CAQ WEBCAST
PCAOB Insights on Smaller Firm
Inspections
The views expressed by the presenters do not necessarily represent the views, positions, or opinions of
the Center for Audit Quality or the presenters’ respective organizations. These materials, and the oral
presentation accompanying them, are for educational purposes only and do not constitute accounting or
legal advice or create an accountant-client or attorney-client relationship.
Slide 1
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Slide 2
CAQ Members-Only Web Site
CAQ Inspection Readiness Resource Area
Slide 3
Today’s Objectives
Today’s program is designed to help you better
understand:
 The basis used to develop the PCAOB’s 4010
report of domestic triennially inspected firms
 The 11 audit areas where significant or frequent
auditing or quality control deficiencies were
observed
 General responsibilities of the auditor
 Common inspection observations
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Today’s Objectives
Mark West
Regional Associate Director of Inspections
PCAOB
Joan Waggoner, CPA
Partner in Charge of Quality Assurance
Blackman Kallick
Kurtis Wolff, CPA
Principal in Charge of Audit and Assurance
Reznick Group, P.C.
**********
Cynthia M. Fornelli
Moderator & Executive Director
Center for Audit Quality
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Caveat
The views expressed are my own views and
do not necessarily reflect the views of the
Board, individual Board members, or the
staff of the PCAOB.
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Overview
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Issued “Report on the PCAOB’s 2004, 2005 and
2006 Inspections of Domestic Triennially
Inspected Firms” – October 22, 2007
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Basis used for preparation of report
Discussion of eleven audit areas where
significant or frequent auditing or qualitycontrol deficiencies were observed
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General responsibilities of auditor
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Common inspection observations
Small Firm Statistics – Inspection Process
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Approximately 1000 domestic small firms are registered
with the PCAOB
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Performed 497 inspections of domestic small firms
between 2004 and 2006
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Geographically dispersed
Diverse in size, number of issuers and number of offices
Approximately 62 percent of these firms had five or fewer
issuer audit clients
Only 10 percent of these firms had greater than 26 issuer audit
clients
Conducted engagement file reviews of portions of
approximately 1600 issuer audits
Report Statistics
There have been approximately 440 small firm
reports issued as final to date related to the
2004 -2006 inspection period
 Approximately 248 reports (57 percent)
identified at least one audit performance
deficiency in one or more audits, as well as
criticisms of, or concerns about potential defects
in, the firm’s quality control system
 Rule 4010 report on small firms –
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Describes deficiencies that the Board views as
warranting emphasis in a general public report
Audit Areas
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Significant or frequent auditing or quality-control deficiencies were
observed in 
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Revenue
Related-Party Transactions
Equity Transactions
Business Combinations and Impairment of Assets
Going-Concern Considerations
Loans and Accounts Receivable (including allowance accounts)
Service Organizations
Use of Other Auditors
Use of the Work of Specialists
Independence
Concurring Partner Review
Revenue
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General responsibilities of the auditor
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Common inspection observations
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Perform substantive procedures to test existence,
completeness, and valuation of revenue
Review revenue contracts for terms and conditions that can
impact revenue recognition
Test whether revenue was recorded in the appropriate period
Inappropriate use of testing A/R or inventory as a proxy for
testing revenue recognition
Inappropriate reliance on management representations without
corroboration regarding appropriateness of revenue recognition
Over-reliance on poorly designed analytical procedures
Complex or specialized revenue-recognition principles not
adequately addressed
Related Party Transactions
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General responsibilities of the auditor
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Common inspection observations
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Identification of the existence of related parties
Identification of material transactions with related
parties
Identification of material transactions that may be
indicative of the existence of related parties
Testing of the nature, economic substance, and
business purpose of transactions with related parties
not effective
Address lack of disclosure of related party
transactions
Equity Transactions
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General responsibilities of the auditor
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Common inspection observations
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Evaluate compliance with applicable accounting principles in
accounting for equity transactions, including adequacy of
disclosures
No evaluation of the reasonableness of fair value assigned to
equity-based transactions for goods/services (employees or
nonemployees)
No testing of assumptions used to value options or warrants
(e.g., volatility factor)
Inappropriate reliance upon management’s decision to
determine fair value based on other sources besides market
value
Business Combinations and Impairment of
Assets
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General responsibilities of the auditor
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Common inspection observations
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Determine whether the transaction was accounted for in
accordance with GAAP (e.g., valuation, purchase price
allocation and disclosure)
Inadequate testing of estimate of fair values assigned to assets
acquired
Inadequate testing of allocation of the purchase price to the
assets acquired and liabilities assumed
Inappropriate evaluation of client's accounting for and reporting
of a business combination (e.g., common control merger, asset
acquisition as business combination)
Unaware of certain terms contained in the merger agreement
(e.g., contingent considerations)
Business Combinations and Impairment of
Assets
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General responsibilities of the auditor
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15
Evaluate recoverability of intangible or other longlived assets in accordance with GAAP
