Advanced Financial Statement Auditing Topics

ACC557
Outline for Seminar #3

Objective
By the end of this seminar students should be able to describe the key activities of
the PCAOB.

Reading
1. Class question and student presentation (see this Seminar outline).***
2. The effect of SOX on small auditor exits and audit quality, 2011, M. DeFond
and C. Lennox, Journal of Accounting and Economics, 52: 21-40.*
3. Auditing the auditors: Evidence on the PCAOBs inspections of audit firms, 2010,
C. Lennox and J. Pittman, Journal of Accounting and Economics, 49, 84103.
4. When auditors fail to audit: Themes from PCAOB enforcements, T. Herron and
D. Gilbertson, The CPA Journal, May 2011.
***: Required reading
*: Optional reading
: Recommended reading for the presenters and optional for everyone else

Question to be discussed during the seminar

Q1. The Sarbanes-Oxley Act granted the Public Company Accounting Oversight Board
(PCAOB) investigative and disciplinary power over auditors of public companies.
During the course of conducting inspections of auditing firms, the PCAOB may
become aware of certain behaviors or other matters that may lead to an
investigation. Such was the case, when the PCAOB contacted Goldstein and Morris
to inform the firm that it would begin an inspection in November 2004. Shortly after
being notified of the impending inspection, the firms managing partner along with
two other partners determined to conceal certain information from the PCAOB. Visit the
PCAOBs website to learn about the disciplinary proceedings against the firm and the
partners involved in this case and then answer the following questions. You should
read two sets of proceedings, one related to the firm of Goldstein and Morris CPAs,
P.C. and the other related to Goldberger and Postelnik.
a. What specific client-related matters prompted Goldstein and Morriss decision to
conceal certain information from the PCAOB?
b. What sanctions were imposed on the firm, the managing partner, and the two
other partners involved in the investigation? Were these sanctions fair?
Multiple choice questions
The Public Company Accounting Oversight Board does not:
i.
perform inspections of the quality controls at audit firms that audit public
companies.
ii.
establish auditing standards that must be followed by CPAs on all audits.
iii.
oversee auditors of public companies.
iv.
perform any of the above functions.
Auditing standards should be looked upon by practitioners as:
i.
ideals to work towards, but which are not achievable.
ii.
maximum standards that denote excellent work.
iii.
minimum standards of performance that must be achieved on each audit
engagement.
iv.
benchmarks to be used on all audits, reviews, and compilations.

Presentation - PCAOB inspections and enforcement

Number of presenters: 1 to 2 students
Expected duration: 25 minutes

Audit Board Finds Flaws By Deloitte; 23 November 2013; The New York Times
The regulator of accounting firms in the United States said on Friday that Deloitte & Touche, for
the second consecutive year, had failed to correct deficiencies in its audit procedures to its
satisfaction. The Public Company Accounting Oversight Board said that in 2009 it told Deloitte
that evidence from the board's inspection of a number of the firm's audits suggested ''that
important issues may exist'' regarding ''the sufficiency of the firm's emphasis on the critical need
to exercise due care and professional skepticism when performing audits.'' It pointed to instances
where the firm had failed to do enough work to check things it was told by management. In the
year after that, the board said, the firm did not fix the problems to its satisfaction.
But, in an indication that Deloitte has since improved, the board allowed Deloitte to say that
criticism in its two subsequent annual reviews, in 2010 and 2011, had been acted upon
satisfactorily. ''We believe the PCAOB's determinations concerning our remediation of the
quality control criticisms'' in the 2009 and 2010 inspection reports ''are reflective of the
significant progress we have made toward the achievement of our audit quality objectives in
more recent years,'' Joe Echevarria, the chief executive of Deloitte, and Greg Weaver, the head of
the firm's audit business, said in a statement. They cited the fact that the most recent board
review had found problems with fewer audits as evidence that ''we are experiencing a positive
trajectory.''
The tone of that statement was in sharp contrast to the one the firm issued in 2009, when the first
part of the report was released. Then, in a statement signed by the firm but not by any individual,
it challenged the board's conclusions on a number of audits, saying Deloitte auditors ''made and
documented well-reasoned and supported judgments during the audit.'' ''In our view,'' the firm
said at the time, ''such reasonable judgments should be inspected and not second-guessed.''
