During the audit of Pall Corp., KPMG found a material misstatement related to the client's estimate of income tax expense and the accrued liability. The misstatement had accumulated over a number of years and was found during the auditor's preliminary work. The client was notably upset and terminated a number of staff personnel who were associated with the income tax accrual and hired new personnel who were more competent. There was not enough evidence available for the auditor to determine whether or not the misstatement was intentional-even though it helped the company meet analysts' earnings expectations. As a result, the client had to restate its past financial statements.
Required
a. Does a restatement of financial statements always imply that there was a material weakness in internal controls? Explain.
b. Given the findings in the Pall case as described above:
• Is there sufficient evidence that the client has remediated the weakness in sufficient time to avoid an adverse report on internal control?
• What evidence would the auditor attempt to gather to determine if the misstatement was intentional? What role does professional skepticism play in this setting?
• What would be the audit requirements if the misstatement were intentional?
c. Assume the following scenario. The auditor normally finds numerous errors in the income tax accrual, so the auditor plans to spend more time on the accrual and the client has agreed this makes sense. The auditor then adjusts the accrual to the correct amount.
• Does this approach violate the auditor's code of ethics or the standard on audit independence? Explain your answer.
• Does the client have a significant deficiency or a material weakness given that the client and the auditor have agreed to the approach? Explain.