Common inspection observations
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Inappropriate reliance on management
representations that asset values were not impaired
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Inadequate testing of underlying assumptions and
data used to assess recoverability
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No evaluation of analysis prepared by management
to support a recorded impairment charge
Going Concern Considerations
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General responsibilities of the auditor
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Common inspection observations
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Evaluate whether there is a substantial doubt about
the entity’s ability to continue as a going concern
No going concern analysis performed despite
warning signs, such as recurring losses, negative
working capital, or accumulated capital deficits
No evaluation of management’s plans to mitigate
going concern conditions, or likelihood such plans
could be implemented
Address lack of disclosure of going concern
conditions or management’s plan
Loans and Accounts Receivable (including
allowance accounts)
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General responsibilities of the auditor
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Common inspection observations
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Presumption that auditor will confirm accounts receivable
unless certain conditions are present
Evaluate reasonableness of the allowance for doubtful
accounts or loan losses
No consideration or documentation of rationale for not
confirming A/R
No or insufficient alternative procedures performed for
confirmations not received or unresolved discrepancies from
confirmation responses
No testing of assumptions or underlying data used by
management to develop the allowance for loan losses
Inadequate testing of aging reports and collectibility of
accounts receivable
Service Organizations
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General responsibilities of the auditor
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Common inspection observations
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Consider effects of use of service organization on issuer’s
internal controls
Perform appropriate procedures to reduce assessed level of
control risk below maximum
Firm did not assess the operating effectiveness of user controls
identified by the service auditor
Firm did not consider whether the service auditor’s report
provided sufficient evidence regarding the effectiveness of
controls to support the assessed level of control risk
If the SAS 70 report did not cover the entire period under audit,
the Firm did not make inquiries regarding the possible changes
in service organization controls
Use of Other Auditors
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General responsibilities of the auditor
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Common inspection observations
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Determine whether firm can serve as principal auditor
If taking responsibility for other auditor’s work (e.g., “outsourced” staff), determine involvement in planning, supervision,
and review of work of other auditor
Materiality of portion of financial statements audited by firm not
sufficient to allow firm to report as principal auditor
Insufficient planning, supervision, review and addressing of
significant audit areas in audits where firm assumed complete
responsibility for the work of other auditing firm and does not
refer to the report of the other firm
Use of the Work of Specialists
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General responsibilities of the auditor
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Common inspection observations
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Evaluate professional qualifications and relationship
to the issuer
Obtain understanding of methods and assumptions
used and make appropriate tests of data
Inadequate consideration of relationship between
issuer and specialist which may impact the
independence or objectivity of the specialist
Inadequate testing of underlying assumptions and
data used by the specialist
Independence – Prohibited Non-Audit
Services
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Most common inspection observation noted on
independence related to the preparation of financial
statements and related footnotes
The auditor is prohibited from providing bookkeeping
and other services related to the accounting records or
financial statements of the audit client, such as 
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Preparing the audit client's financial statements that are filed
with the SEC or that form the basis of financial statements filed
with the SEC
Maintaining or preparing the audit client's accounting records
Preparing or originating source data underlying the audit
client's financial statements
Independence – Indemnification
Firms entered into agreements which impaired
their independence
 Accountant is not independent when he or she
enters into an indemnity agreement with the
issuer audit client that 
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Seeks to provide the accountant immunity from
liability for his or her own negligent acts, whether of
omission or commission, or
Seeks to have the audit client release, indemnify or
hold harmless the auditor from any liability and costs
resulting from knowing misrepresentations by the
audit client's management
Firm Independence Policies and Procedures and
Independence Confirmation with Audit Committees
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Firms did not comply with quality control
standards related to independence policies and
procedures as required by PCAOB Rule
3400T(b)
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Did not confirm independence of firm personnel
Did not test accuracy and completeness of personal
investment information
Did not maintain current listing of issuer audit clients
Did not offer independence training program
Firms did not provide audit committee with
written confirmation of its independence of the
issuer within the meaning of the security laws
Concurring Partner Review
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Common inspection observations
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Scope of concurring partner review
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Timeliness of concurring partner review
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Review points are not addressed by the
engagement team prior to release of the audit
opinion
Qualifications of concurring partner
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No evidence that review was performed
Reviewer does not have sufficient technical
competence and/or experience
Questions & Summary
Slide 25
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www.theCAQ.org
Slide 26
CAQ WEBCAST
PCAOB Insights on Smaller Firm
Inspections
(end)
Slide 27