Under the Sarbanes Oxley Act, which established the board in 2002, it inspects top firms each
year and releases a report discussing any deficiencies in the audits it reviewed. But a second part
of the report, concerning broader deficiencies at the firms, is kept secret unless the firm fails to
correct the problems within 12 months. In 2011, Deloitte became the first large firm to suffer
such a rebuke. Since then, PricewaterhouseCoopers and Ernst & Young also had secret reports
released. Of the Big Four, only KPMG has so far not had such a report released.
In another announcement, the board said it had revoked the registrations of two small auditing
firms and permanently barred the men running them from associating with a registered audit firm
after concluding that they had violated laws against securities fraud by issuing audit opinions not
supported by any work the firms did. Cited were Harris F. Rattray C.P.A. of Miramar, Fla., and
its owner with the same name, and Hood & Associates C.P.A.'s, of Tulsa, Okla., and its sole audit
partner, Rick C. Freeman. Registration was also revoked for a third firm, Acquavella, Chiarelli,
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Shuster, Berkower & Company of New York, but it was told it could reapply in two years. An
auditor for that firm, David T. Svoboda, was also barred, but told he could reapply in three years.
They were not charged with fraud.
One of the firms Mr. Svoboda audited, Universal Travel, a company with operations in China,
was subsequently charged with fraud by the Securities and Exchange Commission, which said it
had hidden the way money was siphoned from the company after it sold stock in the United
States. Mr. Svoboda was said to have not done enough work to check on the company's cash
balances, among other things.
Caribbean Pacific Marketing, a company audited by Mr. Rattray, had its SEC registration
revoked on the grounds it had concealed the fact it was controlled by a man who had been barred
by a court from acting as an officer or director of any public company. ''Across these cases is the
type of misconduct that puts investors at risk: false audit reports, failures relating to the detection
of illegal acts, and a lack of independence,'' said Claudius B. Modesti, the board's director of
enforcement and investigations. He added, ''We want to reduce the availability of auditors who
are willing to cut corners.''
The board said it had previously cited fraud in revoking audit firm registrations three times, once
earlier this year and twice in 2009.
PCAOB Dings Ernst & Young and Grant Thornton for Not Fixing Audit Problems,
Michael Cohn, 11 June 2014, Accounting Today
The Public Company Accounting Oversight Board has made public additional portions of a 2010
inspection report on Ernst & Young and 2008 and 2009 inspections of Grant Thornton because
the firms failed to adequately address some of the quality control problems that the PCAOB had
identified within a year, although Grant Thornton claims the problems have since been
addressed.
In the case of EY, the PCAOB said in its expanded report that as of Nov. 30, 2012, the firm had
not addressed certain criticisms in the report to the boards satisfaction. Among the problems
identified were deficiencies in the engagement quality review process. In an inspection of four
audits, PCAOB inspectors found that the partners did not appropriately evaluate significant
judgments and related conclusions, and did not perform reviews at a sufficient level of rigor and
detail. The inspection results also indicated that the firm, in certain instances, relied heavily on
evidence that supported the issuer's conclusion, without sufficiently taking into account new or
contrary evidence that was available at the time. This tendency frequently contributed to the
concerns noted in prior inspection reports related to a lack of professional skepticism and
deficiencies in auditing estimates, said the PCAOB.
In response to the report, Ernst & Young said the performance of quality audits is its number one
priority but admitted that the PCAOB had found its remediation efforts insufficient. We have
taken substantial remedial actions with respect to both matters, including significantly enhancing
our policies and practices in the two areas noted, said the firm. This includes providing our
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audit professionals with new audit tools, additional training and expanded technical guidance.
More broadly, we have also significantly increased the number of partners and staff devoted to
quality-control and quality-improvement measures across our firm. These efforts have been
beneficial generally and continue to improve the quality of the audits we perform. At the same
time, we can and will continue to improve the quality of our auditsboth generally and in the
areas highlighted by the publicly released portions of Part II of our 2010 Inspection Report. Our
commitment to high quality audits extends to all levels of the firm, from our leadership to our
audit teams. EY also sent the following statement to Accounting Today: As a firm, we are fully
committed to delivering high quality audits. We respect and benefit from the PCAOB inspection
process as it assists us in identifying areas where we can continue to improve.
