Chapter 1
Management’s Assertions
PCAOB RELEASE NO. 104-2005-119
• When auditing the completeness, existence and
valuation assertions for deferred revenue, the
sample of items tested by the Firm was inadequate
because the Firm used the wrong method of
sampling.
PCAOB RELEASE NO. 104-2005-119
• The issuer accounted for lease incentives
received from landlords as a reduction of
depreciation expense, rather than as a reduction
of rental expense as is required by EITF No. 883, Rental Concessions Provided by a Landlord
and FASB Technical Bulletin No. 88-1, Issues
Relating to Accounting for Leases. This
treatment resulted in an understatement of
depreciation expense and an overstatement
of lease expense, as well as an understatement
of deferred liabilities and fixed assets.11/ The
Firm should have identified and addressed the
incorrect accounting.
Chapter 2
Generally Accepted Auditing Standards
GAAS
Auditing Standards of the
Public Companies Oversight Board
Auditing Standards of the PCAOB
PCAOB RELEASE NO. 104-2005-119
• On the audit of this issuer, the Firm represented
that it relied on the work of internal audit related to
the portion of the issuer's loan portfolio that is
serviced by third parties; however, the Firm failed
to perform, or failed to include evidence in the
work papers that it had performed, the following:
procedures to understand and evaluate the
internal controls at the service organizations,
Chapter 2 GAAS
PCAOB RELEASE NO. 104-2005-119
• In this audit, the Firm failed in several respects to
obtain sufficient competent evidential matter to
support its audit opinion –
Chapter 2 GAAS
PCAOB RELEASE NO. 104-2005-119
• . the Firm failed in several respects to obtain
sufficient competent evidential matter to
support its audit opinion –
Chapter 2 GAAS
PCAOB RELEASE NO. 104-2005-119
• the Firm failed in several respects to obtain
sufficient competent evidential matter to
support its audit opinion –
Chapter 2 GAAS
Chapter 12
Reports on audited Financial Statements
PCAOB RELEASE NO. 104-2005-119
The Firm's evaluation of the issuer's ability to continue as a going
concern was inadequate. The Firm's conclusion that the issuer had
the ability to do so was based, in part, on the availability of the
issuer's revolving credit facility. As a result, the Firm did not include a
going-concern paragraph in its report on the issuer's 2003 financial
statements. The issuer's access to the revolving credit facility,
however, was dependent on the issuer's compliance with all the debt
covenants, and the Firm failed to assess adequately the likelihood
that the issuer would be able to meet one of these covenants, the 12month trailing revenue covenant, for the first quarter of 2004.
Specifically, although actual revenues for 11 of the 12 months to be
used for measuring compliance with this covenant were available
before the end of field work, and these amounts appeared to indicate
that revenues for the 12 months would fall short of the amount that
would allow the issuer to meet the covenant at the end of the first
quarter, the Firm did not specifically evaluate the issuer's ability to
meet this covenant for the first quarter, nor did it evaluate how the
issuer would be able to continue as a going concern should it not
meet the covenant.13/ In addition, the Firm did not obtain a
management representation covering projections and assumptions
related to the covenant.
Chapter 12 Reports
Chapter 5
Internal Control Evaluation
PCAOB RELEASE NO. 104-2005-119
The Firm relied on certain controls, in particular general
computer controls, automated application controls and
security controls, without performing, or without
documenting in the work papers the performance of,
sufficient testing to support reliance on those controls.
Deficiencies included: (1) the Firm's documented testing of
certain controls only covered activities occurring outside the
audit period, (2) the Firm's work papers indicated that it used
reports generated by the payroll department to perform certain
tests of controls, but the Firm did not document any test work
over the completeness of those reports, (3) the Firm did not
document the sample sizes, or how they were determined, for
the testing of certain controls,
Chapter 5 Internal control evaluation
PCAOB RELEASE NO. 104-2005-119
the Firm assessed control risk for revenue as below the
maximum, without having performed sufficient tests of the
issuer's general computer controls to support that
assessment. The issuer's information system processing
environment relies heavily on processing of orders through an
electronic data interchange that links with an enterprise
system that interfaces with a separate accounts receivable
system. The Firm failed to perform tests of the electronic data
interchange system or the financial statement system. In
addition, for the controls that the Firm did test, the work
papers did not provide evidence that the systems tested
and relied upon during the audit continued to operate
effectively throughout the period of intended reliance.
Chapter 5 Internal control evaluation
PCAOB RELEASE NO. 104-2005-119
the Firm assessed control risk in one area as "low"
without having performed sufficient tests of controls to
support that assessment. The Firm's controls testing relied
on system-generated reports, without the Firm having tested
the underlying data, general IT controls, or related system
application controls to gain assurance that the reports were
accurate and complete.
Chapter 5 Internal control evaluation
PCAOB RELEASE NO. 104-2005-119
There was also no evidence in the work papers to indicate
that the Firm (1) audited the income tax provision beyond
comparing the issuer's tax schedules to the financial
statement disclosures; (2) obtained testing results that
supported the Firm's assessment of control risk as below the
maximum; (3) considered the effects of distributor agreements
on revenue recognition, even though sales to third-party
distributors contributed 64 percent of net sales in 2003; or (4)
performed required journal entry testing or look-back testing of
significant estimates.
