consensus forecast” mean?

There can be several analysts following a company’s stock with each own estimate of the stock price expectation. The analyst consensus forecast is the average number of the estimates from each of the individual analyst who follows the company’s stock.

In this case, Gol has six analysts following its stock performance. The analyst's consensus forecast is the average of the six estimates of the stock price from the six analysts.

What is a negative earnings surprise?

A public company in the United States may have many analysts following its company’s performance in the market. Based on this, the analysts will come up with the projection of Earnings Per Share for the upcoming three months. A negative earnings surprise is a situation when the management fails to achieve this estimated Earnings Per Share, resulting in lower financial earnings and potentially a drop in the share price.

The Stock Market Reaction to The PCAOB Enforcement Filings on December 5, 2016

In the screenshot above, we can see that on December 5, 2016 (the PCAOB enforcement filing day), the GOL’s share price blipped down slightly as a result of the issue announcement. Even though it was concerning the auditor’s enforcement action, Gol’s stock price also suffered. This was because the investors lost trust in the audit report. They were worried that the report that the auditor issued was incorrect and hence the investors were backing down from the investment.