In its report on the 2009 inspection of Grant Thornton, the PCAOB found quality control
problems in testing internal control. The report said the firm relied on information technology
general controls despite deficiencies in the controls and failed to perform sufficient audit
procedures to support its conclusion that certain application controls were operating effectively.
The PCAOB inspectors also identified six engagements with deficiencies in the firms testing of
fair value measurements and impairment determinations. The report on the 2008 inspection
points to problems with the effectiveness of GTs quality controls relating to auditing accounting
estimates, and with the application of sufficient professional skepticism, supervision and review.
The firm said the PCAOB has found that it has since addressed the problems. As they have
done with several global auditing firms, the PCAOB has decided to release portions of Part II of
our 2008 and 2009 inspection reports, Grant Thornton said in a statement emailed to
Accounting Today. The PCAOB has also notified us that they have determined that our
remedial actions related to the 2010 inspection report address the reports criticisms to the
Boards satisfaction. We take all of the PCAOBs findings seriously. Accordingly, we have taken
additional steps subsequent to the issuance of each inspection report to continue to
comprehensively enhance our audit quality in the areas identified by the PCAOB. Grant
Thorntons success is dependent on the quality of the product we deliver and we are committed
to a spirit of continuous quality improvement.
SEC Sanctions Auditor for Violating Lead Partner Rotation Rules, Michael Cohn, 24
October 2014, Accounting Today
The Securities and Exchange Commission has sanctioned a Florida-based auditor for violating
federal laws and regulations that require lead audit partners to periodically rotate off their audit
engagements with a publicly traded company in order to preserve the integrity of the financial
reporting process. The lead partner primarily responsible for the audit of a public company is
prohibited from performing lead audit partner services for the same issuer for more than five
consecutive fiscal years. The SEC found that Elliot Berman of the Boca Raton, Fla.-based firm
Berman & Company, attempted to circumvent this auditor rotation requirement. For the audit of
a company that he conducted for the previous five years, Berman installed as lead audit partner
an employee at his firm who was not a CPA nor otherwise qualified to lead such an audit,
according to the SEC. Berman also improperly continued to perform many of the lead audit
partner functions for that audit. Berman and his firm agreed to settle the SECs charges. Under
the terms of the deal, Berman must pay a $15,000 penalty and is suspended for at least one year
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from practicing as an accountant on behalf of any publicly traded company or other entity
regulated by the SEC.
The case is part of the SECs ongoing Operation Broken Gate, which aims to identify auditors
who disregard their gatekeeper roles in violating professional standards, thereby increasing the
risk of undetected fraud in financial statements that are not being properly audited. When
investors receive an audited financial statement, they have a right to expect that the audit was
performed by a qualified and independent auditor, said Paul Levenson, director of the SECs
Boston Regional Office, in a statement. Berman attempted to subvert the independence rules by
concocting a sham rotation and naming an unqualified employee of the firm to serve as token
lead audit partner while he continued to pull the strings. The SECs investigation was conducted
by Patrick Noone and Marc Jones, and the case was supervised by Kevin Currid with the
assistance of the Public Company Accounting Oversight Board.
PCAOB Sanctions 5 Auditors for Violations, Michael Cohn, 7 April 2015, Accounting
Today
The Public Company Accounting Oversight Board has sanctioned five current and former
partners and employees of the auditing firms L.L. Bradford & Company, LLC in Las Vegas and
Samyn & Martin in Kansas City, Mo., for violating PCAOB requirements for auditor
independence, audit partner rotation, and audit planning and performance. "These orders
reinforce the principle that independence is the bedrock of auditor objectivity," said Claudius B.
Modesti, director of PCAOB Enforcement and Investigations, in a statement last week.
"Investors rely on auditors being independent of their public audit clients in both fact and
appearance."
