The Professional Judgment in Context scenario at the beginning of the chapter introduced excerpts from the PCAOB inspection of Deloitte & Touche, LLP. The scenario is:
On May 4, 2010, the PCAOB issued its public inspection of
Deloitte & Touche, LLP covering their inspection of audits conducted during 2009. In their summary comments regarding the inspection, the PCAOB inspectors stated:
In some cases, the conclusion that the Firm failed to perform a procedure may be based on the absence of documentation and the absence of persuasive other evidence, even if the Firm claims to have performed the procedure. PCAOB Auditing Standard No. 3, Audit Documentation ("AS No. 3") provides that, in various circumstances including PCAOB inspections, a firm that has not adequately documented that it performed a procedure, obtained evidence, or reached an appropriate conclusion must demonstrate with persuasive other evidence that it did so, and that oral assertions and explanations alone do not constitute persuasive other evidence. (p. 3)
The report went on to say:
In some cases, the deficiencies identified were of such significance that it appeared to the inspection team that the Firm, at the time it issued its audit report, had not obtained sufficient competent evidential matter to support its opinion on the issuer's financial statements or internal control over financial reporting ("ICFR").
It is reasonable to ask, What is the nature of these deficiencies, could this criticism happen to me, and why didn't the firm reviewing partners detect the deficiencies? In order to understand how to answer these questions, the following excerpts describe the nature of deficiencies found on individual audits:
In this audit, the Firm failed in the following respects to obtain sufficient competent evidential matter to support its audit opinion-
• The Firm failed to perform adequate audit procedures to test the valuation of the issuer's inventory and investments in joint ventures (the primary assets of which were inventory). Specifically, the Firm:
o Failed to re-evaluate, in light of a significant downturn in the issuer's industry and the general deterioration in economic conditions, whether the issuer's assumption, which it had also used in prior years, that certain inventory required no review for impairment was still applicable in the year under audit;
o Excluded from its impairment testing a significant portion of the inventory that may have been impaired, because the Firm selected inventory items for testing from those for which the issuer already had recorded impairment charges;
o Failed to evaluate the reasonableness of certain of the significant assumptions that the issuer used in determining the fair value estimates of inventory and investments in joint ventures;
o Failed to obtain support for certain of the significant assumptions that the Firm used when developing an independent estimate of the fair value of one category of inventory; and
o Failed to test items in a significant category of inventory, which consisted of all items with book values per item below a Firmspecified amount that was over 70 percent of the Firm's planning materiality.
• The Firm failed to perform adequate audit procedures to evaluate the issuer's assertion that losses related to the issuer's guarantees of certain joint venture obligations were not probable, because the Firm's procedures were limited to inquiry of management. Discuss in your small group the following requirements:
a. What is the auditor's responsibility to consider information outside of the client's records and processing to develop sufficient and appropriate audit evidence?
b. Why are the items identified above by the PCAOB considered "critical mistakes" in performing an audit? What is the critical error of omission by the auditing firm and why would the specific problem lead to a deficiency in sufficient appropriate evidence?
c. Why is "inquiry of management" not considered "sufficient information" by itself?
d. Assumptions are assumptions! What is the auditor's responsibility regarding the questioning of the assumptions used by the client? In formulating your response, keep in mind that the client will claim that assumptions are just assumptions and it is difficult to say that one is more correct than another.
e. The chapter talked about the tension between controlling audit costs and managing audit risks at the same time. Explain how the pressures to keep the audit within a time budget might have led to some of the deficiencies noted above by the PCAOB.
f. Presumably Deloitte used a standardized audit program. How could a standardized audit program lead to some of the problems identified above, e.g., failing to test a category of inventory that had book value in excess of 70% of the firm's planning materiality, or limiting the testing of impairment to inventory that had already been assessed as impaired by management?