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Chapter 1 Management’s Assertions When auditing the completeness, existence and valuation assertions for deferred revenue, the sample of.

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Presentation on theme: "Chapter 1 Management’s Assertions When auditing the completeness, existence and valuation assertions for deferred revenue, the sample of."— Presentation transcript:

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8 Chapter 1 Management’s Assertions

9 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

10 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 , 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.

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12 Chapter 2 Generally Accepted Auditing Standards GAAS Auditing Standards of the Public Companies Oversight Board Auditing Standards of the PCAOB

13 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, PCAOB RELEASE NO Chapter 2 GAAS

14 In this audit, the Firm failed in several respects to obtain sufficient competent evidential matter to support its audit opinion – PCAOB RELEASE NO Chapter 2 GAAS

15 . the Firm failed in several respects to obtain sufficient competent evidential matter to support its audit opinion – PCAOB RELEASE NO Chapter 2 GAAS

16 the Firm failed in several respects to obtain sufficient competent evidential matter to support its audit opinion – PCAOB RELEASE NO Chapter 2 GAAS

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18 Chapter 12 Reports on audited Financial Statements

19 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 12- month trailing revenue covenant, for the first quarter of 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. PCAOB RELEASE NO Chapter 12 Reports

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21 Chapter 5 Internal Control Evaluation

22 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, PCAOB RELEASE NO Chapter 5 Internal control evaluation

23 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. PCAOB RELEASE NO Chapter 5 Internal control evaluation

24 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. PCAOB RELEASE NO Chapter 5 Internal control evaluation

25 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. PCAOB RELEASE NO Chapter 5 Internal control evaluation

26 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: PCAOB RELEASE NO Chapter 5 Internal control evaluation

27 The Firm relied on information technology ("IT") application controls that had not been tested for several years. PCAOB RELEASE NO Chapter 5 Internal control evaluation

28 The Firm relied on IT system-generated data without testing the IT general computer and/or application controls. PCAOB RELEASE NO Chapter 5 Internal control evaluation

29 ... 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. PCAOB RELEASE NO Chapter 5 Internal control evaluation

30 The Firm assessed control risk as "high" for expenses, but....., failed to perform sufficient substantive procedures on expense balances. PCAOB RELEASE NO Chapter 3 audit risk model

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32 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:. PCAOB RELEASE NO Chapter 4 work paper documentation

33 Chapter 11 Completing the Audit

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35 PCAOB RELEASE NO Chapter 11 – completing the audit 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.

36 PCAOB RELEASE NO Chapter 11 – completing the audit 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.

37 PCAOB RELEASE NO Chapter 11 – completing the audit 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.

38 PCAOB RELEASE NO Chapter 11 – completing the audit ….. 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.

39 PCAOB RELEASE NO Chapter 11 – completing the audit …, 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 ….

40 PCAOB RELEASE NO Chapter 11 – completing the audit …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)

41 PCAOB RELEASE NO Chapter 11 – completing the audit.. 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.

42 PCAOB RELEASE NO Chapter 11 – completing the audit 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,

43 PCAOB RELEASE NO Chapter 11 – completing the audit 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 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/


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