In one order, the PCAOB found that Dustin M. Lewis and Eric S. Bullinger, while partners at
L.L. Bradford & Company, violated audit partner rotation requirements with respect to the audits
and reviews of six public companies. The board also found that, in violation of PCAOB
standards that require a two-year "cooling off" period, Bullinger served as the engagement
quality reviewer immediately after serving as engagement partner for the audits of two public
companies. The Board further found that, on another audit, Lewis failed to perform his
engagement quality review in accordance with PCAOB standards. The PCAOB censured Lewis,
barred him from associating with a PCAOB-registered public accounting firm, with the right to
petition to remove the bar after two years, and imposed a $10,000 civil money penalty against
him. The Board censured Bullinger and barred him from associating with a PCAOB-registered
public accounting firm, with the right to petition to remove the bar after one year.
In a second order, the PCAOB found that Suzanne M. Herring violated independence
requirements by providing bookkeeping services, financial statement preparation services, and
valuation services to two public company audit clients for which she also served on the audit
engagement teams at Samyn & Martin. In addition, the board found that Herring, while at L.L.
Bradford & Company, directly and substantially contributed to the violation of independence
requirements concerning the provision of prohibited non-audit services with respect to a public
company audit client. The PCAOB censured Herring, barred her from associating with a
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PCAOB-registered public accounting firm, with the right to petition to remove the bar after two
years, and imposed a $5,000 civil money penalty against her.
In a third order, the PCAOB found that Hazel-Leilani De Los Reyes Bradford, while a partner at
L.L. Bradford & Company, directly and substantially contributed to violations of PCAOB quality
control standards related to providing sufficient assurance of compliance with independence
requirements. The board found that Ms. Bradford assumed the role of quality control partner at
the firm despite a lack of public company audit experience and an inadequate knowledge of
PCAOB standards and relevant SEC rules and regulations. The board censured Bradford, barred
her from associating with a PCAOB-registered public accounting firm, with the right to petition
to remove the bar after two years, and imposed a $25,000 civil money penalty against her.
In a fourth order, the PCAOB found that Gordon Brad Beckstead, in his role as engagement
partner on an L.L. Bradford & Company audit of a public company, violated PCAOB standards
in multiple respects. Among other things, he failed to properly plan the audit, appropriately
assess risks, evaluate the qualifications and competence of a specialist, perform sufficient audit
procedures to assess the reasonableness of assumptions used by the specialist, and appropriately
test the company's reported revenue. The board suspended Beckstead from associating with a
PCAOB-registered public accounting firm for one year, and limited the activities that he may
perform in connection with public company audits for one additional year. The PCAOB also
censured Beckstead and required him to complete professional education courses related to
public company audits.
AccountingWeb, PCAOB fines Deloitte $1 million, Dec 11, 2007
Deloitte & Touche has agreed to pay a $1 million penalty to settle accusations by the Public
Company Accounting Oversight Board (PCAOB) that it allowed a partner who had performed
poor audits in the past to conduct the 2003 audit of Ligand Pharmaceuticals, a public company
based in San Diego. Under a provision of the Sarbanes-Oxley Act of 2002, the money will be
used for accounting scholarships. The Deloitte partner, James L. Fazio, signed off on Ligand's
books in 2003, but the company later restated the financial results for this year and other periods
because its revenue recognition policy did not comply with U.S. GAAP, The Wall Street Journal
reports. The restatement increased the company's net loss for 2003 by two and one-half times,
according to the PCAOB report. Ligand had reported aggressive sales of drugs to wholesalers
that had a right to return unsold drugs, but was required to report the sales net of estimated
returns. Ligand "had a history of substantially underestimating such returns," the Journal reports,
and Fazio neither performed nor ensured the performance of procedures that took into account
the company's ability to make reasonable estimates of product returns, the PCAOB report says,
according to Reuters.. "A firm is responsible for its audit reports and the quality of its audits,"
said Claudius B. Modesti, the PCAOB's director for enforcement and investigations, according to
The New York Times. "We think the sanctions reflect the seriousness of the violations."
The PCAOB's report also faulted Fazio for not adequately supervising others and Deloitte for
leaving him on the job when some managers had decided he should resign from the firm, the
Journal reports. Fazio resigned from Deloitte in 2005 and is barred from participating in a public
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company audit for two years. Deloitte neither admitted or denied the accusations of the
oversight board. It said in a statement that it was committed to efforts to improve audit quality
and supported the role of the PCAOB. The firm said that it had implemented changes to its
quality control policies and procedures that directly address the PCAOB's concerns.