Chapter 5 Internal control evaluation
PCAOB RELEASE NO. 104-2005-119
PCAOB standards require the auditor to test
internal controls before relying on them for the
purpose of designing and performing the
substantive audit procedures. In 13 instances
involving the audits of 10 issuers, the Firm failed
to test, or failed to perform sufficient tests of,
controls that the Firm relied on in designing and
performing its substantive audit procedures.
The instances included the following:
Chapter 5 Internal control evaluation
PCAOB RELEASE NO. 104-2005-119
• The Firm relied on information
technology ("IT") application controls
that had not been tested for several
years.
Chapter 5 Internal control evaluation
PCAOB RELEASE NO. 104-2005-119
The Firm relied on IT system-generated data
without testing the IT general computer and/or
application controls.
Chapter 5 Internal control evaluation
PCAOB RELEASE NO. 104-2005-119
... the Firm inappropriately relied on the IT
general controls at a service
organization that managed and
operated the infrastructure for the issuer's
centralized general ledger system, without
sufficient testing of those controls.
Chapter 5 Internal control evaluation
PCAOB RELEASE NO. 104-2005-119
• The Firm assessed control risk as "high" for
expenses, but ....., failed to perform sufficient
substantive procedures on expense balances.
Chapter 3 audit risk model
PCAOB RELEASE NO. 104-2005-119
• the Firm failing to obtain, or failing to document in
the work papers that it had obtained, sufficient
competent evidential matter to support its audit
opinion. Those deficiencies included the following:.
Chapter 4 work paper documentation
Chapter 11
Completing the Audit
PCAOB RELEASE NO. 104-2005-119
On this audit, the Firm used the issuer's internal auditors to
assist in auditing cash at an interim date. The Firm,
however, failed to perform, or failed to have the
internal auditors perform, audit procedures on the
activity in the cash accounts between the interim
date and year end.
Chapter 11 – completing the audit
PCAOB RELEASE NO. 104-2005-119
the Firm audited certain accounts receivable balances
at an interim date, but did not audit the issuer's
analysis of the roll-forward of these balances to the year
end.
Chapter 11 – completing the audit
PCAOB RELEASE NO. 104-2005-119
the Firm tested the operating effectiveness of the
controls over certain processes as of interim testing
dates, but the work papers do not evidence any
procedures to roll forward these tests to the
balance sheet date, and the Firm therefore lacked a
reasonable basis for extending its conclusions to the
balance sheet date.
Chapter 11 – completing the audit
PCAOB RELEASE NO. 104-2005-119
• ….. the Firm used analytical procedures as
alternative procedures. The Firm, however, did not
perform certain required steps, such as developing
expectations and defining a significant difference
threshold, when performing the analytical procedures.
Chapter 11 – completing the audit
PCAOB RELEASE NO. 104-2005-119
…, the Firm failed to obtain sufficient evidence, or failed
to include sufficient evidence in its work papers, that
the unallocated component of the allowance represented a
supportable estimate of probable losses inherent in the
issuer's loan portfolio. The Firm's documented testing
specific to this aspect of the banks' ALL was limited to
certain high level analytical procedures that were not
substantive tests ….
Chapter 11 – completing the audit
PCAOB RELEASE NO. 104-2005-119
…the Firm was aware of indications of deficiencies in
the operating effectiveness of the issuer's controls
over the allowance for loan losses. Particularly in light of
the highly judgmental nature of the area, the Firm's
knowledge of such indications rendered its
assessment of the control risk with respect to the
allowance for loan losses as "minimum"
inappropriate. (Issuers D, E, F, and G)
Chapter 11 – completing the audit
PCAOB RELEASE NO. 104-2005-119
.. the Firm apparently did not reconsider its assessment of
risk and materiality or revisit its audit scope in light of the
known and likely errors ... and did not reconsider its fraud
risk assessment related to an issuer that is unwilling to
correct known errors.
Chapter 11 – completing the audit
PCAOB RELEASE NO. 104-2005-119
The work papers did not document the Firm's threshold for
posting errors to the Score Sheet of Unadjusted Audit
Difference, and several uncorrected errors noted in the
work papers were not posted to the Score Sheet of
Unadjusted Audit Difference, were not evaluated for
materiality in the aggregate,
Chapter 11 – completing the audit
PCAOB RELEASE NO. 104-2005-119
During the issuer's first quarter of fiscal 2005, it reached a
settlement with a customer that it included in net
sales and did not disclose. As a result of including the
entire settlement amount in net sales, the issuer's net
sales increased from the first fiscal quarter of 2004 to the
first fiscal quarter of 2005. If the entire settlement had
been omitted from net sales, net sales would have
decreased. The Firm failed to consider the
appropriateness of including the settlement in net
sales and not disclosing that fact.11/
Chapter 11 – completing the audit