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1. CAQ WEBCAST
PCAOB Insights on Smaller Firm Inspections
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6. 6 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.
7. 7 Overview Issued “Report on the PCAOB’s 2004, 2005 and 2006 Inspections of Domestic Triennially Inspected Firms” – October 22, 2007
Basis used for preparation of report
Discussion of eleven audit areas where significant or frequent auditing or quality-control deficiencies were observed
General responsibilities of auditor
Common inspection observations
8. 8 Small Firm Statistics – Inspection Process Approximately 1000 domestic small firms are registered with the PCAOB
Geographically dispersed
Diverse in size, number of issuers and number of offices
Performed 497 inspections of domestic small firms between 2004 and 2006
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
9. 9 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 –
Describes deficiencies that the Board views as warranting emphasis in a general public report
10. 10 Audit Areas Significant or frequent auditing or quality-control deficiencies were observed in -
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
11. 11 Revenue General responsibilities of the auditor
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
Common inspection observations
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
12. 12 Related Party Transactions General responsibilities of the auditor
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
Common inspection observations
Testing of the nature, economic substance, and business purpose of transactions with related parties not effective
Address lack of disclosure of related party transactions
13. 13 Equity Transactions General responsibilities of the auditor
Evaluate compliance with applicable accounting principles in accounting for equity transactions, including adequacy of disclosures
Common inspection observations
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
14. 14 Business Combinations and Impairment of Assets General responsibilities of the auditor
Determine whether the transaction was accounted for in accordance with GAAP (e.g., valuation, purchase price allocation and disclosure)
Common inspection observations
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)
15. 15 Business Combinations and Impairment of Assets General responsibilities of the auditor
Evaluate recoverability of intangible or other long-lived assets in accordance with GAAP
Common inspection observations
Inappropriate reliance on management representations that asset values were not impaired
Inadequate testing of underlying assumptions and data used to assess recoverability
No evaluation of analysis prepared by management to support a recorded impairment charge
16. 16 Going Concern Considerations General responsibilities of the auditor
Evaluate whether there is a substantial doubt about the entity’s ability to continue as a going concern
Common inspection observations
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
17. 17 Loans and Accounts Receivable (including allowance accounts) General responsibilities of the auditor
Presumption that auditor will confirm accounts receivable unless certain conditions are present
Evaluate reasonableness of the allowance for doubtful accounts or loan losses
Common inspection observations
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
18. 18 Service Organizations General responsibilities of the auditor
Consider effects of use of service organization on issuer’s internal controls
Perform appropriate procedures to reduce assessed level of control risk below maximum
Common inspection observations
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
19. 19 Use of Other Auditors General responsibilities of the auditor
Determine whether firm can serve as principal auditor
If taking responsibility for other auditor’s work (e.g., “out-sourced” staff), determine involvement in planning, supervision, and review of work of other auditor
Common inspection observations
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
20. 20 Use of the Work of Specialists General responsibilities of the auditor
Evaluate professional qualifications and relationship to the issuer
Obtain understanding of methods and assumptions used and make appropriate tests of data
Common inspection observations
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
21. 21 Independence – Prohibited Non-Audit Services 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 -
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
22. 22 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 -
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
23. 23 Firm Independence Policies and Procedures and Independence Confirmation with Audit Committees Firms did not comply with quality control standards related to independence policies and procedures as required by PCAOB Rule 3400T(b)
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
24. 24 Concurring Partner Review Common inspection observations
Scope of concurring partner review
No evidence that review was performed
Timeliness of concurring partner review
Review points are not addressed by the engagement team prior to release of the audit opinion
Qualifications of concurring partner
Reviewer does not have sufficient technical competence and/or experience
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27. CAQ WEBCAST
PCAOB Insights on Smaller Firm Inspections
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