The PCAOB's disciplinary action against Deloitte is the first against one of the Big Four
accounting firms. The board's chairman, Mark Olson, told reporters, according to Reuters, that it
was "reasonable to expect that there will be other" enforcement actions against the larger
auditors, since they are responsible for a large percentage of public company audits.
AccountingWeb, PCAOB levies $2 million fine against Deloitte for violation, Oct 23 2013
Deloitte & Touche LLP was fined $2 million by the Public Company Accounting Oversight
Board (PCAOB) on October 22 for permitting a former partner to perform activities as an
"associated person" that were prohibited while he was subject to a PCAOB suspension order. The
Big Four firm was penalized for violating the Sarbanes-Oxley Act (SOX) and PCAOB rules for
allowing Christopher Anderson, CPA, to continue activities related to preparing and issuing
public company audit reports after he was suspended for one year by the PCAOB on October 31,
2008.
According to PCAOB Release No. 105-2013-008, Order Making Findings and Imposing
Sanctions in the Matter of Deloitte & Touche LLP, Respondent, Anderson was issued the
suspension order for violating PCAOB rules and auditing standards while he served as an
engagement partner for Deloitte's audit of Navistar Financial Corporation's fiscal year 2003
financial statements. The PCAOB suspension order prohibited Anderson from being an
"associated person of a registered public accounting firm."
On Tuesday, the PCAOB also ordered Deloitte to undertake certain remedial actions to ensure
that similar violations do not occur in the future. The firm consented to the entry of the order
without admitting or denying the board's findings. "When the board suspends an auditor, it does
so to protect investors," PCAOB Chairman James Doty said in a written statement. "Deloitte
permitted the former partner to conduct work precluded by the board's order and put investors at
risk."
The $2 million penalty against the firm equals the PCAOB's single-largest civil money penalty,
which the board previously imposed in another disciplinary matter. "Considering the magnitude
of the penalty, firms should recognize the importance of abiding by the limitations imposed on a
PCAOB-suspended auditor," Doty said. The PCAOB found that, in anticipation of the
suspension, Anderson was made a salaried director and transferred to an audit group in Deloitte's
national office. After his transfer, Deloitte permitted the suspended auditor to become or remain
an associated person by engaging in activities in connection with public company audits, such as
developing firm-wide policies and audit guidance as well as participating in three national office
consultations with public company audit engagement teams.
The PCAOB explained that Deloitte knew of the suspension order but permitted these activities
to take place without the consent of the board or the US Securities and Exchange Commission.
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"[SOX] and the board's rules specifically prohibit registered firms from allowing suspended or
barred auditors from participating in the firm's issuer audit practice," Claudius Modesti, director
of the PCAOB Division of Enforcement and Investigations, said in a written statement. "For
investors to receive the benefit of those legal protections, all registered firms must take sufficient
steps to ensure that suspended or barred auditors adhere to that requirement. As the PCAOB
order demonstrates, failing to take such steps will result in the imposition of significant
standards."
In an e-mailed statement to AccountingWEB on October 23, Deloitte said it is pleased to have
been able to resolve this matter with the PCAOB. "As acknowledged in the PCAOB's order, in
response to the 2008 one-year suspension of one of our professionals, Deloitte took several
significant actions to restrict the deployment of this individual," the statement said. "However,
we recognize more could have been done at that time to monitor compliance with the restrictions
we put in place. The robust policies and monitoring procedures we have since instituted fully
address the issue and will prevent a similar matter from arising in the future."
Suggested Questions
1. What kinds of quality control deficiencies were disclosed in the second parts of the
inspection reports issued to the Big 4 audit firms?
(NB: you can obtain the inspection reports from the PCAOB website:
http://pcaobus.org/Inspections/Reports/Pages/default.aspx).
2. Do you consider that audit firms quality control deficiencies should be kept secret unless
an audit firm fails to correct the deficiencies within 12 months?
3. The news articles refer to instances where auditors have been sanctioned by the PCAOB.
Why were the auditors sanctioned? Do you consider that the penalties were merited? Do
you think the penalties are sufficient to deter future infringements by other auditors?